CARES ACT INCREASES BANKRUPTCY OPTIONS FOR SMALL BUSINESSES IN FINANCIAL DIFFICULTY
April 9, 2020
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Despite the President’s signing of the stimulus bill, it is anticipated that bankruptcy filings still will increase, particularly in middle and small markets. Creditors who prepare in anticipation of those filings will usually find themselves in much better position to those who first react only after the bankruptcies begin. These preparations are important to establish leverage with the debtor and the other creditors which can improve the creditor’s treatment in the case. Proper preparation should include not just knowledge of the debtor’s financial condition but also how the bankruptcy process works in the early days of the case.
The automatic stay is effective upon the filing of the bankruptcy petition. It prevents any action against the debtor or property of the estate to collect a pre-petition debt or claim, to enforce a judgment, to perfect a lien against property of the estate, to obtain possession of property of the estate, or to exercise a right of setoff. The automatic stay will allow a creditor to file, but will not enforce certain liens that, if timely perfected, are superior to a trustee. These include the perfection (but not enforcement) of a mechanic’s lien or certain purchase money security interests.
In a bankruptcy, a new post-petition lender may, under appropriate circumstances, prime a prior creditor’s pre-petition liens and security interests. However, the pre-petition creditor’s interests must be adequately protected which may include periodic payments, an additional or replacement lien, administrative expense priority, or such other relief that constitutes the indubitable equivalent of the creditor’s interest. Additionally, also in accordance with the Bankruptcy Code, professionals employed by the estate may seek compensation from the pre-petition creditor for post-petition services primarily benefiting the pre-petition Creditor or enhancing its collateral. Finally, applicable non-bankruptcy law is often relied upon to prime a pre-petition secured creditor. Examples are state law mechanic’s liens and other state liens available to the debtor’s employees for unpaid pre-petition wages and employment benefits.
Proofs of claim
The filing of a proof of claim is necessary in chapter 7 liquidation cases to preserve a creditor’s rights to distribution. In chapter 11 reorganization cases, if the creditor’s claim is listed as undisputed and in the correct amount, it is not necessary for the creditor to file a proof of claim. However, unless the creditor has concerns about subjecting itself to jurisdiction of the bankruptcy court where the case is pending and, in most instances, the loss of the right to a jury trial, it is advisable for any creditor who seeks payment to file a proof of claim in the bankruptcy case. The filing of a proof of claim is simple and inexpensive and will allow the creditor to maximize its chance of a distribution in the bankruptcy case.
Cash collateral is defined by the Bankruptcy Code to include cash, negotiable instruments, documents of title, securities, deposit accounts, and other cash equivalents in which the estate and an entity other than the estate (e.g., a Creditor) have an interest. The term cash collateral includes proceeds, rent and virtually all other cash assets. The debtor may use cash collateral only with the consent of the creditor who has an interest in the cash collateral or upon order of the bankruptcy court. The bankruptcy court, after notice and a hearing, may authorize the use, sale or lease of cash collateral. Usually, the court will condition the debtor’s use of cash collateral upon providing the creditor with adequate protection. The bankruptcy court also may determine that adequate protection is not required because of the creditor’s equity cushion in the collateral.
If a creditor faces any avoidance actions or holds secured claims that require protection and enforcement, a lawyer should be consulted. In addition, many chapter 11 cases involve complex legal maneuvers, which may require consultation with an attorney to clarify. Most appearances in the bankruptcy court, including any contested matter or adversary proceeding, will require the use of an attorney.
Underwood Perkins is ready to assist creditors in navigating bankruptcy minefields and preserving their interests during this volatile period.