Creditor preparation for a debtor’s bankruptcy filing

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.

Assess the debtor’s financial condition and the creditor’s potential risk

A creditor and its counsel should thoroughly evaluate the debtor’s financial circumstances, including its cash flow, balance sheet (including contingent liabilities) liens, tax and other governmental obligations. The creditor should also assess its recovery alternatives and develop a realistic exit strategy prior to the bankruptcy filing. This requires not only hard work, but also a recognition that the creditor’s pre-petition leverage changes significantly once a bankruptcy is filed and the automatic stay becomes effective. Since the first creditors to reach post-petition accommodations with the debtor may receive more favorable treatment than creditors who delay, advance preparation and early intervention in the case are critical. Upon any hint that bankruptcy may be forthcoming, the creditor should immediately assemble all pertinent contract or loan and security documentation, including updating all UCC-1 searches. Additionally, the creditor’s counsel should be supplied with copies of the debtor’s contract and payment histories and other relevant contract file information. Thereafter, the creditor should confer with counsel as soon as possible to develop a case strategy and discuss whether ultimate recovery expectations are realistic. The key is to be the first in line, not the last.

Become Familiar with How the Bankruptcy Filing Affects a Creditor’s Rights and Remedies

A creditor should also be familiar with how a bankruptcy case in its early stages may affect its rights and remedies. Below are a few examples:

Automatic stay

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.

Priming liens

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

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.

Retaining counsel

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.


If you have questions regarding this article or any other matter concerning bankruptcy and creditors’ rights, please email David Campbell, head of our Bankruptcy section at

Underwood Perkins, P.C. (972) 661-5114