On March 23, 2010, the U.S. Supreme Court issued a 9 – 0 opinion in United Student Aid Funds, v. Espinosa  (08-1134) in which the Court affirmed the 9th Circuit’s holding that a chapter 13 debtor can obtain a discharge of a student loan by including it in a chapter 13 plan, if the creditor fails to object after notice and opportunity to do so, and the BK court enters an order confirming the chapter 13 plan. In bankruptcy, a student loan is not discharged unless the bankruptcy court makes a determination that excepting the student loan would be an undue hardship on the debtor. Under Bankruptcy Rules, the court is required to make such a determination in an adversary proceeding — a lawsuit within the bankruptcy case. In Espinosa, the debtor did not bring an adversary proceeding. Rather, the debtor put in his plan that only the principal amount of the loan would be paid through the plan, but that accrued interest would be discharged. The student loan lender did receive a copy of the plan, and even filed a Proof of Claim. But, the lender did not object to confirmation.

The court did, subsequently, enter an order confirming the plan as proposed. After confirmation, the chapter 13 trustee sent a notice to the lender, saying that the Proof of Claim amount differed from the amount stated in the chapter 13 plan, and that if the lender disputes the amount in the plan, they should notify the trustee within 30 days. After the debtor completed his plan payment, the student loan lender tried to collect the remaining amount due. The debtor filed a motion seeking enforcement of his bankruptcy discharge.

The lender filed a motion seeking to declare the order confirming the chapter 13 plan void — which was the issue before the Supreme Court. That is, the student loan lender argued that the BK Court order confirming the chapter 13 plan void because they (the lender) was denied due process regarding the required statutory finding of undue hardship, which did not happen here.

The Supreme Court, in looking only at Bankruptcy Rule 60(b)(4), which permits a court to relieve a party for a final order or judgment, found that the lender was not denied due process, since the lender did receive the plan, filed a claim, and received the notice from the chapter 13 trustee. The Court agreed that the confirmation of the plan without an undue hardship determination was legal error, legal error does not void the order. The Court noted that Rule 60(b)(4) strikes a balance between the need for finality of judgments, and the right of parties to have a full and fair opportunity to raise issues.

The lesson to be learned — creditors should indeed carefully review proposed chapter 13 plans, and raise objections to disputed issues before a plan is confirmed.

We have been discussing preferential payments, defenses and avoidance tactics.  But what businesses care about most is getting paid for goods and services provided. This entry will discuss how to collect from a customer who has declared bankruptcy.   

After I send back the preferential payment, how do I get paid for the original goods/services?

To obtain any kind of recovery on a debt from a debtor who has filed for bankruptcy protection, you must file a document called a “Proof of Claim,”  which summarizes the amount of debt and its priority.  Often, your debt will be listed in the bankruptcy filing, and you will be sent a Proof of Claim by the Bankruptcy Court.  You don’t necessarily need a lawyer to fill out the Proof of Claim form, but you probably should consult an attorney if you receive a preference demand letter.   Attach to the Proof of Claim a copy of the invoice or contract that forms the basis of your claim, or a summary of the elements that make up the claim.  The Proof of Claim is then filed with the Court, or sent to a claims agent if the case is a big, publicly traded company like Circuit City or LandAmerica. 

After I file my Proof of Claim, when will I get paid, and how much will I get paid?

When you get paid, and how much you get paid, depends on several factors, including which chapter the debtor has filed (7, 11 or 13), and how much there is available to pay creditors.  In a chapter 7, for example, a trustee sells all of the assets of the bankrupt company, and then distributes what is left after costs of liquidation to the creditors.  If there are a lot of things to be sold by the trustee, it will take a long time before funds are distributed to creditors.  In a chapter 13, distributions to creditors generally happen more quickly.  In large, Chapter 11 cases, the Chapter 11 Plan must first be confirmed – a process that can take many months.

We previously dissussed what preferences are and some common defenses.  Many small businesses may be wondering if there is any way to get your money, but avoid claims of preferential payment.   Unfortunately, there is no absolute, “slam dunk” way to avoid a bankruptcy preference claim risk. In general, however, the two best business strategies to protect your company in these economic times are to have a written collections policy that is strictly followed for every customer, and to watch your receivables closely.  If a customer starts lagging — getting behind the “normal” or historical payment history — then that should be a red flag, and the best advice is to put that company on a cash basis.  If you “tighten” the payment terms (net 15 instead of net 30 or increase the interest on late payments), the Bankruptcy Court may interpret this as a “change” of the payment terms, and you might lose the “ordinary course of business” defense.  A cash basis, however, might be subject to the “contemporaneous exchange” defense, as the goods or services are being exchanged for payment at the same time.   

Another situation that might reduce the amount of repayment is to provide “subsequent new value”  to the debtor.  It is like a set off.  If you receive a preference demand that is not subject to any defenses, but after (subsequent to) the payment they seek back, your company sent more goods or provided more services to the debtor, and has not yet been paid for those subsequent goods/services, then you can reduce the preference liability exposure by the amount of subsequent unpaid goods/services. 

Although this does reduce the preference liability, companies don’t like to be in this position, because they are not getting paid full value for any of the goods/services provided. 

One final tactic may be to demand alternative sources of recovery for you, such as co-borrowers, or guarantors of the debt. A good creditors’ rights attorney can properly identify which of these strategies may be useful in your particular situation.

Yesterday we discussed preferential payments – payments made to an insolvent company within 90 days of the bankruptcy filing.  To more equitable or fairly divide the limited assets among the creditors, these payments must be returned to the debtor.  Your first question upon receiving a preference demand letter is likely to be:  Do I have to give the money back?

 Although the Bankruptcy Code gives the power to recover these preferential transfers, your business may have certain defenses to defeat, or at least lessen, your exposure. 

These defenses include:
• The debtor was not insolvent when it paid you;
• payments made in the ordinary course of business;
• contemporaneous exchange for new value;
• payments made outside of the 90 day preference period (so long as you are not an insider);
• payments made via C.O.D. 

 Whether a defense applies is a very fact-specific determination made after detailed review of the account information and history between the debtor and creditor.  Unfortunately, it is becoming common for Trustees or debtors in possession to sue everyone receiving payment 90 days prior to the bankruptcy filing, and to sort out the merits of each claim later.  In practicality, this often results in unknowing creditors sending back non-preferential payments or creditors deciding it is too much trouble to defend a preference claim and not asserting valid defenses.

This area of law is not only very fact-specific, but very technical and procedural.  We strongly advise consulting a bankruptcy attorney to assist in minimizing your risk and maximizing your recovery.