What do you need to know if you are a creditor of an entity that is financially distressed or has filed bankruptcy? Below are answers to some of the most commonly asked questions related to bankruptcy.

What Is The Automatic Stay?

The filing of a bankruptcy case automatically “stays” a wide-range of actions against the debtor. This stay prevents creditors from, among other things, collecting debts and terminating contracts. Although there are certain exceptions, the scope of the stay is very broad, and creditors must request permission from the bankruptcy court before taking any action against a debtor or its property. Liability for violating the stay can be costly. It is very important to seek advice about how to deal with a financially distressed party and how to proceed upon the first threat of a bankruptcy filing.

What Rights Do I Have If Goods Were Recently Supplied To A Customer That Has Filed Bankruptcy?

Creditors who supply goods to a debtor within 20 days of the filing of a bankruptcy case may be entitled to certain priority payment rights, provided such rights are timely claimed. State law reclamation rights may also exist, but such rights are subject to certain limitations that must be affirmatively asserted very early in the bankruptcy case. An agreement to have the debtor return goods shipped to it prior to the bankruptcy filing may also be made in the early stages of a case, provided that the agreement is approved by the bankruptcy court. Seeking advice early is important to protecting and preserving these rights.

What Impact Does Bankruptcy Have On Contracts And Leases With The Debtor?

Generally, all parties to “executory” contracts and unexpired leases, including supply and service contracts, license agreements, real property leases and equipment leases, must initially continue to perform after the filing of a bankruptcy petition. Bankruptcy, however, significantly affects the treatment of contracts and leases. For instance, debtors are allowed to “reject” or repudiate executory contracts and unexpired leases. Proper risk management requires that you understand your rights regarding contracts with a financially distressed party prior to a bankruptcy filing. If bankruptcy is filed, you can minimize your exposure by seeking advise about your rights early in the case.

Will I Be Required To Return Money That I Have Received From A Debtor?

Transfers made by a debtor to creditors within 90 days prior to the filing of a bankruptcy petition, including payments on debt and the granting or perfection of certain security interests, generally are “preferential” and may have to be returned. Several exceptions and defenses exist, including defenses for payments made and received in the ordinary course of business, and for payments that are made after the extension of “new value.” Best practice is to timely collect debts in accordance with all relevant contracts. When a customer is slow to pay, continue to press for and collect payments, but beware that money may need to be returned if bankruptcy is filed shortly after payment.

May I Set Off Debts That I Owe To The Debtor Against Debts Owed To Me?

Bankruptcy generally does not affect the right to offset a debt owing by a creditor to the debtor that arose prior to the bankruptcy filing against a claim that the creditor has against the debtor as of the bankruptcy filing. Furthermore, to protect setoff rights, a creditor may impose an “administrative freeze” and temporarily withhold payment of a debt that it owes to a debtor. To avoid violating bankruptcy law, however, seek assistance when imposing a freeze, and be aware that bankruptcy court permission normally must be obtained before any setoff actually is effected. Note also that some setoffs made within 90 days prior to the filing of a bankruptcy case may be deemed “preferential” and may undone.

Do I Need To File A Claim In The Bankruptcy Case To Recover Money?

Generally, claims against a debtor for monies owed must be affirmatively asserted in the bankruptcy case within a set period of time or they are forever barred. You should seek advice on how to prepare and file your claim because, although most claims are paid on a pro rata basis with all other creditors, some types of claims are entitled to priority of payment. Furthermore, by obtaining assistance in preparing your claim, you will avoid waiving rights regarding the amount of your claim and your rights to assert certain types of claims. Finally, properly categorizing and documenting your claim from the outset will avoid litigation costs in the bankruptcy case.