Thursday, February 17, 2005

Bankruptcy: License to Steal

In last weeks Members Newsletter, Marie Leone writes “Courts and Torts: Bankruptcy’s Perks” where she describes a company that is recovering from 9/11 and suddenly gets hit with a suit to return a $30,000 payment they received (and were due) from a company that had recently filed bankruptcy. ( )

Companies that file bankruptcy can claim a ‘preference’ on payments made to creditors for 90 days prior to bankruptcy. Preference is an interpretation by bankruptcy attorney’s that the payment made by the company was not in the normal course of business and can be recovered by the bankrupt company and sometimes the interpretation is pretty loose.

Fight the preference! You have as much right to prove that the payment was in the normal course of business as the other side has of trying to collect it back. In the particular case noted, where the debt owed was $60,000 and the payment was $30,000 it is hardly a preference. If the entire debt was paid that might be seen differently, but to pay down half should not be. Also the days the $30K was outstanding (longer than normal payment terms) means a lot to the court.

In a previous life I was appointed as DIP (debtor in possession) of several bankruptcies by court appointed trustees. The first one was my own company which I had walked away from as a rogue management tried to take over. That walk away and my previous business practices left my integrity enough in tact that the unsecured creditors agreed to appoint me as DIP. In that case the unsecured recovered more than $0.60 on the dollar by the time I was finished.

Due to that outcome, trustees began to call on me to come in and assess companies that filed bankruptcy and determine if they had a viable chance of recovery or they should be immediately closed and liquidated.

The bankruptcy process is a license to steal if you know what you are doing and that is your intent. Don’t get me wrong, the process is a good one for the right reasons, but it is not so difficult to run in to the wrong reasons.

The court and the trustees are really on the side of the unsecured creditors and will lean toward them heavily in most cases as they should. The problem is that the judge and the trustee can only argue and rule on what they know. If they are not fully informed as to what is going on much can go on that will bleed the already comatose business dry.

If you are an unsecured creditor like the CEO of the company noted in the article, you should immediately get on the unsecured creditors committee. You should have someone review the ‘cash collateral’ agreements that are put before the judge. Those agreements are weekly or monthly requests for the DIP to use the cash of the company to continue working. In those details can be found many items that add no value and should be excluded leaving more cash in the coffers.

Remember that bankrupt companies still have accounts receivable to collect and preferences to draw in and other operations to generate cash. What happens most of the time is the DIP keeps drawing the cash and keeps paying some salaries and some bills until all is gone and the unsecureds get nothing. That happens usually under the guise of generating a plan to save the company which burns too much time and all the cash.

My first experience with the ‘license to steal’ was when a DIP who was a former two time US Congressman used cash collateral agreements as a jobs program for his friends while selling off assets of the company (computers, equipment, furniture etc) out the back door for additional cash (something that is illegal in bankruptcy). All the while supposedly building a business plan and raising money to save the business and make everyone happy.

It was thievery of the worst kind and because the judge did not know and the trustee did not know and in the proceedings there was no one of standing in the case who knew the details that could put them before the court. Hundreds of thousands of dollars that unsecured creditors owned were squandered and nothing was done about it.

The cash of the business in bankruptcy belongs to the unsecured creditors and any of it that is misspent is theft pure and simple.

If you are an unsecured creditor, and the bankrupt company wants to try work through and come out of bankruptcy, have a consultant review the company quickly and give you an alternative opinion of its chances. If there is no clear view of what the plan is or where it is going in 4 to 6 weeks, push the trustee to remove the DIP and liquidate. DON’T WAIT. Every day some of your money is being spent!

For small businesses, the chance of pulling out of a bankruptcy is slim and none. There are a very few that make it. For medium sized businesses a few more make it, but again very few. For large businesses who can get financing there is much more opportunity to make it, but if you’re a creditor get involved. Shrink the timeline for the plan. Question the cash collateral agreements. Be an activist. Its your only chance on getting some of what you are rightfully owed.

I have made no comments about secured creditors who usually spend the most on lawyers to attend the proceedings and keep their interests protected. Keep in mind if you are unsecured, the secured creditors are not on the same team you are! They prefer liquidation and they can get their assets back (usually buildings and major equipment). They usually are not interested in what happens to cash and other asset items that are not owned by them and they are not usually confrontational with the bankruptcy representative (of the company) unless its about their assets.

I applaud CFO for giving some warning about preference payments and suits to recover them. Hopefully this post will give you some “how to” about protecting what you are owed or have already been paid.



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