SHAW & MARTIN

ATTORNEYS

A BUSINESS AND FAMILY PRACTICE LAW FIRM

WHEN YOUR CUSTOMER FILES BANKRUPTCY

© August 1998

By

Robert E. Shaw

When the inevitable Notice of Bankruptcy arrives from the Bankruptcy Clerk’s office all is not lost. Here are five measures that may enable the small business creditor to lessen the financial impact of a customer’s bankruptcy.

1. STOP ALL COLLECTION EFFORTS.

The "Automatic Stay" arises as soon as a bankruptcy Petition is filed in the office of the Clerk of the Bankruptcy Court. The automatic stay prohibits creditors from seizing the debtor’s property or taking or continuing any action against the debtor to collect a debt. Bankruptcy Court permission (relief from stay) must be obtained before a creditor can repossess collateral or make any attempt to collect a debt that existed before the bankruptcy filing.

Financial consequences for violating the automatic stay can be severe. Bankruptcy Code §362(h) provides that an individual injured by a willful violation of the stay "shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages."

As soon as notice of a bankruptcy filing is received (it could be through a telephone call from the debtor’s attorney before the official notice arrives by mail) all verbal and written communication with that customer about existing debts should immediately cease. If an account has been referred to counsel for collection that attorney should be called so that all litigation and other enforcement efforts may be suspended.

2. ORDER A COPY OF THE PETITION AND SCHEDULES.

The Bankruptcy Clerk’s office for the Southern District of Illinois provides instructions on the reverse side of the Notice of Bankruptcy for ordering copies of the debtor’s Petition and Schedules. Included with the Petition and Schedules will be the debtor’s Statement of Financial Affairs. This is a detailed questionnaire covering the debtor’s business and financial transactions in the two years preceding bankruptcy. A careful analysis of the Schedules and the Statement of Financial Affairs is needed to determine, among other things, whether debts are disputed, whether other creditors may have received preferential transfers and whether grounds may exist to object to the debtor’s discharge (see ¶5 below).

3. FILE PROOF OF CLAIM WHEN AUTHORIZED.

The great majority of bankruptcy filings are Chapter 7 no asset cases. The Notice of Bankruptcy will state in the top margin whether or not it is a no asset case, and if it is the words "Please Do Not File A Proof Of Claim Unless You Receive A Notice To Do So" will appear near the bottom. In all other cases the Notice of Bankruptcy will either give a deadline for filing proof of claim or state that a deadline will be given later. It is essential to file proof of claim in the Bankruptcy Clerk’s office within the time allowed in order for unsecured creditors to share in dividends or plan payments. Copies of invoices or other evidence of the debt should be attached to the proof of claim, and copies of the proof of claim with attachments should be sent to the Bankruptcy Trustee and the debtor’s attorney. (A POC form can be downloaded from the court’s web site: http://home.stlnet.com/~usbcsdil.)

4. GET A REAFFIRMATION AGREEMENT.

If the debt is secured by tangible personal property an individual Chapter 7 debtor in the Seventh Circuit (which includes the Southern District of Illinois) has four choices. He or she can return the collateral to the creditor (surrender), he can pay the creditor in cash the value of the collateral and keep it (redemption), or he can keep the collateral and pay the creditor the full amount due on the debt according to terms agreed upon by the parties (reaffirmation). Conversion to Chapter 13 and retention of the collateral pursuant to a Confirmed Plan would be the fourth alternative.

The Chapter 7 debtor is required to choose one of the first three options in the Individual Debtor’s Statement of Intention filed with the Petition. For either of the first two options no additional paperwork is required once the creditor has proven to the trustee’s satisfaction the validity and priority of the secured claim and the value of the collateral. Often the surrender or redemption can be coordinated with the trustee and the debtor’s attorney at the first creditors meeting.

If the debtor takes the third option to reaffirm the debt rather than to redeem or surrender the collateral, then a Reaffirmation Agreement must be signed by both the debtor and the creditor and filed with the court. Reaffirmation Agreements require strict adherence to the terms of Code §§524(c) and 524(d) to be enforceable, but when properly drafted they enable the creditor to hold the debtor liable for the entire debt upon default, including any deficiency after sale of the collateral, just as if no bankruptcy had occurred.

A Reaffirmation Agreement must be filed before the date given in the Notice of Bankruptcy as the "Deadline to File a Complaint Objecting to Discharge of the Debtor or to Determine Dischargeability of Certain Debts." Unless extended by the court, that deadline will be sixty days from the date of the first meeting of creditors.

5. OBJECT TO DISCHARGE.

It sometimes happens that a debtor has supplied a false financial statement, such as by overstating assets and/or understating debts, in applying for credit or a loan; or he or she may have disposed of collateral or other property of the estate with intent to hinder, delay or defraud a creditor. If a review of the debtor’s schedules and statement of affairs suggests the likelihood of such an occurrence a creditor may wish to exercise his right under Bankruptcy Rule 2004 to examine the debtor under oath with regard to his or her assets and debts and any other matter which may affect the debtor’s right to a discharge. If the results of that examination reveal sufficient cause then a complaint objecting to the debtor’s discharge (Code §727) or requesting that a particular debt be excepted from discharge (Code §523) will need to be filed before the deadline given in the Notice of Bankruptcy.

There is some risk to the creditor in objecting to the discharge of a consumer debt since the court may award attorneys’ fees against a creditor if the creditor’s challenge to discharge " was not substantially justified." Code §523(d). But where a well founded objection can be made it may provide the leverage to negotiate a settlement that will avoid a total write off in a no asset case.