Financial and economic challenges due to the pandemic have resulted in a growing number of bankruptcy filings for both individuals and businesses. A number of creditors’ rights challenges arise when a business or individual whom you transact with files for bankruptcy.

Here are examples of several scenarios currently impacting landlords, tenants, and business owners and the basics that you should know when faced with such a scenario. Remember, however, that every bankruptcy is different, and it is important to review the bankruptcy law and possibly consult an attorney to advise on the nuances of the case and your rights.

1. My commercial tenant has filed for bankruptcy. What happens now?

If your tenant has filed for bankruptcy, as an initial matter, be aware that a bankruptcy filing imposes an automatic stay on any collection of debt. Violation of the automatic stay can lead to serious consequences, so do not reach out to the tenant to demand rent be paid or threaten eviction. You must go through the bankruptcy process.

After a bankruptcy filing, the debtor is permitted to occupy the commercial property and is allowed at least 60 days (depending on the chapter of bankruptcy and subject to extension by court order) to decide whether to assume the lease and continue to occupy the premises or assign the lease to a third party.

If a debtor chooses to assume the commercial lease agreement, it must pay all pre- and post-petition defaults or provide adequate assurance that it will do so in a timely way. If a tenant chooses not to assume or assign the lease, the lease is deemed rejected, or terminated, as of the bankruptcy filing date or another date set by the court.

The Bankruptcy Code requires debtors to perform all commercial lease obligations from the time of the bankruptcy filing until the lease is assumed or rejected. Thus, tenants must pay rent due on the first lease payment date following the bankruptcy petition filing. If the tenant fails to do so, the landlord can move the bankruptcy court to compel payment as an administrative priority claim. Bankrupt tenants also must perform all other post-petition lease obligations, such as paying common area maintenance, tax, and insurance charges.

If the lease is rejected by the debtor, the landlord should file a proof of claim for any pre-petition rent owed plus rejection damages, which are determined using a formula set out in the Bankruptcy Code.

2. My commercial landlord has filed for bankruptcy. What will happen now?

The Bankruptcy Code requires debtors to perform all commercial lease obligations from the time of the bankruptcy filing until the lease is assumed or rejected. The landlord is allowed at least 60 days (depending on the chapter of bankruptcy and subject to extension by court order) to decide whether to assume the lease in full – allowing your tenancy to remain as is – and either retain the lease itself or assign it to a third party, likely as part of the sale of the landlord’s real estate asset.

If the lease is below market or determined not to be beneficial to the landlord’s estate, it is possible your lease will be rejected, or terminated, by the landlord. If that is the case, you may have damages against the landlord and you may consider filing a proof of claim for those amounts.

3. A trustee has demanded that I return a “preferential payment” or a “fraudulent transfer” from a debtor in bankruptcy. What will happen now?

A payment received by a creditor within the ninety (90) days prior to a debtor’s bankruptcy filing may constitute a “preferential payment”. A payment received by a creditor in the two years prior to a bankruptcy filing for less than equivalent value and while the debtor is insolvent may constitute a “fraudulent transfer”. A bankruptcy trustee has the power to claw back certain preferential payments or fraudulent transfers for the benefit of a bankruptcy estate and re-distribute such payments for the benefit of all creditors.

If you receive a demand letter for return of one of these types of payments, you should respond in writing with any defenses you have to the return of the payments under the Bankruptcy Code. If you assert valid defenses, the trustee may decide not to pursue the return of such payments.

Whether or not the trustee informally demands return of the preferential or fraudulent payment, the trustee may file a lawsuit called an adversary proceeding in bankruptcy court seeking return of the payment. If this happens and you are served with a summons, you should promptly seek legal assistance to file an appropriate responsive pleading in bankruptcy court asserting any defenses you may have.

Failure to timely respond may result in a default judgment against you. At any time during this process, you may be able to reach a settlement with the trustee with respect to payment of a portion of the payments into the bankruptcy estate.

4. I’d like to purchase assets out of a bankruptcy estate. How do I proceed?

The sale of assets out of a bankruptcy estate requires court approval. Generally, the debtor must file a motion seeking approval of the sale of assets pursuant to a sales contract which is subject to higher and better offers. The bankruptcy court may hold an auction or authorize that the debtor hold an auction outside of court if there are multiple interested purchasers so that the best price is achieved.

You or your attorney should reach out to debtor’s counsel or the trustee if you are interested in purchasing certain assets out of bankruptcy. If the debtor has not already sought court approval for the sale of assets, you may be able to negotiate the initial sale contract – sometimes called the stalking horse. If there is already a stalking horse purchaser, then you may wish to submit a competing bid.

Depending on the posture of the bankruptcy case, you may do this informally by contacting debtor’s counsel or the trustee, by submitting a bid pursuant to court-approved bid procedures or by filing an objection to the sale motion in bankruptcy court providing that the current bid is not the highest and best.

5. I supplied goods on credit and my customer has just filed for bankruptcy. What are my options?

Generally speaking, you’ll have a pre-petition claim against the bankruptcy estate which you should assert by filing a proof of claim. However, if you supplied goods very recently, you may have some additional protections including:

• an administrative expense claim for the value of goods sold, delivered to, and received by a customer in the ordinary course of business within 20 days of the customer’s bankruptcy filing. An administrative expense claim must be asserted by filing a motion in bankruptcy court seeking administrative priority and payment.
• a right to reclaim goods sold to an insolvent customer within 45 days of the customer’s bankruptcy filing. To reclaim goods, the creditor must make a written demand in the first 20 days of the bankruptcy.

If you supply goods to the customer on order by order basis, then you are likely not required to supply additional goods on credit after the bankruptcy filing. However, if you have a guaranteed supply contract with the customer, you may be prevented from refusing to supply goods on credit even after the bankruptcy case is filed and until the customer assumes or rejects the contract.

Be aware also that a bankruptcy filing imposes an automatic stay on any collection of debt. Violation of the automatic stay can lead to serious consequences, so do not reach out to the customer to demand payment.

6. I’ve been asked to serve on an official creditor’s committee in a bankruptcy case. What does this mean?

The Bankruptcy Code provides a mechanism for unsecured creditors to form a committee and hire counsel to represent their collective interests. A committee requires the participation of actual creditors to make decisions on behalf of the class.

In larger cases, the United States Trustee, typically, will reach out to the largest unsecured creditors in the case to gauge interest in serving on a committee. The unsecured creditors committee typically has a very powerful voice in the case and can sometimes secure payment of unsecured claims that would not have been paid otherwise or that would have received a lower payment.

Serving on the committee can be time consuming. It typically involves frequent emails and phone calls with counsel and consideration and negotiation of case matters with debtor’s counsel and secured creditor’s counsel (as well as any other key players in the case). Sometimes, the creditors committee will also take on derivative standing of certain claims of the debtor and will litigate those claims, with the unsecured creditors able to reap the benefit of any proceeds of such litigation.

7. I’ve leased equipment and the lessee just filed bankruptcy. Can I retrieve the equipment?

Initially, no. The automatic stay prevents an equipment lessor from retrieving the equipment immediately. Your options going forward, however, depend on the lease itself and whether it is deemed by law to be a true lease or a loan secured by the equipment.

Typically, the equipment lease is deemed an executory contract and will be subject to be assumed and assigned or rejected by the debtor. The debtor is allowed at least 60 days (depending on the chapter of bankruptcy and subject to extension by court order) to make this decision but must make payments during that time.

If the debtor assumes the lease, it will need to cure all pre- and post-petition defaults. If the lease is rejected, you will have a pre-petition claim for any lease payments not made prior to the bankruptcy filing, and you may have a rejection damages claim for amounts still due and owing under the lease. The equipment should be returned upon rejection.

If your contract is actually a secured loan, and the debtor does not continue to make post-petition payments, then you may have good cause under the bankruptcy code to seek relief from the automatic stay to retrieve your equipment.

8. I’m in the middle of litigation and one of the parties filed bankruptcy. What can I do?

The automatic stay prohibits a third-party from continuing to pursue claims against a debtor in bankruptcy. The debtor is likely to file a “suggestion of bankruptcy” in active litigation so that the litigation is stayed as to that party. However, even if the debtor does not file a suggestion, once you are aware of the bankruptcy, you should specifically exclude that party from any litigation efforts, including discovery. Violating the automatic stay can have very serious consequences so it is best to proceed with caution.

Please contact Andrea Davison with questions on any of the above matters or to seek additional information at adavison@beankinney.com or 703.284.7277.

This material is intended for general informational purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how laws apply to specific facts and situations.