Business bankruptcy basics

Although bankruptcy fillings have significantly slowed down in recent months, the recent filing of Caesars Entertainment Operating Company, a well-known Las Vegas-based gaming company, serves as an important reminder that every company you do business with is potentially at risk of declaring bankruptcy. This article addresses several basic bankruptcy principles to keep in mind so that you are prepared to protect yourself when you receive a bankruptcy notice from an insolvent business entity.

1. What is the difference between Chapter 7 and Chapter 11?

Federal law governs all bankruptcy proceedings. There are several types of bankruptcy, but a business entity is most likely to file for protection under either Chapter 11 or Chapter 7 of the United States Bankruptcy Code. A Chapter 11 bankruptcy allows the debtor entity to reorganize its financial affairs and, hopefully, return to economic viability. Under Chapter 11, the business generally continues to operate while attempting to return to profitability. The goal of a Chapter 7 bankruptcy is different. In a Chapter 7 bankruptcy, the business stops operating and is liquidated. A bankruptcy trustee is appointed to marshal the debtor’s assets. Those assets are sold to pay the business’ creditors to the extent possible and the business closes its doors.

2. What is considered property of the debtor’s estate?

It is important to understand that upon the filing of either a Chapter 11 or a Chapter 7 bankruptcy, the debtor entity’s property is no longer under its control. Accordingly, another important bankruptcy principle to consider is what assets make up the “debtor’s estate”. The debtor’s estate is a new entity that is created by law the moment the debtor files the petition. The estate consists of all of the debtor’s property including real estate, personal property, accounts receivable, intellectual property, licenses and insurance policies. The estate holds all legal and equitable interest in the property that the debtor owns.

3. What is the automatic stay?

The automatic stay is one of the first issues a creditor must be aware of when an entity files bankruptcy. This is one of the most powerful protections provided to a bankruptcy debtor. The stay is effective the moment the debtor files a bankruptcy petition. It acts as an injunction against all collection activities to recover any debt incurred prior to the bankruptcy. The automatic stay prohibits any new liens, repossessions, foreclosures, collection calls, garnishments or lawsuits to collect on a debt, even if the debt is not disputed.

4. How does a creditor assert a claim?

In order to even potentially receive any distribution from a bankrupt debtor, a creditor must file a proof of claim. This is a relatively simple form that should be filed setting forth the amount the debtor owed to your company before filing bankruptcy. A creditor seeking to assert a claim must keep in mind that there is an absolute deadline, or “bar date,” for filing such a claim.

5. What if you got paid and another creditor did not?

If you got paid in lieu of the debtor paying another creditor, the payment you received may be cancelled and subject to refund if it is considered a preferential payment. Under Section 547 of the bankruptcy code, the bankruptcy trustee may avoid any preferential payments. A payment may be considered a preference because it “prefers” one creditor over another. Creditors who have received payments during the 90-day period prior to the bankruptcy filing may be required by the court to return those payments to the debtor’s estate.

6. What happens to pending contracts with the debtor?

If you have an agreement for ongoing or future performance, the contract is said to be pending or “executory.” An executory contract includes a contract for work that is partially complete and on schedule with completion due in the future. An unexpired lease is an example of an executory contract. Such contracts are considered “executory” because the parties have a legally binding agreement that requires both parties to fulfill obligations in the future.

Bankruptcy is a complex area of law and the circumstances of a given business entity’s bankruptcy will vary. This article is a general overview of this complex body of federal law; however, it does identify some of the major issues you should consider if you are owed money or services by a bankrupt business. If you are in the unfortunate position of being a creditor of a bankrupt business, you should see a qualified bankruptcy attorney for specific advice.

Caryn S. Tijsseling is an attorney with the Lemons, Grundy & Eisenberg firm.