A Prudent Approach to U.S. Bankruptcy Law: Pay Attention, Plan and Proceed
Insolvency and Restructuring International, Vol.1, No.1, International Bar Association
Lurking beneath the explosion of East-West trade is the inevitable rise in contractual disputes between debtors and creditors that will play out in the US bankruptcy courts. To the uninitiated, US bankruptcy law creates what appears to be a complex minefield of traps and hazards that impede the ability of creditors - US and foreign vendors and investors alike - to obtain the benefit of their contractual bargain. However, those same laws, properly and punctually utilised, present opportunities to maximise recoveries and, in some cases, to acquire a new business and to expand existing business. Those laws are ignored at the creditors' peril.1
For non-US counsel, foreign vendors and investors, it is rarely possible, nor arguably even desirable, to learn the intricacies of US bankruptcy law. Indeed, most US attorneys and their clients lack even a working knowledge of US bankruptcy law, at least sufficient to handle a complex bankruptcy case. Thus, the challenge for non-US counsel, foreign vendors and investors is to be able to anticipate the need for expert help and to develop relationships before that need arises.
From a bankruptcy perspective, two periods of time have particular significance: pre-petition and postpetition (the 'petition' being a reference to a filing in the US bankruptcy court which invokes the protection of the US Bankruptcy Code). In the pre-petition period, foreign vendors and creditors must be alert to payment delays and any deviations from agreed terms of sale. In effect, these are the warning signs that your American customer is in financial distress. That distress can arise from any number of causes. For example, a customer's largest customer may be late in paying. Similarly, other, more demanding creditors may be getting paid more regularly. Whatever the reason, allowing deviations to go unchallenged during the pre-petition period is ill-advised. What can be done in this situation? Consider, for example: stopping delivery of goods in transit due to the 'insolvency' of the buyer; demanding reclamation of goods already sold, once inability to pay is established; and requesting - in the form of COD payment terms, guarantees, letters of credit and the like - adequate assurances of an insolvent buyer's ability to perform the contract.
When these warning signals are recognised and before a bankruptcy is filed, it is imperative that a foreign creditor promptly meet with its non-US local counsel, who should assist the client in preparing an analysis that weighs the credit risk and potential benefits and harms of participating in the anticipated bankruptcy. That analysis, for a trade vendor, would compare payments received and product shipped at three critical points in lime: 90 days prior to the petition; one year prior and two years prior. The analysis also must review whether the payments received were in accordance or conformity with the business terms for that particular client or with industry standards.
Once a petition has been filed, a creditor's options are more limited, although there are still some protective actions that can be taken provided the creditor acts quickly. For example, a pre-petition right of reclamation will be recognised in bankruptcy for goods shipped within 45 days of the bankruptcy filing, if the creditor demands reclamation promptly (failure to take any action nonetheless affords a creditor some protection in the form of an administrative claim for goods shipped 20 days before the bankruptcy filing).
The foregoing examples are also illustrative of another immutable truth. Once a company has filed for bankruptcy protection, whether the company is the object of a sale to a third party or intends to reorganise and emerge as a stand-alone entity, it likely will seek to use the US bankruptcy law as either a 'sword' or a 'shield' to alter its existing relationships with its vendors and investors. In bankruptcy, some trade creditors have greater value than others to the company in bankruptcy, either to an eventual buyer or for an ongoing business. Competent bankruptcy counsel will exploit those differences to the benefit of certain creditors. In these circumstances, if meaningful dollars are at issue, foreign vendors and investors are at a dramatic disadvantage if they elect to ignore the bankruptcy proceedings. An attempt to cope with the bankruptcy maze, without engaging expert US bankruptcy counsel of their own, is equally dangerous.
The very nature of the bankruptcy process implies a business that is experiencing financial difficulties beyond its ability to manage such difficulties in the absence of legal protection. This almost invariably means that events are occurring rapidly. The bankruptcy process does not slow down the pace of events, although a stated objective of bankruptcy-found in the 'automatic stay' - is to give a business some breathing space from creditor pressure. Rather, a bankruptcy filing gives the filing party greater power to achieve a positive outcome, without the immediate creditor pressure that exists pre-petition. The pace of the bankruptcy, however, is breakneck. In what is effectively a zero-sum game (ie all participants are seeking recovery from a fixed set of assets and, to the extent someone else has a recovery, you may get less), speedy action is critical to a successful outcome for vendors and investors. While this is true for both foreign and US vendors and investors, traditionally the US vendors and investors have been more familiar and more comfortable with participating in the process. In our view, that must change. Foreign vendors and investors who are able to respond immediately to a bankruptcy filing are likely to be rewarded with greater protection of their rights and, ultimately, with a more favourable financial result.
Notwithstanding the foregoing, in many instances it may simply not be financially worthwhile for a foreign vendor or investor to get involved. If the filing party is not a meaningful customer, if the amounts at issue are not substantial, or if there is greater risk to participation than not participating (such as when a filing party has made payments to a vendor or investor that are subject to challenge and by participating in the bankruptcy the creditor submits - for all purposes - to jurisdiction in the United States), then there are clear benefits to be gained from doing nothing. These are issues that non-US counsel can and should consider, before getting their US counterparts involved. Our experience with this decision-making process is to provide our non-US professional colleagues with a questionnaire that allows them to collect sufficient information to enable a thoughtful examination of the pros and cons of proceeding. Ultimately, this is the client's decision to make in consultation with its local non-US counsel, as well as US counsel. As stated earlier, this examination should include the payment/shipment analysis discussed above and should be undertaken by non-US local counsel with their client as soon as it is clear a customer is slow paying.
Finally, amid the disruptions and failures that seem to be integral to the bankruptcy process, we would urge foreign vendors and investors and their non-US counsel to realise that a US bankruptcy potentially represents a business opportunity. While that may seem counter-intuitive, particularly given the impending demise of a customer, most sophisticated creditors see a bankruptcy - not as the end of a case - but, rather, as the beginning of a new business relationship and/ or as a potential acquisition opportunity. Specifically, many vendors/investors see bankruptcy as an opportunity to 'go vertical' - that is, to own and control another part of the sales stream by acquiring a compatible customer (or its key assets, such as its customer base) on more favourable business terms than normally might be found in the market.
As supply chains extend around the world and globalisation inexorably moves forward, other markets will emerge as critical venues for exporters. That being said, the US market nonetheless is huge, desirable and, to a certain extent, unavoidable for all players on the global stage. Increasingly, non-US vendors and investors are racing to expand their exports of goods and services to the United States. In turn, non-US counsel could and should be helping their clients by becoming more familiar with the activities of those clients in the US market. They also need to gain a working knowledge of US bankruptcy law. So educated, non-US counsel could and should be able to act quickly to help their clients salvage and create value by exploiting the opportunities that the US bankruptcy law provides.
These are no small challenges that face local non-US counsel. The rise of international law firms with offices in multiple countries further threatens the competitive position of such counsel. Non-US counsel, however, have inherent competitive advantages of their own (for example trust, price and local knowledge) and are ideally suited to meet the challenges that we have described in this short article. Perhaps the best advice we can offer is that non-US lawyers should actively and continuously be learning about and from their clients concerning their business activities - and those of their customers - in the United States. Additionally, non-US counsel should be identifying - before a crisis arises - US bankruptcy counsel with whom they can work on an as needed basis. In our view, establishing cross-border law firm relationships in advance of time-critical events is a best practice requirement in a global economy. Establishing such relationships in advance enables all parties to avoid the pitfalls that frequently characterise, and needlessly delay implementation of, initial cross-border legal efforts, such as translation problems, payment arrangements, engagement letters and case management processes. Our point is simple: create your legal team well before you need it.
1. The precarious financial condition of an insolvent company often demands emergent access to the courts and expedited judicial decisions. The dual considerations of 'notice' and an 'opportunity to be heard', as benchmarks for due process in a bankruptcy case, often result in truncated judicial hearings being concluded on one day telephonic notice, with objections being allowed orally in court on the day of the hearing without any written legal briefs required. Absent obtaining a stay of an expedited judicial decision pending an appeal, which appeal generally must be filed within ten days of a decision, a final decision of this kind nonetheless is binding and can drastically affect rights throughout a bankruptcy.
David Ravin, is a member of Wolff & Samson PC. In October of 2007, Mr. Ravin was a member of the Fellows of the American Bar Association trip to Beijing, Shanghai and Hong Kong under the auspices of the People to People program setting up bridges to the legal community in China. He interfaced with a number of law firms and academics to establish links for future business in mainland China and Hong Kong and has already been able to direct a client to a law firm in Shanghai in connection with establishing a manufacturing site for international market penetration, principally in the Far East and Europe. He also has laid the groundwork for representation of Chinese companies in the U.S. and presented a written summary in Mandarin (translated from the English by others) to the lawyers he met with. Mr. Ravin also was invited to and did address the members of ASSOCHAM (the equivalent of our U.S. Chamber of Commerce) in New Delhi, India on his way back to the U.S. with respect to the Bankruptcy Code in the U.S. and its affect on Indian businesses having commercial relations with U.S. companies. Robert E. Nies, email@example.com, is a member, and Andrew D. Ellis, is of counsel at Wolff & Samson PC. Wolff & Samson P.C. is located at One Boland Drive, West Orange, New Jersey. The phone number is: (973)325-1500.
This article was first published in Insolvency and Restructuring International, Vol. 1 No. 1, May 2007, and is reproduced by kind permission of the International Bar Association, London, UK.