Facts about business bankruptcy. (Selected Topic).

* accounting irregularities (and in some instances accounting fraud);

* a weakening U.S. economy;

* the bursting of the high-tech bubble; and

* a crisis of confidence resulting in investors and banks pulling back when corporations ask either for "help," or possibly even a financial bailout.

In connection with their risk management responsibilities, credit managers need to know if the worst is over. It seems likely that more companies will step forward in 2003 and admit to "accounting irregularities", but it seems unlikely that any bankruptcies that may result from these revelations will match the size and scope of the bankruptcies in 2002--which included the Enron Corporation bankruptcy and the WorldCom Corporation bankruptcy filings.

Here are a few interesting facts about business bankruptcies:

* There are approximately 40,000 business bankruptcies filed each year in the United States.

* Contrary to popular belief, a bankruptcy filing by a customer resulting in a bad debt loss to a creditor company is not necessarily an indication that the credit department made a mistake in extending credit to that company. Bad debt losses are a cost of doing business and a consequence of selling to customers on open account terms.

* An automatic stay protects companies that file for bankruptcy. The automatic stay stops any lawsuit filed against the debtor as well as all actions against the debtor by a creditor, a collection agency or a government entity. Violation of the automatic stay may result in fines and other sanctions.

* Contrary to popular myth, there is no guarantee that a creditor selling on open account terms to a debtor-in-possession ("DIP") in a Chapter 11 bankruptcy will be paid in full. The "administrative priority" that post-petition creditors receive as an inducement to extend credit to the DIP is, to some extent, illusory to the extent that it purports to guarantee payment to post-petition creditors.

* A significant percent of companies that enter Chapter 11 bankruptcy protection are unable to successfully emerge with a confirmed plan of recognition

* A company in Chapter 11 may continue to sell goods and to employ workers.

* A company exits Chapter 11 when the U.S. Bankruptcy Court has approved a Chapter 11 Plan of Reorganization and the transactions and payments proposed in the Plan are consummated.

* This Plan is usually developed by the debtor-in-possession in conjunction with its pre-petition secured and unsecured creditors, and in consultation with the official unsecured creditors' committee.

Following a bankruptcy filing, trade creditors can lawfully:

* Place the account on credit hold

* Stop all shipments in transit

* Arrange for the return of any merchandise in transit

* File a reclamation claim for any shipments received by the bankrupt debtor within a specific time frame

* Refuse to extend credit to the bankrupt debtor

* Ask the court to appoint a trustee to run and manage the business if the debtor's management is incompetent or is involved in some form of theft or fraud

* Ask to be made a part of the official unsecured creditors' committee

* Refuse an invitation from the U.S. Trustee to join the official unsecured creditors' committee

* Petition the Court to convert a reorganization bankruptcy into a liquidation

* Demand immediate payment against any personal guarantee or inter-corporate guarantee that a pre-petition creditor may have on file. The creditor company can also sue the guarantor (if necessary) to collect against a guarantee

Any payment received within 90 days prior to the bankruptcy filing date may be subject to a preference action. Preference avoidance power is granted to "ensure an equitable distribution of the debtor's assets".

There are numerous defenses that can be raised by a creditor to a preference action. A creditor often needs the help of an attorney to evaluate possible defenses against preference action, and/or to represent the creditor in Bankruptcy Court when hearings are held on the preference claims. Since less than half of the companies that go into bankruptcy successfully emerge from it, unsecured creditors need to think carefully before agreeing to sell to a debtor-in-possession. Before doing so, creditors should be certain that:

* The debtor acknowledges receipt of your reclamation notice/demand

* The Court has issued an order authorizing the use of cash collateral

* The debtor has secured DIP financing (if such financing is necessary)

* The debtor has a plan for returning to profitability

* The creditor's records and the debtor's records match with regard to the amount of the pre-petition debt

From the creditor's perspective, the advantages of a bankruptcy filing include:

* The fact that a bankruptcy filing forces the debtor to treat all "like" creditors the same way, rather than offering preferential treatment to some at the expense of others

* The debtor is required to respond to questions about its financial dealings under oath--and this may uncover certain transactions that can be "unwound" under the U.S. Bankruptcy Code, resulting in a larger payout to unsecured creditors

* A bankruptcy filing can prevent a dishonest or incompetent debtor or management team from draining the company's assets and enriching themselves at the expense of the company's creditors

RELATED ARTICLES: A Bankruptcy Checklist

Managing the credit department's activities following a bankruptcy filing using a preprinted checklist can save time and money, and more importantly, doing so can prevent mistakes.

Important activities that should be included on the checklist:

* Promptly sending a reclamation notice on shipments sent within 10 days of the bankruptcy filing date

* Reviewing payments received from the bankrupt debtor within 90 days of the bankruptcy filing date to determine the potential amount of preference claims (if any)

* Calculating how much product was shipped to this customer in the 90 days prior to the filing date

* Reprinting copies of all invoices, debits and credits open on the filing date, along with at least two copies of the entire account statement

* Ordering proof of delivery on all open invoices

* Promptly reviewing every document received from the court to be sure that no action is required

* Filing a proof of claim before the bar date: including the required supporting documentation with the proof of claim; completing it in its entirety; signing the claim; sending the claim to the court by mail; confirming your company's claim was received and was filed by the court and keeping a copy of every documentation sent to the court

Bankruptcy Reclamation

Bankruptcy reclamation rights are often misunderstood. Reclamation involves the right of pre-petition creditors to reclaim goods shipped to an insolvent customer shortly before the bankruptcy filing date.

The reclamation process begins when a creditor sends a letter to the insolvent debtor demanding the return of goods. This letter/demand should be faxed, sent by overnight delivery, and sent by electronic transmission sent by mail with return-receipt requested. This demand letter should be sent as soon as possible. It should instruct the debtor to set aside, safeguard and not sell any of the items that are the subject of the reclamation demand. A seller, under the Uniform Commercial code generally has only 10 days to make its written reclamation demand, but if the 10-day period expires after a bankruptcy has been filed, the seller can make its reclamation demand within 20 days of the buyer's receipt of the goods.

A seller can reclaim goods delivered to a buyer if the seller satisfies all of these conditions:

a. the seller delivered the goods to the buyer;

b. the goods were sold to the buyer in the ordinary course of business;

c. the buyer must have possession of the goods at the time of the demand; and

d. the buyer was insolvent when it received the goods.

A creditor cannot require or demand that the debtor allow them access to inspect and count inventory, but a creditor can request permission to do so. Also, a creditor's reclamation rights may be subordinate to the rights of a prior secured creditor with a security interest in inventory. Also a creditor's reclamation rights are subordinate to the rights of a secured creditor with a security interest in all of the buyer's inventory. The courts are divided on whether the existence of an inventory secured creditor will wipe out reclamation claims. However, the emerging view of the courts is to deny relief to reclamation creditors where the proceeds of their goods were paid to the secured creditor or the secured creditor is undersecured.

Michael Dennis, M.B.A., CBF is a business consultant and author of "Credit and Collection Handbook". For more information, please visit www.coveringcredit.com.

Disclaimer: This article is not legal advice, or a substitute for competent legal advice on the subject of bankruptcy to reclamation.