Other Weapons: Appoint a Trustee (§ 1104(a)) Strong presumption debtor should be permitted to remain in possession • Appoint Trustee – best interests of creditors f • If current management committed a) Fraud a) Fraud b) Dishonesty c) Incompetence d) Gross mismanagement d) Gross mismanagement e) Other (Examples: failure to keep accurate records, questionable transactions) • B Best interest of creditors, equity security holders, and t i t t f dit it it h ld d other interests of estate • As an alternative to dismissal or conversion if in best interest of creditors 28
Other Weapons: Force a Sale Process (§ 363) • Attempt to capture going concern value • Management/shareholder preservation of g equity, jobs, and control versus Committee's desire to maximize distribution • Examples E l (a) Forcing sale process (b) Competitive dynamic (b) Competitive dynamic • Creating a competitive dynamic before it is too late (a) Opportunity for buyer (b) Opportunity for creditors to maximize value 29
Other Weapons: Director & Officer Lawsuits • Very underutilized weapon • Upon becoming insolvent directors owe a Upon becoming insolvent, directors owe a fiduciary duty to creditors (a) ( ) states differ upon the precise duty p p y (b) creditors v. shareholders • California example ( ) (a) f forced sale through involuntary d l h h i l bankruptcy (b) (b) D&O D&O (c) Reverse Merger • Important to use throughout case in Important to use throughout case in negotiations 30
R Remember Committee Members Owe a b C itt M b O Fiduciary Duty to ALL Unsecured Creditors • Act in best interest of all unsecured creditors creditors • Competing Interests: Committee versus p g your own company • Duty of diligence, loyalty, candor • When in doubt, fully disclose and abstain 31
How do I Become a Become a Committee Member? Member? 32
Getting on the Committee 1. Top 10 to 15 creditors will receive a notice from the Office of the U.S. Trustee - Address on Top 20 - Contact U.S. Trustee 2. Fill out request to serve on Committee 33
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Getting on the Committee 3. Attend formation meeting – In person In person – Via telephone – Written proxy 4. Once selected – Select Committee chairperson Select Committee chairperson – Select counsel – Agree to bylaws – ATTACK! ATTACK! 5. Committee member time commitment 37
Committee Impact • Hereford Biofuels, LP – 180 million out of the money 180 million out of the money – Objected to cash collateral, financial advisor, bidding procedures – 2004 Examinations of the bank and the debtor 2004 E i ti f th b k d th d bt – Emergency Hearings – Deal Deal • R&S Strauss – Deal – Size up case – Pick fights carefully – Get deal done Get deal done 38
Committee Impact • Arrow Speed – Attack first days Attack first days – Attack cash collateral – Attack sale – Attack insiders • FirstPlus Financial, Inc. Fi tPl Fi i l I – 300 boxes of documents – 25 2004 Examinations in 75 days 25 2004 Examinations in 75 days – Reach deal – Obtain court approval of deal Obtain court approval of deal 39
The Creditor's Committee – Fighting within the System CONCLUSION CONCLUSION • Your case – Create an immediate presence presence • Find leverage – Look under every rock • Pick your battles – Get a deal approved • Be a good fiduciary g y 40
OVERVIEW: Weapons for the Proactive Credit Professional � Section 503(b)(9) – 20 day Administrative Claims � Bankruptcy Rights of Reclamation � The Creditors' Committee – Fighting g g Within the System � Defending Preference Litigation g g � MFSG Bonus Offer – Filling out a Proof of Claim Form 41
Preferential Transfers: (Why Credit Professionals Hate Them) • An account debtor owes you money. y y • You do your job well, and your company gets paid. • You collect a due and owing debt in a legal • You collect a due and owing debt in a legal manner. • Guess what? The account debtor files bankruptcy, and your company may have to return the money! • Why did Congress allow this to happen??? Isn't • Why did Congress allow this to happen??? Isn t the government here to help you??? (Answer: No, you're not G.M.) 42
Rationale Behind Bankruptcy Code Section 547 “The purpose of the preference section is twofold. p p p First, by permitting the trustee to avoid prebankruptcy transfers that occur within a short period before bankruptcy, creditors are discouraged i d b f b k t dit di d from racing to the courthouse to dismember the debtor during the debtor's slide into bankruptcy debtor during the debtor s slide into bankruptcy. The protection thus afforded the debtor often enables the debtor to work its way out of a difficult y financial situation through cooperation with all of his creditors. . . 43
Rationale Behind Bankruptcy Code Section 547 Second, and more important, the preference provisions facilitate the prime bankruptcy policy of p p p y p y equality of distribution among creditors of the debtor. Any creditor that received a greater payment than others of his class is required to disgorge so that all may share equally. The operation of the preference section to deter 'the ti f th f ti t d t 'th race of diligent' of creditors to dismember the debtor before bankruptcy furthers the second goal debtor before bankruptcy furthers the second goal of the preference section, that of equality of distribution.” distribution. 44
Rationale Behind Bankruptcy Code Section 547 C S • “Ideally” encourages creditors to continue dealing with troubled companies in the ordinary course of business. di f b i • Prevents debtor from selectively paying favored customers favored customers. • Prevents secret liens. • • Prevents debtors from paying insiders and Prevents debtors from paying insiders and related entities. 45
Mechanics of a Preference Lawsuit TRUSTEE'S JOB: Gather Assets For Distribution Gather Assets For Distribution To Creditors 46
Mechanics of a Preference Lawsuit Assets include preference lawsuits. Assets include preference lawsuits. Trustee ASSETS ASSETS TRUSTEE (Debtor-in-Possession) HAS THE FIDUCIARY DUTY TO GATHER ASSETS UNDER BANKRUPTCY UMBRELLA 47
Mechanics of a Preference Lawsuit Chapter 7: Chapter 7: Trustee Pursues Recovery Trustee Pursues Recovery Chapter 11: Chapter 11: Debtor in possession Debtor-in-possession, Creditors' Committee or Post Confirmation Entity Post-Confirmation Entity (such as Creditors' Trust) Pursues Recovery Pursues Recovery 48
Creditor Creditor 49 BANKRUPTCY BANKRUPTCY 90 days within 90 d preference preference lawsuit Trustee Debtor
Mechanics of a Preference Lawsuit The Demand Letter 50
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52 The Summons Mechanics of a Preference Lawsuit
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54 The Complaint Mechanics of a Preference Lawsuit
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Mechanics of a Preference Lawsuit Burden of Proof Plaintiff: Has burden of proving that a given p g g transfer(s) is avoidable, according to the standard set forth in Bankruptcy p y Code Section 547(b). Defendant: Has burden of proving the non- avoidability of a transfer under one or more of the exceptions set forth in Bankruptcy Code Section 547(c). 56
Mechanics of a Preference Lawsuit Parties Liable. Parties liable for preferences include not only p y the initial transferee, but also the parties for whose benefit the transfer was made and the immediate or mediate transferees of the initial immediate or mediate transferees of the initial transferee. 57
Elements of Proof in a Preference Lawsuit P f L it 1. 1. Transfer by the debtor; Transfer by the debtor; 2. Of an interest of the debtor’s property; 3. 3 To or for the benefit of a creditor; To or for the benefit of a creditor; 4. On account of an antecedent debt; 5 5. Made while the debtor is insolvent; Made while the debtor is insolvent; 6. Made within 90 days before bankruptcy; and 7 7. Enables creditor to receive more than in Enables creditor to receive more than in Chapter 7. 58
Elements of Proof in a Preference Lawsuit (Trustee’s Burden) ( ) 1. Any transfer; - broadly defined “every mode direct or - broadly defined every mode, direct or indirect, absolute or conditional, voluntary or involuntary, disposing of or parting with y, p g p g property or an interest in property . . .” In other words, any action that removes property or an , y p p y interest in property from the debtor and delivers it to another party is a “transfer.” If the property given to the creditor does not come from the debtor then it is the creditor does not come from the debtor, then it is not a “transfer” for preference purposes. 59
Elements of Proof in a Preference Lawsuit (Trustee’s Burden) ( ) 2. Of an interest of the Debtor in property; "property that would have been part of the property that would have been part of the estate had it not been transferred before the commencement of the bankruptcy [case]". Payments; Granting liens; Executions on judgments; Giving up options; Anything that diminishes or depletes the debtor's estate. d bt ' t t Examples include security interests, assignments, distribution rights, tax benefits, options, and numerous g p other items that might not ordinarily come into mind as being a debtor's "property." Virtually any kind of advantage that a creditor obtains from a debtor during the period is vulnerable to attack. l bl t tt k Compare letter of credit 60
Elements of Proof in a Preference Lawsuit (Trustee’s Burden) ( ) 3. To or for the benefit of a creditor; - Creditor: Anyone with a “claim.” Broadly defined: y y contingent, disputed, not matured. . . 4. For or on account of an antecedent debt owed by the debtor before such transfer owed by the debtor before such transfer was made; - i.e. for invoices that are due or past due. p - Payment on any outstanding invoices, whether they are due or not, is a payment on account of an antecedent debt an antecedent debt. - Note that a payment for goods that is made prior to shipping or receiving those goods is not a payment of an antecedent debt payment of an antecedent debt. 61
Elements of Proof in a Preference Lawsuit ( (Trustee’s Burden) ) 5. Made while the debtor was insolvent; - financial condition such that the sum of the debtor's debts is greater than all of the debtor's property at a fair valuation property, at a fair valuation - Solvency is presumed - Solvency presumption can be “burst” S l ti b “b t” - Significantly alters the negotiation dynamics 6. Made within 90 days before bankruptcy is filed (one year for insiders); and 62
Elements of Proof in a Preference Lawsuit (Trustee’s Burden) ( ) 7. That enables such creditor to receive more than such creditor would receive if – a. the case were a case under Chapter 7 of the Bankruptcy Code; b. b the transfer had not been made; the transfer had not been made; and c. c. such creditor received payment of such creditor received payment of such debt to the extent provided by the provisions of the Bankruptcy C d Code. - Hypothetical Chapter 7 test. 63
64 Preference Defenses
Defenses in a Preference Lawsuit (Creditor’s Burden) ( ) 1. Contemporaneous Exchange – Section 547(c)(1) 547(c)(1) 2. Ordinary Course of Business – Section 547(c)(2) 547(c)(2) 3. Enabling Loan Defense – Section 547(c)(3) 547(c)(3) 4. Transfer of Subsequent New Value – Section 547(c)(4) Section 547(c)(4) 5. Security Interests in Inventory or Receivables – Section 547(c)(5) Receivables Section 547(c)(5) 65
Defenses in a Preference Lawsuit (Creditor’s Burden) ( ) Contemporaneous Exchange a a. Intent for contemporaneous exchange Intent for contemporaneo s e change by both debtor and creditor; b. A contemporaneous exchange actually occurs; and c. Creditor provides “real” new value. (Examples: COD/cash in advance) ( p ) 66
Defenses in a Preference Lawsuit Ordinary Course of Business Defenses Ordinary course of business test requires that a transfer be in payment of a debt incurred by the debtor in the ordinary course of business the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and either: 1) Made in the ordinary course of business or financial affairs of the debtor and the transferee (the so- called “subjective” ordinary course test); or called subjective ordinary course test); or 2) Made according to ordinary business terms (the so- called “objective” ordinary course test). 67
New Ordinary Course of Business Defense N O di C f B i D f Ordinary course defense is essentially a new statute post- y y p BAPCPA. This substantial change was accomplished by changing an 'and' to an 'or'. What does this mean for creditors? Two disjunctive, alternative defenses: 1. Preferential payment was made in the ordinary course of the debtor's and the creditor's/defendant's business, -OR- 2. Payment made in accordance with ordinary business y y terms. 68
Defenses in a Preference Lawsuit Ordinary Course of Business Defenses Ordinary course of business test requires that a transfer be in payment of a debt incurred by the debtor in the ordinary course of business the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and either: 1) Made in the ordinary course of business or financial affairs of the debtor and the transferee (the so- called “subjective” ordinary course test); or called subjective ordinary course test); or 2) Made according to ordinary business terms (the so- called “objective” ordinary course test). 69
Defenses in a Preference Lawsuit Determination of “Ordinary Course of Business” entails: Business entails: a. Consideration of quantifiable factors (Mathematical comparison of payment (Mathematical comparison of payment history before and during the preference period); and p ); b. Consideration of non-quantifiable factors (i.e., timing, amount, manner, collection efforts, and circumstances of transfers). 70
Defenses in a Preference Lawsuit Ex: Debtor files bankruptcy on May 11, 2009 Pre-preference Preference “Historical” Period Period 90 days Beginning of Beginning of Vendor 05/11/09 02/10/09 relationship (Petition Date) 71
Defenses in a Preference Lawsuit Learn the facts using: Learn the facts, using: 1 1. Preference Defense Questionnaire P f D f Q ti i 2. Ordinary Course of Business Worksheet 3. New Value Worksheet 72
Defenses in a Preference Lawsuit PREFERENCE DEFENSE QUESTIONNAIRE To properly evaluate your company's defenses to the alleged preferential transfers at issue it to the alleged preferential transfers at issue, it is essential that we understand the business relationship between your company and the p y p y bankrupt debtor. Accordingly, we ask that you provide us with a brief, but complete, written response to the following questions: 73
Defenses in a Preference Lawsuit 1. How long has your company done business with the debtor? 74
Defenses in a Preference Lawsuit 2 2. What is the name of the entity to which the payments Wh t i th f th tit t hi h th t were made? Is that the same as the entity being sued? 75
Defenses in a Preference Lawsuit 3. What is the name of the entity from which you received the payments? Is that the name of the debtor seeking avoidance of the transfers? 76
Defenses in a Preference Lawsuit 4 4. What credit terms did you offer the debtor before the What credit terms did you offer the debtor before the bankruptcy? (Beginning 15 months prior to the debtor's petition date and continuing to the petition date itself ) What grace period if any do you allow date itself.) What grace period, if any, do you allow for payment? Are special terms ever given for limited periods of time for promotional/seasonal reasons? 77
Defenses in a Preference Lawsuit 5. Are there seasonal factors associated with the 5. Are there seasonal factors associated with the products you sell, such that you sell more product (or the debtor pays earlier or later) depending on the time of year? of year? 78
Defenses in a Preference Lawsuit 6. Are the credit terms you offer the debtor comparable to those you offered to similarly situated customers? Are your credit terms for this debtor comparable to Are your credit terms for this debtor comparable to those provided by your competitors? 79
Defenses in a Preference Lawsuit 7 7. Do you have any reason to believe the debtor was Do you have any reason to believe the debtor was paying you in a more favorable manner than it paid other creditors? 80
Defenses in a Preference Lawsuit 8. Was there a change in credit terms during the 8. Was there a change in credit terms during the preference period or in the year prior to the preference period? Explain. Is there any documentation (memos letters e-mails etc ) of the change? How (memos, letters, e mails, etc.) of the change? How was the change communicated to the debtor? 81
Defenses in a Preference Lawsuit 9. Did your company engage in any unusual collection 9. Did your company engage in any unusual collection activity during, or immediately prior to, the preference period? Cessation of shipments? Threatening collection phone calls or Threatening collection phone calls or correspondence? Describe in detail, and be prepared to provide copies of all related correspondence. 82
Defenses in a Preference Lawsuit 10. How are credit memos handled with this debtor, including timing of returns and credits and payment of advertising co-op payments, if any? Is this typical of advertising co op payments, if any? Is this typical of the procedure your company uses with other customers? 83
Defenses in a Preference Lawsuit 11 What is the timing between the date an invoice is 11.What is the timing between the date an invoice is prepared and the date related product is shipped? 84
Defenses in a Preference Lawsuit 12.Did the debtor pay for goods shipped/services provided during the preference period? Be prepared provided during the preference period? Be prepared to identify by (i) invoice number, date and amount and (ii) check number, check amount and deposit date. 85
Defenses in a Preference Lawsuit 13.Has a proof of claim been filed? If not, why not? Be prepared to provide us with a copy of all proofs of prepared to provide us with a copy of all proofs of claim, including any exhibits or attachments to the proof of claim. 86
Defenses in a Preference Lawsuit 14.Did you receive financial statements from the debtor in the six months prior to the bankruptcy filing or did in the six months prior to the bankruptcy filing, or did you receive any other information or assurances from the debtor during that time indicating that the debtor was financially sound? was financially sound? 87
Defenses in a Preference Lawsuit 15.Are there other facts that might indicate that your preference period transactions with the debtor took place in the ordinary course of business? Explain. 88
89 Preference Defenses
Creditor Defenses in a Preference Lawsuit O di Ordinary Course of Business C f B i Worksheet Worksheet 90
Ordinary Course of Business Worksheet 15 Month History Before Petition Date Invoice Date to Payment Invoice Check/Wire Check/Wire Payment Payment Due Payment Receipt Date Number Invoice Date Invoice Amount No. Date Amount Date Receipt Date (Days) HISTORICAL DATA HISTORICAL DATA 1001 03/01/08 $10,000.00 536 03/07/08 $10,000.00 03/31/08 03/11/08 10 1002 04/01/08 $15,000.00 604 04/13/08 $15,000.00 05/01/08 04/17/08 16 1003 05/01/08 $25,000.00 642 06/05/08 $25,000.00 05/31/08 06/09/08 39 1004 06/01/08 $62,000.00 699 07/17/08 $62,000.00 07/01/08 07/21/08 50 1005 07/01/08 $40,000.00 713 07/16/08 $40,000.00 07/31/08 07/20/08 19 1006 08/01/08 $70,000.00 722 09/05/08 $70,000.00 08/31/08 09/09/08 39 1007 09/01/08 $45,000.00 $ 754 10/15/08 $ $45,000.00 10/01/08 10/19/08 48 1008 10/01/08 $30,000.00 789 11/23/08 $30,000.00 10/31/08 11/27/08 57 1009 11/01/08 $22,000.00 839 12/15/08 $22,000.00 12/01/08 12/19/08 48 1010 12/01/08 $13,000.00 862 01/16/09 $13,000.00 12/31/08 01/20/09 50 1011 01/01/09 $18,000.00 899 02/12/09 $18,000.00 01/31/09 02/16/09 46 1012 02/01/09 $20,000.00 908 03/17/09 $20,000.00 03/03/09 03/21/09 48 PREFERENCE PERIOD DATA 1013 03/01/09 $21,000.00 912 04/16/09 $21,000.00 03/31/09 04/20/09 50 1014 04/01/09 $40,000.00 950 06/20/09 $40,000.00 05/01/09 06/24/09 84 1015 05/01/09 $62,000.00 951 06/09/09 $62,000.00 05/31/09 06/13/09 43 91
Ordinary Course of Business Worksheet 12 Month History Before Petition Date Invoice Date to Payment Invoice Check/Wire Check/Wire Payment Payment Due Payment Receipt Date Number Invoice Date Invoice Amount No. Date Amount Date Receipt Date (Days) HISTORICAL DATA HISTORICAL DATA 1001 03/01/08 $10,000.00 536 03/07/08 $10,000.00 03/31/08 03/11/08 10 1002 04/01/08 $15,000.00 604 04/13/08 $15,000.00 05/01/08 04/17/08 16 1003 05/01/08 $25,000.00 642 06/05/08 $25,000.00 05/31/08 06/09/08 39 1004 06/01/08 $62,000.00 699 07/17/08 $62,000.00 07/01/08 07/21/08 50 1005 07/01/08 $40,000.00 713 07/16/08 $40,000.00 07/31/08 07/20/08 19 1006 08/01/08 $70,000.00 722 09/05/08 $70,000.00 08/31/08 09/09/08 39 1007 09/01/08 $ $45,000.00 754 10/15/08 $ $45,000.00 10/01/08 10/19/08 48 1008 10/01/08 $30,000.00 789 11/23/08 $30,000.00 10/31/08 11/27/08 57 1009 11/01/08 $22,000.00 839 12/15/08 $22,000.00 12/01/08 12/19/08 48 1010 12/01/08 $13,000.00 862 01/16/09 $13,000.00 12/31/08 01/20/09 50 1011 01/01/09 $18,000.00 899 02/12/09 $18,000.00 01/31/09 02/16/09 46 1012 02/01/09 $20,000.00 908 03/17/09 $20,000.00 03/03/09 03/21/09 48 Mean 39 Median 47 Mode 48 Std. Dev. 15 Minimum 10 Maximum 57 92
Ordinary Course of Business Worksheet Preference Period Invoice Date to Payment Invoice Check/Wire Check/Wire Payment Payment Due Payment Receipt Date Number Invoice Date Invoice Amount No. Date Amount Date Receipt Date (Days) PREFERENCE PERIOD DATA 1013 03/01/09 $21,000.00 912 04/16/09 $21,000.00 03/31/09 04/20/09 50 1014 04/01/09 $40,000.00 950 06/20/09 $40,000.00 05/01/09 06/24/09 84 1015 05/01/09 $62,000.00 951 06/09/09 $62,000.00 05/31/09 06/13/09 43 Mean 59 Median 50 M d Mode N/A N/A Minimum 43 Maximum 84 93
Defenses in a Preference Lawsuit Ordinary Course of Business Worksheet Focus is on average number of days between invoice date and date check is received (or between due date and check receipt date) and check receipt date). 94
Defenses in a Preference Lawsuit Average time to pay during Preference Period: 59 days A Average time to pay historically: ti t hi t i ll 39 d 39 days Which data set works best for you? y A. 12 month historical average: _________ 39 days y B. 9 month historical average: _________ 45 days C. 6 month historical average: _________ 50 days 95
Defenses in a Preference Lawsuit What is within “Ordinary Course?” A. 10 days of average? 15 days? B. Consistent with prior practices? C I C. Inside the historical range? id th hi t i l ? D. Well established payment practices? E. Look at actual payment history, not contract terms. 96
Defenses in a Preference Lawsuit Analysis of Ordinary Course of Business Get creative: Get creative: • Remove/include extraneous data points that skew averages g • Different historical analysis: 9 months; 18 months; 24 months • Median, mode • Standard deviation • Frequency analysis F l i • Seasonality charting • Special promotions effects S i l ti ff t 97
Defenses in a Preference Lawsuit Factors most frequently considered by the courts when evaluating whether a the courts when evaluating whether a transfer took place in the “ordinary course of business” include: course of business include: - timing of the transfer - amount of the transfer - manner of the transfer - circumstances of the transfer 98
Defenses in a Preference Lawsuit Timing of the transfer Did th Did the transfer occur: t f - on the eve of bankruptcy? - later than usual? - earlier than usual? earlier than usual? - on a non-standard basis? 99
Defenses in a Preference Lawsuit Amount of the transfer W Was the transfer: th t f - larger than usual? - in an other than ordinary payment amount? amount? 100
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