Pacific Gas and Electric and Southern California Edison, key units of the State’s biggest utilities, are reportedly considering seeking bankruptcy protection due in part to nearly $13 billion in debt and continuing cash drains caused by surges in wholesale electricity power prices. This developing situation has left trade creditors, banks and holders of various debt instruments wondering how and when they will be paid on their outstanding obligations. In order to increase the likelihood of payment, creditors should be proactive in their efforts to collect on their outstanding obligations. Listed below are several creditors’ rights issues to consider.
1. Is The Obligation Secured or Unsecured? An initial review of the debt instrument or contractual documentation will indicate whether or not a claim is secured or unsecured, i.e., whether or not personal or real property collateral, or a third party’s guaranty, has been given to secure payment if the obligation is not paid when due. Generally speaking, a secured or guaranteed creditor is in a stronger position for collection on a debt, since that creditor may resort to the underlying collateral, whereas the unsecured creditor will have to look to the general assets of the payor for satisfaction of its obligation. Large corporations may choose to file bankruptcy for some, but not all, subsidiaries or related companies, so creditors should also specifically identify the contracting party or obligated entity.
2. Requests for Assurance of Payment or COD Terms. A vendor which has contracted to provide goods or services may under some circumstances ask for written assurance of payment under the Uniform Commercial Code if there is substantial insecurity of payment evident, such as reports of unpaid creditors. Vendors may also consider going to a cash on delivery basis for providing new goods or services.
3. A Seller of Goods Has a Limited Right to Reclaim Goods After Delivery to an Insolvent Buyer.
If it is too late to stop delivery of goods because the debtor has already received them, the creditor may still be able to reclaim shipped goods if (1) the goods have been received while the debtor was insolvent, (2) the creditor makes a demand for the goods within 10 days after the debtor receives them (the demand should be in writing and indicate that the seller is “reclaiming” the goods), and (3) the creditor clearly identifies what goods are being reclaimed. The right of reclamation is an important remedy which is commonly missed due to the stringent time limits imposed. Although reclamation will not solve existing obligations that are due, the procedure can reduce a vendor’s overall exposure to unpaid debt.
4. Workout Agreements. Upon default of an obligation, a demand letter should be sent to the debtor indicating the amount and nature of the default and requesting payment in full by a date certain. If the debtor responds to the demand letter, it presents an opportunity for the creditor to enter into an agreement that clearly states the amount of the claim, and cures any problems in the underlying documentation or security agreement. The workout may provide, among other things, for the creditor’s forbearance in exchange for partial payments or for the entry of a judgment in case the debtor fails to make agreed upon payments.
If the debtor does not respond, the creditor will need to consider commencing a lawsuit on the underlying obligation, together with an analysis of appropriate prejudgment remedies. Generally speaking, unsecured creditors will want to complete collection efforts as soon as possible (which could trigger preference issues, see Item 6 below). Secured creditors may want to complete foreclosure on their collateral before a bankruptcy petition is filed by the debtor.
5. The Possible Filing of Bankruptcy. Almost all collection efforts against debtor entities will be immediately and automatically stayed upon the filing of the debtor’s bankruptcy petition — no court order or notice to the creditor is required. The automatic stay acts as a blanket injunction preventing creditors from attempting or continuing any collection activity on their pre-petition claims. As a general rule, actions taken in violation of an automatic stay are void and a willful violation of the stay can result in an award of actual damages (including costs and attorneys’ fees) and in some circumstances also can provide the basis for punitive damages.
If a bankruptcy is commenced, it is likely that creditors committees will be formed to represent various classes of unsecured creditors, to investigate and oversee the debtor’s operations during the bankruptcy, and to assist in the formulation of a plan of reorganization. Secured creditors may seek relief from the automatic stay in order to complete foreclosure and credit the sale proceeds against the outstanding balance.
6. Preferential Transfersand How it Affects Creditors. The Bankruptcy Code gives the debtor (or the bankruptcy trustee, if one is appointed) the power to recover for the benefit of the bankruptcy estate certain property transferred from the debtor to a creditor before or after the filing of a bankruptcy petition. The most well-known avoidance action involves preferential transfers, meaning a creditor which recently received payment may be forced to return some payments if other creditors were not paid similarly. Whether or not a creditor has a concern that a late payment or a settlement payment will end up constituting a preferential transfer in a potential bankruptcy, the creditor should always retain the payment. A preferential transfer is only an avoidable transfer, requiring that the debtor (or bankruptcy trustee) first initiate an adversary proceeding to recover the transfer. If no adversary proceeding is brought, the creditor retains the transferred property. Even if an action is commenced to recover an alleged preferential transfer, the Bankruptcy Code allows creditors various statutory defenses to limit the debtor (or the bankruptcy trustee) from avoiding and recovering the transfer.
The above summary is necessarily brief and incomplete. If you have any questions, or would like assistance in any pre-bankruptcy or post-bankruptcy efforts in collecting on your obligation against a debtor entity, please do not hesitate to contact one of Cooper, White & Cooper LLP’s Bankruptcy/Creditors’ Rights attorneys.