Three Questions with Lindsay Zahradka Milne about Bankruptcy
For some, the word “bankruptcy” may feel synonymous with “punishment” or “liquidation.” To Bernstein Shur Shareholder and bankruptcy lawyer Lindsay Zahradka Milne, bankruptcy is a method of protection. Here she breaks down her area of expertise and provides perspective on how she counsels companies to protect their assets.
- How do you help clients understand the complex world of bankruptcy and restructuring?
Bankruptcy is different than insolvency. I would guess when a lot of people hear “bankruptcy,” they think “liquidation”—meaning a company is closing its doors, selling its assets, and ending its business. In fact, the United States was the leader in creating a bankruptcy regime bent toward facilitating a debtor’s “reorganization” instead of effectively mandating its liquidation: chapter 11 permits a debtor to restructure its obligations and relationships with lenders and other creditors, unions, or business counterparties, for example. This process is overseen by the Bankruptcy Court, which ultimately confirms that the business’s chapter 11 plan meets certain requirements of bankruptcy code. In general, a successful, “confirmed” plan will deliver a business from chapter 11 with a healthy capital structure (which means less debt, or at least more comfortably serviceable debt), better control over creditor recovery actions and any other pending litigation, and fewer burdensome contracts. In a sense, filing for chapter 11 is a way to implement unilateral financial and operational hygiene, which “reorganization” of obligations would have required all parties’ consent outside of bankruptcy.
- Before or during times of economic uncertainty, what are some concrete steps that businesses can take to protect their assets?
I regularly help businesses identify untapped sources of capital, and coach them to be proactive in protecting their assets by managing liquidity, getting their books and records in order, and more—all, ideally, before there is any threat of financial distress. Here are a few tips:
- Get a line of credit from your bank for a rainy day. Consider applying for a line of credit—or an increase in an existing line of credit—through your bank (or if you don’t have one, establishing a relationship with a local bank). A line of credit is basically a credit card for businesses, and often costs nothing if you don’t draw on it (but does usually require a lien on assets). This gives you liquidity should you need it, without having to wait for a bank approval process amid financial distress.
- Protect your ability to “reclaim” your goods. Many companies sell goods on “payment terms”— that is, they do not require cash on delivery, but rather include an invoice with the delivery for payment in, say, 30 days. In the event such a seller delivers goods to a customer and, before the customer pays on its invoice, the customer files for bankrutpcy, the general rule is that the seller can reclaim its goods and sell them elsewhere (instead of waiting for payment via the bankruptcy process). But a seller only retain that “reclamation” right if there are no liens on its customer’s inventory. This is because the law treats goods delivered (even if not yet paid for) as the customer’s property, unless the seller has gone through the prescribed steps to notify the customer’s inventory lender that certain goods have been carved out of the lender’s collateral pool. This is inexpensive and relatively quick, and can be a good option for long-term, high-volume customers.
- For B2B companies, have good Accounts Receivable (AR) hygiene. If your customer files for bankruptcy, it may claw back any payment made within the prior 90 days (or one year, for payments made to “insiders”), subject to certain defenses. Such payments are called “preferences.” One of the ways you can defend against a preference demand is to demonstrate that the payment was made in ordinary course of business—that is, consistent with your historical payment practices with that customer, or with practices in your industry. Mounting a strong ordinary course defense requires being consistent on payment terms with a given customer on the front end, and implementing a system for to ensure consistency in timing on following up on unpaid invoices. All the better if your payment terms are in alignment with what is typical in your industry. This benefits you even if your customers never file by providing predicability in the terms on which you do business.
- What protections are in place for businesses experiencing financial distress?
Bankruptcy is a tool for distressed companies — not a swear word or a taboo. A company feeling financial distress invokes the protection of the Bankruptcy Code by filing a petition with a federal bankruptcy court, and that filing automatically prohibits anyone from pursuing any collection action or other litigation against the company. That’s called the “automatic stay,” and affords the debtor a breathing spell to get its affairs in order and determine a path forward.
That path forward is governed by the Bankruptcy Code, a title of the United States Code. The Bankruptcy Code balances creditor democracy with debtor rehabilitation, and thus does not require unanimous consensus on a path forward. It’s not a windfall for debtors, nor is it a hammer for creditors, but a codified architecture for shepherding a company in financial distress through an organized process of court-supervised, transparent restructuring.