If I hear that a client is declaring bankruptcy, what should I do first?

The safest thing is to confirm that filing by contacting the debtor and obtaining a case number and/or name and telephone number of the debtor’s attorney. Alternatively, most attorneys can confirm the filing through the bankruptcy court’s online filing system, PACER.

Failing to confirm a filing can have adverse consequences. Not only is any action taken in the pursuit of collection voidable post-filing, such action may open you to monetary liability. Actions taken in pursuit of debt collection — even actions as simple as filing a lien — violate the Bankruptcy Code’s ‘automatic stay’ provisions and are voidable.

What is ‘proof of claim’?

In the business world, to receive payment for services rendered or products supplied, you submit an invoice. In a bankruptcy proceeding, creditors file a proof of claim. You should attach any and all documents that support your claim. For example, if the claim is based on a promissory note, attach the note. If the debt is secured by collateral, attach confirming documents, such as a Uniform Commercial Code Financing Statement (UCC-1). A proof of claim is deemed allowed upon filing with no more action to be taken unless and until an objection is filed as to the claim.

This does not mean that you will receive all or any money from the debtor. Rather, it establishes your claim and its position within the hierarchy of claims payment. You do not have unlimited time to file proof of claim. In a Chapter 7 (liquidation) case, the deadline is usually 90 days after the first meeting of creditors. In Chapter 11 (reorganization) cases, the court sets the deadline.

How do I move up in the payment hierarchy?

Vigilance in the processing and protection of your claim before bankruptcy is filed is key to your position in the hierarchy of claims payment under the Bankruptcy Code. Where your claim falls in terms of payment is entirely dependent upon the classification of your debt prior to the bankruptcy filing. So, if your debt is secured, your claim will have priority, i.e., be paid before general unsecured creditors. This does not mean that your claim will be paid in full, or even at all.

Conversely, failure to properly perfect and record your security interest may cause your claim to be classified as unse-cured, which is close to last in line for payment. Further, because the bankruptcy trustee (or the debtor in Chapter 11 cases) can avoid any transfer of an interest in the debtor’s property (such as filing a UCC-1 or other lien documents) that occurred up to 90 days before the filing, it is important to ensure that you are timely taking the necessary steps to perfect your security interests and thereby protect any potential claim should the debtor file for bankruptcy protection.

What is this going to cost me?

This depends on numerous variables that should be analyzed in considering how best to proceed. Just because a debtor files for bankruptcy protection does not mean you should throw up your hands and write off the debt. Chances are you will not receive 100 cents on the dollar. But, if you take the necessary steps during the course of your everyday business activities to perfect and protect your claim, chances are good that you will receive some return.

In any case, consult a bankruptcy attorney who can explain the process and your options and help you determine an appropriate course of action.

Successor liability generally describes the result of a court’s application of various legal theories to an acquisition transaction to hold the buyer responsible for liabilities the buyer did not explicitly agree to assume. Two of the significant theories of successor liability include the de facto merger doctrine and the continuity of enterprise doctrine.

The de facto merger doctrine holds the buyer responsible for liabilities not expressly assumed under the theory that the result of the acquisition is essentially a merger of the buyer and the seller. The elements of a de facto merger are 1) continuity of management, personnel, physical location, assets and general business operations, 2) continuity of shareholders, 3) cessation of the seller’s ordinary business operations and its dissolution as soon as legally possible and 4) the buyer’s assumption of the seller’s obligations ordinarily necessary for the uninterrupted continuation of the seller’s normal business operation.

The continuity of enterprise doctrine does not require proof of the continuity of shareholders. Instead, this doctrine holds the buyer responsible for liabilities the buyer did not explicitly agree to assume under the theory that the buyer has essentially continued the seller’s business. The elements of a continuity of enterprise finding are 1) continuity of the outward appearance of the seller’s enterprise, management, personnel, physical plant, assets and general business operations, 2) the seller’s prompt dissolution following the transfer of assets and 3) the buyer’s assumption of the seller’s liabilities and obligations ordinarily necessary for the uninterrupted continuation of the seller’s normal business operations.

Some courts have also found buyers strictly liable for defects in products previously manufactured and distributed by sellers under a variation of the continuity of enterprise doctrine that, in essence, holds that responsibility for such liabilities was the price the buyer had to pay for the seller’s good will and the buyer’s ability to enjoy the fruits of that good will.

What structural steps can the buyer take to minimize the likelihood of a successor liability finding?

The buyer should obtain guidance regarding the development and treatment of theories of successor liability under the laws of jurisdictions that could potentially govern the acquisition transaction to select a reasonable jurisdiction with less expansive successor liability doctrines. The buyer should also analyze and implement potential acquisition structures with the aim of avoiding elements that contribute to a successor liability finding. The buyer may, for example, significantly reduce or eliminate common personnel and business locations since continuity of the seller’s business into the buyer’s period of ownership is a common theme in current successor liability doctrines. In addition, the buyer could require the seller to delay liquidation proceedings for a reasonable period of time to avoid a finding of prompt dissolution. While business considerations will significantly impact the acquisition structure and the integration of the acquired assets into the buyer’s operations, the buyer should remain mindful of structural components under the buyer’s control that can minimize a successor liability finding.

What contractual provisions can the buyer include to reduce the risk of successor liability?

The buyer should negotiate for an unambiguous listing of the liabilities the buyer is acquiring through the inclusion of clauses in the acquisition agreement specifically setting forth the liabilities assumed by the buyer (i.e. at the closing, the buyer shall assume and agree to discharge only those liabilities of the seller set forth on Schedule 1) and clauses explicitly providing that liabilities not assumed by the buyer are retained by the seller (i.e. every liability of the seller not assumed by the buyer shall remain the sole responsibility of and shall be retained, paid, performed and discharged solely by the seller). The terms of the acquisition agreement should clearly state that unexpected liabilities are the seller’s responsibility.

In addition, the buyer should seek to incorporate provisions in the acquisition agreement requiring the seller to comprehensively indemnify the buyer for unexpected liabilities, including liabilities accruing to the buyer as a result of a finding of successor liability (i.e. the seller will indemnify and hold harmless the buyer for any loss, liability, claim, damage or expense, whether or not involving a third party, arising from or in connection with any liability arising out of the ownership or operation of the acquired assets prior to the closing other than the assumed liabilities). The buyer should also consider including an arrangement whereby the parties will place a portion of the acquisition consideration in escrow to meaningfully support the seller’s indemnification obligations.

The buyer should consult with appropriate counsel on a case-by-case basis regarding additional and/or alternative contractual provisions to include in the acquisition agreement to further reduce the risk of successor liability.