Best Practices in an Economic Downturn: Minimizing Risks and Maximizing Returns in Bankruptcy Court

Best Practices in an Economic Downturn: Minimizing Risks and Maximizing Returns in Bankruptcy Court

By Shannon Raye Martinez

It is never good news to hear that someone who owes you money has filed bankruptcy. At least, that is the common perception of bankruptcy for creditors. Many people feel that it’s hopeless when someone files bankruptcy, and you will never recover what is owing to you. But, it’s not hopeless. There are a lot of opportunities available to a proactive creditor facing a potential bankruptcy filing. There are ways to protect yourself, both before and after the bankruptcy filing, to recover the debts owed to you. This article will discuss some of the options available to creditors to minimize the risks and impacts of a potential bankruptcy filing.


If you are a “secured” creditor in the bankruptcy, you have much better odds of recovery, provided that the collateral securing the debt has sufficient value. If the debtor has assets available, it is good practice to get a lien or security interest in one or more of the debtor’s assets to cover the amount owing to you. Some liens are also available to a creditor, provided certain actions are taken by the creditor without the consent of the debtor. Some examples of these liens include agricultural service liens and construction liens. Where such liens are not available, it is usually best to negotiate receiving security before you loan money or sell goods to the debtor; however, you can still negotiate and obtain a security interest, if available, even after the debt is owing to you.


Whether the debtor is an individual or a business, you could obtain a personal guaranty from a third party to guarantee repayment of the debt. Often owners of the business will personally guarantee repayment, for example, in order to obtain a loan. This is also something that should be negotiated at the onset of the relationship with the debtor. If the debtor files bankruptcy, the bankruptcy case will not affect your ability to recover the debt from the guarantor in most cases.


The Bankruptcy Code allows the bankruptcy trustee, in some circumstances, to recover amounts paid by the debtor to its creditors within 90 days before the bankruptcy petition. These payments are referred to as “preferential transfers.” There are several defenses that may be available if the trustee attempts to recover payments received shortly before a bankruptcy filing. But, a creditor must take measures before the bankruptcy filing to have these defenses available.

There are seven elements the trustee must prove in order to prevail in a preference action against a creditor. First, the transfer must be a transfer of the “debtor’s property.” In many cases, if the creditor receives the payment from a third party, this is not considered the debtor’s property. For example, to avoid receiving payments directly from the debtor, a creditor could sell the debt or receivable to a third party.

In order to be considered as a preferential transfer, the payment must be made while the debtor is “insolvent.” The test for solvency is whether the debtor’s assets exceed its liabilities. To try to minimize or avoid this argument, the creditor can obtain an affidavit or sworn statement from the debtor explaining that its assets exceed its total liabilities at the time of the payment.

Another common defense to a preference action is that the payment was made in the “ordinary course of business” with the debtor. For example, suppose a supplier has been selling goods to the debtor on a monthly basis, and the invoices state that the payments are due to the supplier within 30 days after the date of the invoice. Previously, the debtor made payments between 30 and 45 days after the date of the invoice. However, in the six months prior to filing bankruptcy, the debtor only made one payment. That one payment was made just 30 days before the bankruptcy filing. Also, the payment only covered the amount of one month’s invoice, even though the debtor owed payments for the past six months.

This is a typical example where the bankruptcy trustee may try to recover the payment made 30 days before the bankruptcy filing as a preference payment. The best way to avoid this scenario is to constantly monitor accounts receivables and be diligent about obtaining payments timely. Unfortunately, of course, this is not always an option. In the scenario above, another option is to apply the payment to the most recent invoice, such that the payment is made in the ordinary course, or within 30 days after that invoice date. In order to assert this defense; however, the debtor should consent, in writing, that the debtor intended the payment to be applied in this manner.


If you have sold goods to the debtor, there may be options available to you to “reclaim” or take your goods back. This rule only applies if the goods were sold to the debtor: (1) in the ordinary course of the seller’s business, (2) while the debtor is insolvent, and (3) within 45 days of the bankruptcy filing. To reclaim the goods, you must send written notice to the debtor demanding reclamation within 45 days after the debtor received the goods, or 20 days after the date the debtor filed for bankruptcy, if the 45 day period expires after the bankruptcy case was commenced.

The above are examples of just some options available to creditors to minimize risks and to maximize recovery when a bankruptcy filing is likely. Bankruptcy does not have to be a hopeless process for creditors. If you are proactive, you may be able to put yourself in a better position if a bankruptcy occurs. If you have questions regarding the issues addressed in this article, please contact a member of the firm’s Creditors’ Rights Practice Group.