Web prepared, posted and Copyright © March 31, 2001, by the American Bankruptcy Institute.

Prompt Payment of Your Pre-petition Claim May Not Be a Good Thing

By: Thomas G. Macauley
Zuckerman, Spaeder, Goldstein, Taylor & Kolker LLP

Shortly after filing a chapter 11 petition, a debtor has an opportunity to request immediate relief from the bankruptcy court to facilitate operations of the company and administration of its chapter 11 case. It has become common for a debtor to request authorization to pay certain pre-petition claims of critical vendors under the "necessity of payment" doctrine, which allows payment of pre-petition claims if such payment is essential to the continued operation of the company.

To most creditors, this seems like a great result: immediate payment of a pre-petition claim without chapter 11 delay or doubt. Before accepting such a payment, however, the creditor would be wise to determine whether the offer has strings attached that diminish or eliminate any benefit from the payment.

As an initial matter, the creditor should realize that payment of the pre-petition claim does not lessen or eliminate the creditor's potential exposure to preference attack for payments received in the 90-day pre-petition period. Thus, a creditor would be wise to conduct a preference analysis before accepting payment of its pre-petition claim, and consider whether some additional bargaining may be possible on the issue.

More importantly, however, many orders authorizing payment of pre-petition claims contain what is referred to as a "trade credit clause," which requires the creditor to provide trade credit to the debtor for some period of time on terms similar or identical to the terms available before the chapter 11 filing. Several recent trade credit clauses approved by the Delaware bankruptcy courts have required creditors to provide such credit for the duration of the chapter 11 case. The penalty for non-compliance with a trade credit clause is generally disgorgement of any payment received on the pre-petition claim as an unauthorized post-petition transfer under Bankruptcy Code §549.

By agreeing to provide trade credit for the duration of the chapter 11 case, the creditor loses its ability to modify trade credit terms or to withhold credit altogether in the event the debtor's financial picture deteriorates. Thus, before a creditor agrees to be bound by a trade credit clause, the creditor should consider the debtor's financial condition and the extent of the pre-petition trade relationship.

Trade credit clauses may also bind a successor or assignee of the creditor, or be enforced by a successor of the debtor. It is conceivable that a debtor could seek disgorgement from a trade creditor that is unwilling to subsequently extend trade credit to a purchaser of the debtor's assets, especially if the purchase agreement penalizes the debtor for the trade creditor's actions.

In short, creditors that receive notice from a debtor, whether by letter or motion, that the debtor will seek authority to pay the creditor's pre-petition claim must closely read the fine print of the offer. Only by actively participating in the process can the trade creditor learn the true terms of the deal, including whether an ongoing obligation to provide continuing trade credit is a necessary prerequisite to payment. Only with such knowledge can the trade creditor determine what course of action to take.

2000 Winter Leadership Conference UTC Committee Minutes

The meeting was conducted by co-chairs Judy D. Thompson (Poyner & Spruill L.L.P.; Charlotte, N.C.) and Sandra Schirmang (Kraft Foods Inc.; Northfield, Ill.).

Congratulations and acknowledgment were given to Geoffrey Berman (Development Specialists Inc.; Los Angeles) for his completion of the publication, General Assignments for the Benefit of Creditors—A Practical Guide. Copies of the handbook were distributed to all participants at the ABI Winter Leadership Conference.

Bruce Nathan (Davidoff & Mailito L.L.P.; New York) reported on the Reclamation Handbook project. The manuscript for the Reclamation Handbook has been completed and submitted to the ABI Vice President-Publications, Rick Meth (Herrick Feinstein LLP; Newark, N.J.). It is anticipated that, barring new legislative developments, the handbook will be available for distribution during the first quarter of 2001 at the NACM Legislative Conference.

Lynnette Warman (Jenkens & Gilchrist PC; Dallas) was commended for her continuing good work in the area of committee publications and for the November 2000 issue of News & Views. A call was issued to all committee members and credit managers for articles.

The 2001 National Association for Credit Managers' Legislative Conference was held March 4-5, The UTCC, working under the leadership of Joseph S.U. Bodoff (Bodoff & Associates; Boston) sponsored a social event. Jim Jenson (Northwest Hardwoods; Portland, Ore.) and Steve Darr (KPMG Pete Marwick; Boston) assisted Mr. Bodoff.

The preference subcommittee has completed the first draft of its manuscript for the preference handbook under the leadership of David Wheeler (Moore & Van Allen; Charleston, S.C.). A request was issued for persons who may be interested in assisting in editing the final version of the handbook, which is targeted for publication in spring, hopefully in time for the ABI Annual Meeting in April.

The continuing education program at our meeting was presented by Lawrence R. Ahern III (Gullett, Sanford, Robinson & Martin PLLC; Nashville, Tenn.) and Kim Martin Lewis (Dinsmore & Shohl, Cincinnati). The program was titled "Current Issues of Interest to Unsecured Creditors" and covered recent case developments regarding payment of expenses (including attorney fee expenses) of members of creditors' committees, consignment issues, reclamation and purchase money security interests. Copies of the materials are available from Mr. Ahern at lahern@aol.com.

The next regular meeting of the UTCC will be at the annual meeting April 19-22, 2001, in Washington, D.C. For more information, or to get involved in committee activities, e-mail Judy Thompson at jdthompson@poynerspruill.com or Sandra Schirmang at sschirmang@kraft.com. Contributions to the newsletter should be addressed to Lynnette Warman at lwarman@jenkins.com.

—Judy Thompson
Poyner & Spruill LLP; Charlotte, N.C.

The "Nuts & Bolts Creditors' Forum" is a feature that contains questions relating to credit issues and their suggested solutions. Questions or comments to be included in future newsletters are welcome. Question: How can members of a creditors' committee protect themselves from liability for their actions as a committee member? Answer: The subject of liability issues facing creditors' committees has come up in various forums and with several different viewpoints over the past four years. I have been directly involved with this subject since I first was asked to insure a pre-petition committee during an informal workout in 1995. As I familiarized myself with the various issues the committee faced and subsequently spent several months with bankruptcy attorneys discussing how to properly insure committees against these issues, I was surprised that the concept of insuring committees had not come up earlier. Conceptually, it is very simple. Nearly everyone involved in the bankruptcy process has already availed themselves of this form of protection against the uncertainties that may arise as a result of their participation. In the event that someone sues you over allegations that you either did something that you should not have, or did not do something you should have, and it negatively impacted them, an insurance policy provides a defense and potential indemnity.1 Because the Bankruptcy Code confers significant responsibilities upon the various committees negotiating under chapter 11 but does not offer corresponding protections, the courts originally attempted to correct the imbalance by finding an "implied grant of limited immunity." In re Drexel Burnham Lambert Group Inc., 138 B.R. 717 at 722 (Bankr. S.D.N.Y. 1992) (equity committee). The steady erosion of the protection offered by limited immunity has been both rapid and predictable to anyone familiar with other areas of liability law. The grounds under which limited immunity can be pierced have finally devolved to their current status, as illustrated by the committee in Vascon v. Credit Manager Assoc. of Calif., 1997 WL 383170 (N.D. Cal. 1997) (quoting In re Tucker Freight Lines Inc., 62 B.R. 213, 216 (Bankr. W.D. Mich. 1986)). The allegations in this case involve nothing more than malpractice. In that instance, the committee returned nearly 125 cents on the dollar, and was sued on the grounds that they could have improved the return. The court found in favor of the committee, the case was appealed, and the appellate court found in the committee's favor on every point. In closing dicta, the court noted that the committee had limited immunity. Nevertheless, the question that has to be answered is, "What good is limited immunity if it costs a committee nearly $200,000 and two years of litigation to put an end to what is arguably one of the most significant abuses of the legal process regarding a committee in recent memory?" Because of growing concerns by those selected to creditors' committees, insuring against committee liability has become increasingly popular. In nearly every instance where a committee has requested this coverage, the debtor has ultimately agreed, and the courts have followed suit. Courts are aware of the tenuous nature of the limited immunity protections, and they favor judicious application of insurance protection in an effort to keep the process functioning smoothly. Chapter 11 and post-confirmation committees have found insurance to provide a satisfactory resolution to the uncertainties raised by the ever-aggressive plaintiff's bar. The actual mechanics of procuring the coverage and gaining court appro-val follow a similar pattern. For informal committees, it's quite simple: The committee simply asks the debtor to fund the policy, and the rest is a standard insurance transaction. Post-confirmation committees often build the provisions for insuring the committee into the plan and secure the coverage once the plan is confirmed. Chapter 11 committees face the most involved process. The interested committee typically has their counsel contact a firm for a quote. If the committee votes to obtain the coverage, the committee counsel seeks to obtain the agreement of the debtor, since it is understood that gaining court approval will go much more smoothly if the debtor has raised no objection. By presenting the debtor with the specifics of the request, committee counsel can make the committee's argument to the debtor, starting with, but not limited to, the fact that the committee is integral to the process and it must be protected if the members are to serve and do their job properly. In addition, the potential financial impact to the debtor is capped by purchasing the coverage because, once the policy is in force, the likelihood of the committee seeking reimbursement for costs associated with defending themselves in the event of a lawsuit are remote. At this point, counsel for the committee will frequently ask for copies of successful motions that they can study as they prepare their own. Though the courts have been uniformly supportive of this approach, the committee can generally expect significant opposition from the U.S. Trustee assigned to the case. Philosophically, the trustee's office is generally opposed to the use of estate funds to purchase insurance, and their position remains consistent with respect to committee liability insurance. In In re Criimi Mae Inc., Case No. 98-23115 (Bankr. S.D. Md. May 26, 1999) (granted as to equity committee, denied as to creditors' committee), the court approved the use of estate funds as a reasonable and necessary expense over the objection of the U.S. Trustee. The U.S. Trustee appealed the case, arguing that the court did not have the authority to grant such a request and that in any event, the purchasing of insurance for the committee was not a reasonable and necessary expense as set forth in the Bankruptcy Code. The appellate court found that not only was the court within its authority when it granted the motion, but also that the U.S. Trustee had attempted to define "reasonable" and "necessary" too narrowly, and that this expense was indeed permissible within the intent of the law. In In re Kennetech Windpower Inc., Case No. 96-44426 T. (Bankr. N.D. Cal. Oct. 30, 1998), the committee argued that even the cost of litigation would cause significant harm to certain members of the committee, and that the fact that these policies have no deductible made the protections offered to the committee well worth the cost of such policies. Of course, courts have typically reviewed the provisions of the proposed insurance and the associated costs, but as yet neither of these subjects have proven an obstacle in the granting of the committee's motion. *   *   * In early 1999, we received our first notice of claim under one of our policies and have been in the process of litigating the case since. Thus far, underwriters have expended in excess of $80,000 in the defense of this lawsuit, and it will likely top $100,000 before all is said and done. In this instance, the committee's cost of insurance was less than half of the expected total defense for a two-year policy. The costs associated with even something as simple as a motion for summary judgment are far in excess of the premium of almost every policy that's been sold. Thus, each committee should analyze the various issues and potential liabilities at the start of the case and make a decision regarding insurance that is appropriate under the circumstances. —Robert Gore RKG Surplus Lines Brokers; Irvine, Calif.2 Footnotes 1 For a more detailed background discussion of the evolution of case law surrounding committee liability, please visit my web site at www.rkgore.com and review the articles that appeared in the ABI Journal's Last in Line column on this subject. Return to Nuts & Bolts 2 RKG Surplus Lines has developed a line of insurance policies specifically tailored to address the issues facing committees and their members. Return to Nuts & Bolts

UTC Committee Meeting Calendar

The UTC Committee will meet at the upcoming conferences:

• April 19-22, 2001:
  ABI Annual Spring Meeting
  J.W. Marriott, Washington, D.C.
• Nov. 29-Dec. 1, 2001:
  ABI Winter Leadership Conference
  LaCosta Resort & Spa, Carlsbad, Calif.

The next issue of News & Views will be published in the late summer. Call Lynnette Warman at (214) 855-4792 or e-mail lwarman@jenkens.com for more information.

2001 ASM UTCC Agenda

The UTCC will meet at the 2001 ABI Annual Spring Meeting in Washington, D.C., on Sunday, April 22, 2001, from 8:00-9:30 a.m.

I. Ad Hoc Task Force on Trade Creditor Involvement (Tom Grace, Locke Liddell & Sapp; Houston)
II. Reclamation Project (Bruce Nathan, Davidoff & Mailito L.L.P.; New York)
III. Report on Publications (Lynnette Warman, Jenkens & Gilchrist PC; Dallas)
IV. NACM Legislative Conference Outcome Report (Joe S.U. Bodoff, Bodoff & Associates; Boston)
V. Preference Project Update (David Wheeler, Moore & Van Allen; Charleston, S.C.)
VI. Identification of New ProjectÜIdeas?
VII. Educational Program (Eugene Chikowski, Becket & Lee LLP, Malvern, Pa.):

• Unsecured Creditors in Bankruptcy Land—Bug or Windshield? How to Avoid One and Become the Other
• Pre-bankruptcy Planning—It's Not Just for Debtors Anymore
• First-day Orders (Critical Vendors)—They Want Me to Sell to Them?
• Avoidance Litigation—Who'd Have Thunk Those %$#^@& Sued Us After All We Did for Them!
• The Liquidating 11—Who Died and Left the Committee in Charge?