Creditor’s Rights: A General Overview

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As a society attempting to navigate a post-Covid19 pandemic environment, creditor rights are more important than ever before.  Legal issues related to creditor rights, insolvency, and reorganizations represent urgent and critical issues for many creditors during these times.  Bet the company issues for both debtors and creditors include complex chapter 11 bankruptcy reorganizations and chapter 7 liquidations, insolvency, business reorganization, related commercial litigation, non-judicial liquidations, acquisitions, out-of-court workouts and general assignments for the benefit of creditors.  Creditors need sound and experienced advice on how to best protect their interests, including creditor rights during debtor’s pre-bankruptcy petition planning and post-bankruptcy petition planning.  A creditor should proactively engage counsel and move diligently through a review of collateral and security interests, material adverse changes, force majeure, and contract provisions like assignment clauses, representations and warranties, and indemnification.

In addition to issues directly affecting creditors, other entity rights include bankruptcy trustees, creditors’ committees, asset purchasers and assignees/assignors in the context of a general assignment for the benefit of creditors. These issues arise in the context of publicly and closely held companies, as well as high net worth individuals.

Proper advisory services to creditors and related entities should place great emphasis on counseling clients regarding risk mitigation and other preventative and dispute resolution measures, which include mediation and arbitration, to minimize loss where possible and to minimize legal costs and disruption of business operations. However, in many context, litigation may be necessary to protect rights and require aggressive responses to disputes that cannot be settled by the parties themselves.

Advising clients based on economic value is a key consideration where decisions cannot be made based on the law alone, but instead based on the economics of the situation, the value of the issue at hand, the expected cost to obtain results, and the probability of achieving success.

Insolvency is the legal term describing the situation of a debtor who is unable to pay his, her, or its debts. There are two primary types of insolvency: cash flow and balance sheet.

In cash flow insolvency, the debtor suffers from a lack of financial liquidity making it impossible to pay debts as they fall due. This is the type of insolvency most individuals experience prior to filing for bankruptcy.

Balance sheet insolvency, on the other hand, involves having negative net assets, where one’s liabilities exceed their assets. This is the form of insolvency normally described by corporate entities prior to filing for bankruptcy.

Notably, insolvency is not the same as bankruptcy. For example, a business be cash flow insolvent but balance sheet solvent and, as a result, would likely be unable to qualify for bankruptcy protection. Indeed, many businesses have negative net assets (i.e., they are balance sheet insolvent) but remain cash flow solvent as their ongoing operations meet their regular debt obligations, helping them avoid default. This is usually the period prior to a company being “in the black,” as it is commonly described.  Insolvency means the inability to pay one’s debts as they fall due. Usually used to refer to a business, insolvency refers to the inability of a company to pay off its debts. Business insolvency is defined in two different ways: Cash flow insolvency Unable to pay debts as they fall due. Balance sheet insolvency is having negative net assets – in other words, liabilities exceed assets.

Under the Uniform Commercial Code, a person is considered insolvent when they have stopped paying their debts or cannot pay their debts as they become due. Some federal laws exist to protect insolvent persons or businesses, including the bankruptcy code.   However, a recent trend has put the focus onto individual corporate officers and directors if it is shown that they have intentionally or negligently driven a company into the ground, possibly for the purpose of seeking bankruptcy relief.

Key Creditor Rights Statutes and Organizations in US

Fair Debt Collection Practices Act.  The Fair Debt Collection Practices Act (FDCPA), 15 U.S.C. § 1692 et seq., is a United States statute added in 1978 as Title VIII of the Consumer Credit Protection Act. Its purposes are to eliminate abusive practices in the collection of consumer debts, to promote fair debt collection, and to provide consumers with an avenue for disputing and obtaining validation of debt information in order to ensure the information’s accuracy. The Act creates guidelines under which debt collectors may conduct business, defines rights of consumers involved with debt collectors, and prescribes penalties and remedies for violations of the Act.

Model Law on Cross-Border Insolvency – Chapter 15 of the US Bankruptcy Code.  Chapter 15 is a new chapter added to the Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. It is the U.S. domestic adoption of the Model Law on Cross-Border Insolvency promulgated by the United Nations Commission on International Trade Law (“UNCITRAL”) in 1997, and it replaces section 304 of the Bankruptcy Code. Because of the UNCITRAL source for chapter 15, the U.S. interpretation must be coordinated with the interpretation given by other countries that have adopted it as internal law to promote a uniform and coordinated legal regime for cross-border insolvency cases.

United States Federal Courts – Bankruptcy.  Bankruptcy laws help people who can no longer pay their creditors get a fresh start – by liquidating assets to pay their debts or by creating a repayment plan. Bankruptcy laws also protect troubled businesses and provide for orderly distributions to business creditors through reorganization or liquidation.

American Bankruptcy Institute.  The American Bankruptcy Institute is the largest multi-disciplinary, non-partisan organization dedicated to research and education on matters related to insolvency. ABI was founded in 1982 to provide Congress and the public with unbiased analysis of bankruptcy issues.

FTC – Bureau of Consumer Protection.  The Federal Trade Commission is the nation’s consumer protection agency. The FTC’s Bureau of Consumer Protection works for the Consumer to prevent fraud, deception, and unfair business practices in the marketplace. The Bureau: Enhances consumer confidence by enforcing federal laws that protect consumers * Empowers consumers with free information to help them exercise their rights and spot and avoid fraud and deception * Wants to hear from consumers who want to get information or file a complaint about fraud or identity theft.

International Association of Restructuring, Insolvency and Bankruptcy Professionals.  INSOL International is a world-wide federation of national associations for accountants and lawyers who specialize in turnaround and insolvency. There are currently 40 Member Associations world-wide with over 10,000 professionals participating as Members of INSOL International.

National Association of Credit Management.   NACM® was founded in 1896 to promote good laws for sound credit, protect businesses against fraudulent debtors, improve the interchange of credit information, develop better credit practices and methods, and establish a code of ethics.

Another key issue for creditors is to prevent its debtors from transferring key assets out of the reach of creditors and out of the control of the debtor.  It is critical that a creditor preemptively prevent such transfers but when they occur, a creditor must move aggressively through the court system to reverse such transfers under the fraudulent transfer laws.  What is a fraudulent transfer?  The basic goal behind California’s Uniform Fraudulent Transfer Act (UFTA) is to prevent debtors from “giving away” their assets before creditors can get to them. Just before filing for bankruptcy, a debtor may attempt to give his or her home or other properties to a relative. A debtor may also attempt to sell property at a bargain price. These types of transactions are illegal under California law, and may give rise to an action by creditors to void the transaction or treat it as if it never happened.

Under the UFTA, a transfer may be fraudulent whether the creditor’s “claim” arose before or after the transfer was made or the obligation was incurred. A “creditor” is defined to mean a person who has a claim.” A “claim” means a right to payment, whether the right to payment has been ordered by a judge or is disputed. Therefore, a debtor’s transfer could be deemed fraudulent under the UFTA even before a lawsuit has been filed by a creditor.

Two Types of Fraudulent Transfers.  There are two types of fraudulent transfers–actual fraud and constructive fraud. Actual fraud requires the specific intent to defraud a creditor. The typical scenario involves a debtor who donates his or her assets, typically to an “insider” who is a friend or family member, and leaves nothing to pay his or her creditors. The court will consider a number of factors in determining whether intent to defraud has occurred, including, whether the transfer or obligation was disclosed or concealed, whether the transfer was of substantially all the debtor’s assets, and whether before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit.

Constructive fraud does not require proof of an actual intent to hinder or delay a creditor’s rights. Rather, it looks to the underlying economics of the transaction to determine whether a fraudulent transfer has occurred. For example, where the debtor was insolvent and did not receive reasonably equivalent value for the property transferred, the transfer may be deemed fraudulent.

Once a transfer has been deemed fraudulent under the UFTA, the law provides several remedies for both present and future creditors. If the creditor has obtained a judgment on a claim, the creditor may attach the asset transferred or the proceeds from a sale. If a claim has not been reduced to judgment, the fraudulent transfer may be “voided” and treated as if it never happened. The creditor can also obtain an injunction against further disposition of the asset by the debtor.

Fraudulent Transfer Lawsuits. There are many different scenarios that can lead to a fraudulent transfer lawsuit other than the actions of a simple debtor and creditor. Innocent buyers thinking they were making a great investment as well as trustees and administrators may be liable for their part. Speaking with a trusted and knowledgeable fraudulent transfer attorney is the best line of defense. Alternatively, an experienced fraudulent transfer attorney is also needed if you believe you have a claim under the UFTA. Wherever you stand, the attorneys at YK Law, LLP can help.

When a business’s customer fails to pay his or her debts, the business (as a “creditor” to which the debt is owed) has several remedies to help collect the money from the customer (as “debtor”). These methods include remedies that do not require court involvement (called “self-help” remedies), and remedies that do involve the courts, discussed in more detail below.

Many creditors’ first attempts at debt collection do not involve the courts. The creditor may simply contact the debtor directly and demand payment. If these attempts fail, the creditor may transfer the debtor’s account to another business whose focus is debt collection. The practices of these debt collection agencies are regulated in order to avoid abuses. For instance, the Fair Debt Collection Practices Act (FDCPA) prescribes how, when, and where debtors may be contacted, and prohibits deceptive practices. If a debt collector violates the act, the debtor may be entitled to recover damages. The FDCPA applies only to persons who regularly collect debts owed to someone else, but not to creditors collecting their own debts.

Secured transactions, for instance, are sale or loan transactions in which the debtor gives the creditor a claim to the debtor’s property in order to ensure payment as promised. A secured creditor takes priority over an unsecured creditor if there are competing claims to the property or to the proceeds from the sale of the property. To attain this higher status, however, the creditor must “perfect” its security interest, usually by filing certain required documents. Most consumer transactions are unsecured, but home and motor-vehicle financing usually is secured by the property being purchased by filing financing statements through a Uniform Commercial Code, UCC-1. If a car loan is secured and the debtor fails to make the payments, the lender can take back the car in order to cover at least part of the remaining debt.

Sometimes, a creditor will initiate court proceedings in order to collect on a debt. In cases involving emergencies, the creditor may be able to seize the debtor’s property even before the court decides the matter. These are extraordinary measures, however, and should be employed only when other methods would be futile or useless, such as when perishable goods are involved, or when the collateral, if left in the debtor’s control, would rapidly decline in value.

Two of the more common pre-judgment remedies are replevin and attachment, which is similar to garnishment. In a replevin action, a creditor that holds title to property that is the subject of a debt may take that property back if the debt is not repaid. A lessor of furniture, for example, may be able to take back its property if the lease payments are not made, but often notice and hearing requirements must be met before that can happen. These requirements may be waived if the property is in imminent danger of destruction, or under other exceptional circumstances. Ordinarily, the county sheriff must execute the order of replevin, seize the property, and deliver it to the creditor.

Attachment is a procedure set forth in state statutes, and the particular details of the procedure vary by jurisdiction. In an attachment proceeding there is usually a court hearing, after which the court issues an order authorizing the creditor to take the debtor’s property or title to the property. Like replevin, attachment is available in only extraordinary cases, such as when the debtor is about to dispose of the property.

Lawsuits and Liens. If all of the remedies described above fail, the creditor can sue to collect the debt under numerous legal theories such as breach of contract, and state claims such as the common counts of money had and received, money lent, account stated, and open book account. The creditor will be entitled to an enforceable judgment if it proves its case and obtains a judgment on the merits of its case or if the debtor fails to contest the claim and the creditor obtains a default judgment.

Judgment Enforcement.  Once a judgment is obtained, the creditor can enforce the judgment by claiming enough of the debtor’s property to cover the amount of the judgment, and depending on the contract terms between the creditor and debtor, potentially attorney fees and costs of collection, although this varies by the specific facts of your case.  Specific procedures for collection post-judgment includes a writ of execution of the judgment, abstracts of judgment, wage garnishment, property liens, foreclosures, and local sheriff enforced procedures such as a till tap, bank account levy (or other levy), and repossession.  The sheriff may literally seize property (except for cannabis related to a lawful cannabis transaction), if the property is an asset subject to a writ of execution or other judgment enforcement procedure.  In other cases, a sheriff or other court official will simply record into a state or county’s property records the creditor’s lien against the property, such as when real estate or a sales transaction is involved.

A local sheriff can arrange for a sale of the property at an auction, the proceeds of which are used to satisfy the debt. Often, more than one creditor is involved in attempting collection, but they will be paid in a particular order of priority, which is usually based on the order in which the creditors established (either through perfecting or recording first) their legal claims to the property.  As you can see, it is important to include a security interest in the debtor’s collateral in any agreement where you have the bargaining leverage to add such a requirement to your contract.  You can secure your interest in the contract through any assets of the contracting party by agreement. One way to increase leverage is to renegotiate due dates in exchange for a security interest or a further pledge of collateral.

A lien is another type of legal claim to the debtor’s property that helps ensure debt repayment. There are several types of liens, including:

  • Judgment liens: These liens can arise if a creditor goes to court to collect on a debt and proves its case, or the debtor fails to contest the matter. The court will order a judgment in the creditors favor in the amount owed to it by the debtor, and the creditor then has a lien against the debtor’s property in the amount of the judgment.
  • Materialmen’s and mechanics’ liens: These are two examples of this type of property interest that ensures the creditors’ recovery. A creditor with a lien on the debtor’s property may in certain circumstances foreclose on the lien and sell the property to satisfy the debt.

Involuntary Bankruptcy Proceedings.  If none of these debt-collection tactics is successful and the debtor owes a substantial amount to several creditors, the creditors may be able to initiate an involuntary dissolution of the entity or an involuntary bankruptcy proceeding.  If the court accepts the petition, the debtor may be forced to liquidate its assets to pay off its debts, or it may be able to file a reorganization plan that sets out how its debts will be paid. If the creditors initiate such a proceeding in bad faith, however, they may be subject to severe financial penalties, including punitive damages.

Chapter 7 Business Liquidations and Chapter 11 Reorganizations.  YK lawyers are experienced at handling complex company matters where a party seeks the protection of US Federal Bankruptcy protection under Chapter 7 Business Liquidations and Chapter 11 Reorganizations.  YK attorneys handle both debtor and creditor related matters.  In the liquidation setting, firm lawyers are experienced in making such liquidation on an orderly basis and handling any claims of bad faith or fraudulent transfers. Under Chapter 11, YK lawyers have experience in assisting a Debtor in Possession, who attempts to negotiate a Confirmed Plan of Reorganization with each one of the classes of creditors.  Our attorneys are also experienced in litigation of adversary proceedings arising under the bankruptcy case before the Federal Bankruptcy Court.

Appointment of a Receiver.  YK lawyers handle cases where creditor rights demand a skilled third-party accountant or financial professional to take charge of an entity bookkeeping procedures through a court appointed procedure.  Creditor rights are on the line and require a YK attorney to appear on behalf of creditor protection in certain cases.

Creditor Claims in Statutory Dissolution.   YK lawyers handle protecting creditor rights in situations involving statutory voluntary and involuntary winding down of an entity.  Where necessary, YK lawyers make the necessary legal filings where creditor rights are compromised through the dissolution process.

Bankruptcy, Restructuring, Creditors’ Rights in general.   The attorneys at YK Law practicing in the Creditor Rights, Business Bankruptcy and Corporate Restructuring Practice are experienced in advising and representing creditors affected by insolvency, bankruptcy and financially troubled businesses, to address the impact of financial distress.   Our firm’s experience in multiple areas of the law, spanning numerous industries, assures our ability to effectively and efficiently address every aspect of a case, whether in judicial proceedings in federal, state court or out of court.  Issues may include advising and representing clients in matters involving bankruptcy litigation,  complex multi-party litigation in federal and state court, corporate reorganizations and bankruptcies creditors’ rights, distressed sales and acquisitions, insolvency proceedings, receiverships, assignments for the benefit of creditors, out of court workouts, real estate transaction restructurings, committees and other ad hoc groups of creditors, secured creditors or landlords of distressed businesses, governmental entities, insurance carriers, purchasers and sellers of assets in distressed sales, receivers and other probate and trust estate representatives, secured and unsecured creditors, sureties, tenants of distressed companies, UCC Article 9 foreclosure sales, and trustees (Chapter 7 and Chapter 11).  These and other matters may also involve representing Chapter 11 creditors or debtors in possession, lenders and other secured creditors, unsecured creditors, indenture trustees, liquidating, litigation, and post-confirmation trustees, asset or stock purchasers from a merger/acquisition transaction, landlords, intellectual property licensors and licensees, franchisors and franchisees, investors, shareholders, advisors, officers and directors in creditor rights issues, and actors, writers, producers, and other talent.

We regularly advise clients in out-of-court restructurings, loan workouts for both borrowers and lenders, distressed acquisitions, debtor-in-possession financing, investments in distressed assets and securities, creditors’ rights, bankruptcy and insolvency-related litigation, including pursuing and defending collection and recovery actions and bankruptcy court adversary proceedings, defending preference and fraudulent transfer lawsuits, and establishing and enforcing receiverships.

Complementing our broad experience in restructuring and reorganization, we are assisted by our attorneys in other practice areas, including commercial litigation, tax, ERISA, securities law, intellectual property, real estate, landlord-tenant, environmental, labor and employment, banking, corporate, healthcare, entertainment, capital markets, mergers/acquisitions and regulatory, to assist our clients in achieving their business objectives. Our team delivers the kind of personalized, focused attention normally associated with boutique firms while demonstrating the deep knowledge, relationships, and capabilities of a large, multi-national law firm.

In addition, YK Law, LLP attorneys have unique experience in recapitalizing, restructuring and turning around cross border deals of all kinds and domestic deals that have EB-5 investments in the capital structure, including real estate and entertainment financing transactions, as well as other projects that utilize EB-5 funds.

Our clients benefit by receiving consistent counsel from one integrated team as they proceed through a complex bankruptcy, restructuring or creditors’ rights matter. Working as a team, we can anticipate each aspect of a case from beginning to end, achieving better results and more efficient representation for our clients.

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