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Bankruptcy in the 21st Century and the Vendor/Creditor
By David N. Ravin and Michael D'Aries


As the inevitable cycle of upticks in bankruptcy filings upsets the economy, we lawyers must be aware of the vicissitudes of the Bankruptcy Code.1 There are two times we need to be concerned about the Bankruptcy Code.1 before a client enters into a transaction with another party; and 2) when a client or the party to a transaction with a client files or is involved in their own or a third party's bankruptcy. In other words, all the time.2

General Considerations

There have always been unintended consequences as a result of legislation, and bankruptcy is an area of the law with more than its share. By and large, few contracts or commercial relationships survive bankruptcy of one of the parties without being substantially modified, if not abrogated completely. Payment and performance become problematical once the race to the courthouse has been neutralized by bankruptcy. The pre-bankruptcy litigation may only serve to quantify the amount in dispute for which a claim can be filed.

To set the stage, the bankruptcy courts, district courts, and circuit courts throughout the country are not uniform in their handling of similar bankruptcy issues. Besides the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure (FRBP),3 there are local rules of the various bankruptcy courts, other federal statutes relating to bankruptcy, and the Federal Rules of Civil Procedure as incorporated by the FRBP, as well as differing substantive state law or circuit law.4 Consequently,local law and/or the interpretation of federal and/or bankruptcy law, may differ widely depending upon venue. Attorneys for debtors, given a choice of forums, frequently file where it is most advantageous to the debtor under applicable law.

A bankruptcy case can be transferred or dismissed if there is a showing that there was a bad faith filing,5 or that the balancing of equities dictate the initial place of filing was inconvenient to most creditors or employees, or the case has no nexus to the court. If there is no dispute regarding venue, or it is resolved, the main case is deemed properly filed. If necessary, the debtor also will cause some or all other affiliates, subsidiaries, and/or parents, wherever located, to file in the same jurisdiction, if they have not initially filed.6

Usually all related cases will be procedurally consolidated. Substantive consolidation is possible, but is much more complex, and in the Third Circuit is very difficult.7

Assuming your client has not been part of pre-filing negotiation with the debtor, and you are faced with a fait accompli, you will need to assess your client's options in a very short timeframe. Further, if the filing is out of state, you will need to retain local counsel quickly to provide the lay of the land regarding local rules and case law applicable to your client's issues, as well as the judge to whom the case has been assigned. But for vacations, illness, recusal, removal, death or retirement, the assigned bankruptcy judge will have the case for its duration.

Because of space constraints, the authors will review five important timing and procedural decisions that are critical to the debtor and the creditor in Chapter 7 and Chapter 11:

1. the automatic stay;
2. reclamation by creditor;
3. filing of a proof of claim by creditor; 4. removal of pending non-bankruptcy matters; and
5. remand of removed matter

The Automatic Stay

The moment a debtor files a bankruptcy petition or a creditor files an involuntary petition, most civil actions against the debtor, whether asserted by a complaint, counterclaim or cross-claim, are stayed automatically, without the need for any application or motion.8 In fact, your client's action is stayed whether you know of the filing or not. In addition, under Section 105 of the Bankruptcy Code as well as the All Writs Act, the debtor (or its trustee) can apply for injunctive relief, but that will be on notice, and the usual requirements for an interim or permanent stay will apply.9

Section 362(b) sets forth more than 27 important exceptions to the automatic stay. Section 362(c) sets forth additional situations in which the stay does not apply, including criminal proceedings, alimony and support and special provisions dealing with bad faith and repeat bankruptcy filers.10

If a party in interest believes the stay does or should not apply, it may file a motion for relief from the stay pursuant to Section 362(d).11 This motion is filed in the bankruptcy court where the bankruptcy matter is pending.

Stays can be vacated, for example, by the granting of a landlord's application for possession of leased premises where the debtor does not pay post-petition rent while determining whether to assume the lease and cure all defaults.12 Similarly, if a mortgagee or secured creditor can demonstrate the debtor has no equity in property and the property is not necessary for an effective reorganization, the stay can be lifted.13

Prior to the Bankruptcy Abuse Prevention and Consumer Act of 2005 (BAPCPA), bankruptcy judges granted "comfort orders." These orders confirm that a subject action is not affected by the stay. This has now been codified.14

Counsel is strongly advised to err on the side of caution with regard to the stay. If in doubt regarding whether the stay applies to another matter, counsel should seek relief from the stay pursuant to Sections 362(d) and (e). This is not an area where an attorney can be cavalier. As one bankruptcy court stated, "[i]t is safer to ask permission than forgiveness."15 Should you guess wrong and take action that is later deemed to be in violation of the stay, you and/or your client could face severe sanctions, including actual damages, punitive damages and legal fees. For the same reason, a party in interest who obtains relief from the stay is wise to confine its conduct within the parameters of the order granting relief; to stretch for more than the order provides may be deemed a violation of the stay.16 In any event, actions taken in violation of the stay are void ab initio.17

A bankruptcy court will sometimes grant full or partial relief from the stay.18 The bankruptcy court can lift the stay partially to the extent of liquidating damages up to judgment. However, this victory may be a hollow one, since it will only determine the amount of the claim, not the allowance or priority of payment. This saves the bankruptcy court's time and effort in presiding over the matter itself. If the debtor/trustee has claims to offset, or an adversary claim or counterclaim, chances are the bankruptcy court will hear the whole matter subject to removal and remand issues, discussed below.

Reclamation by Creditor

BAPCPA has improved the reclamation rights of a seller of goods to the debtor. The utilization of the written notice of the rights of reclamation provided by the statute will not violate the stay.19 A recovery of the goods or upgrade of the claim to administrative status is possible subject to prior security interests in goods or proceeds.20

There should be a warning on every purchase order issued to a vendor: "Our bankruptcy may be injurious to your financial health!" Maybe then clients will consult with counsel in advance of their customers' bankruptcy, rather than after the fact. BAPCPA provides vendors some expanded strategies. Obviously, the vendor should be cognizant about when title and possession pass.

Sale of goods on credit leaves a vendor exposed in the advent of bankruptcy if the vendor has not obtained a purchase money lien, a carve-out from the secured party (or parties), or a meaningful guaranty or letter of credit, prior to a bankruptcy filing. The vendor's reclamation rights are subject to the rights of the holder(s) of security interests in the goods or proceeds.21 To address this, the vendor may try to obtain a purchase money security interest or a carve-out from the secured creditors in advance of delivery of the goods.

The vendor of goods to an insolvent debtor can reclaim the goods that were received within 45 days before the commencement of the case, providing written demand is made "not later than 45 days after the date of receipt,"22 or "not later than 20 days after the date of commencement of the case if the 45 day period expires after the commencement of the case."23 There is an issue that has not been resolved regarding whether the 20-day period is tacked on to the 45-day period or overlaps it from the date of commencement. In light of this uncertainty in the law, the safer practice is to give written notice within both periods.

The code also provides that within 120 days of the order for relief in a Chapter 11 proceeding, there is a process for the return of the goods by the debtor. This procedure is based on a motion by the trustee, and subject to the "prior rights of the holder of the security interests in the goods or proceeds and the consent of the creditor."24

Proof of Claim25

If you represent a general creditor, your client may get a notice to file a proof of claim if it is not listed on the debtor's schedules, but you must check the schedule regarding amount and category. The claim must be filed 90 days after first date set for the Section 341(a) meeting of creditors, subject to extensions and enumerated exceptions.26 Failure to timely file a proof of claim is dealt with strictly. Both the Supreme Court and the Third Circuit have been rigorous in denying the approvals for late filing.27

The Third Circuit also is strict regarding application of the mootness doctrine. If the claim is contested and the bankruptcy court decision is adverse to your client (or your client obtains an adverse decision on any other dispute with the debtor), you must apply for a stay and seek appellate review. Without a stay, the Third Circuit will apply the mootness doctrine, and will leave the lower court's decision in place except in the most unusual case.28 The problem is exacerbated in that Chapter 11 proceedings move very quickly, and if there is a pre-pak (a pre-petition agreement with most of the classes of creditors) or a Section 363 sale of all or most of the business of the debtor, for all practical purposes the case can be over before the appeal is heard, except for avoidance actions and litigation over priorities.29

Removal of a Pending Case to Bankruptcy Court30

It is difficult to explain to a client that the pending litigation against the bankrupt has been stayed or removed to a foreign bankruptcy court from a federal, state or arbitral venue after the expenditure of tens or hundreds of thousands of dollars or more pre-bankruptcy. The Bankruptcy Code provides for venue and change of venue and the contract between the parties cannot trump that.

The bankruptcy removal statute is broader than the federal removal statute for civil actions. The statute permits "a party"-not just the defendant or defendants-to remove a case to federal court.31

The critical question is, should you remove? The pending litigation may no longer be worthwhile in light of the bankruptcy filing. If the debtor-party is bankrupt, counsel and the client must seriously consider whether it is appropriate to spend more time, money and effort pursuing an action in which the client may only receive pennies on the dollar if successful. In many instances, the client would be better served by simply filing a proof of claim. The debtor may have an offset or counterclaim, or a bankruptcy-based counterclaim such as a preference, fraudulent transfer, or executory contract right of termination. Another factor to consider when deciding whether to try to remove or remand, is that New Jersey bankruptcy courts apply New Jersey state law regarding res judicata, collateral estoppel, and the entire controversy doctrine.32

To remove pending state courtlitigation in New Jersey-regardless of where the bankruptcy has been filed-a notice of removal is filed directly with the clerk of the bankruptcy court.33 There are then three possibilities if the bankruptcy is pending in New Jersey: 1) the action stays in the bankruptcy court; 2) the automatic referral of the case to the bankruptcy court is withdrawn and the case is transferred to the district court; or 3) the case is remanded to state court. If the bankruptcy is pending in another state, venue of the removed action is transferred to the district court in which the bankruptcy case is pending.34

Remand of a Removed Matter

Once the action is in bankruptcy court, it is possible to remand after removal. A motion for remand based upon abstention can be filed.

There are two types of abstention: mandatory and permissive. Federal courts in New Jersey apply six prerequisites to determine whether mandatory absention requires the court to remand the case to the state court from which the action originated.35 In considering permissive, or discretionary, abstention, New Jersey federal courts analyze up to 12 factors that are different from those for mandatory remand.36 Permissive remand is authorized in part by the statutory equivalent of a Hail Mary pass, which permits abstention when it is in the "interest of justice," judicial economy, or respect for state law.37

The proper procedure to seek remand is to file a motion to remand in the bankruptcy court where the case is pending. There may be no hearing, just a decision.

Remand means send back, not send elsewhere, so if the remand motion is successful, the case is then returned to the state court from which it came. For example, a case is removed from Florida state court to Florida federal court, then transferred to Delaware federal court. If remand is ordered, the case must go back to the Florida state court and not a Delaware state court.38 Also, a case that has been removed to federal court from state court may nonetheless be remanded back to that state court under mandatory abstention provision.39 Importantly, while Section 1452(b) provides that there may be a remand from the bankruptcy court, the order to remand or not to remand is governed by Rule 9027, and may only be appealed to the district court, not the circuit court.40

Core v. Non-Core

Two important concepts in bankruptcy are: 1) whether a proceeding is "core" and 2) whether a proceeding is "related to" a bankruptcy. This important distinction stems from Congress's bifurcation of bankruptcy court jurisdiction.41

In core proceedings, the bankruptcy court "may enter appropriate orders and judgments."42 Actions that are core, are matters that are exclusively tried by the bankruptcy court.43 The Judicial Code sets forth a non-exhaustive list of the categories of actions that are core.44 The legal framework for whether a given action is core is whether the action invokes a right that is created by the Bankruptcy Code or whether "it is a proceeding that, by its nature, could arise only in the context of a bankruptcy case."45 Examples of core matters include: an action to collect an account receivable; an action against a trustee for negligent disposition of estate assets; a debtor's notice of intention to abandon property (and the EPA's objection to that abandonment).

In non-core, but related-to matters, on the other hand, the bankruptcy court may hear the proceeding, but without the consent of all parties and a referral from the district court, the bankruptcy court must submit its proposed findings of fact and conclusions of law to the district court.46 Further, in non-core but related-to proceedings, only the district court may enter final orders or judgments.47 For example, a simple state contract action that could have gone forward in state court but for the bankruptcy is non-core, but may remain in the bankruptcy court.48 Additional examples of non-core but relatedto actions include: a New Jersey state court suit based upon alleged environmental coverage on pre-petition insurance policies;49 an action by a debtor's minority shareholders against its majority shareholder and directors;50 a breach of contract claim against a general contractor brought by a Chapter 7 trustee;51 and racketeering claims against a liquidating trustee who was appointed under the debtor's plan.52

Conclusion

The authors hope the foregoing has provided some ideas and a starting point for bankruptcy issues. The Bankruptcy Code is often viewed with dismay by creditors and their lawyers. Many problems stem from the failure of vendor/creditors to plan for the possible bankruptcy of counter parties to a transaction. Once a petition is filed, for all practical purposes the die is cast and the debtor and/or trustee is up at bat. The vendor/creditors can only play defense, hopefully advantageously based upon prior planning.


David N. Ravin is a partner in the law firm of Wolff & Samson, PC, Mr. Ravin can be reached at: dravin@wolffsamson.com or phone number:(973)530-2034.
Michael C. D'Aries is an associate at Helfand & Helfand in New York City, New York.


Reprinted by permission of the New Jersey State Bar Association, February 2008.


  1. U.S.C. Title 11.

  2. This article will concern itself with non-individual debtor filings, since the recent amendments-Bankruptcy Abuse Prevention and Consumer Act of 2005. Public Law 109-8 (BAPCPA) in addition to substantive amendments to the Bankruptcy Code, has made the representation of individual debtors a minefield that is beyond the purview of this article.

  3. F.R.B.P. 1001-9036.

  4. For example, in addition to Title II, other statutes relating to bankruptcy are Title 18, Section 151, 157 (involving bankruptcy crimes); Title 26 Sections 6321, 6323, 6334, 6672, 7425 (Internal Revenue, Code applications) and Title 28 Sections 157,
    158,455,586,959,960,1291,1292,1334,1408,1409,1410,1411,1412,1441, 1452 Gudiciary and Judicial Procedures), 1655 (Lien enforcement), 1927 (Counsel's liability for excessive costs), 1930 (Counsel fees), 2075 (promulgation of bankruptcy rules by Supreme Court)et als.

  5. In re SGL Carbon Corp., 200 F.3d 154 (3d. Cir. 1999).

  6. See In re Kara Homes, 363 B.R. 399, 400 (Bankr. D.N.J. 2007).

  7. In re Owens-Coming, 419 F.3d 195 (3d. Cir. 2005).

  8. 11 U.S.C. § 362.

  9. 28 U.S.C. § 1651.

  10. 11 U.S.c. §§ 362(b),(c).

  11. 11 U.S.C. § 362(d).

  12. 11 U.S.C. § 365(d)(3)).

  13. 11 U.S.C. § 362(d)(2).

  14. 11 U.S.C. § 362(j).

  15. In re Steward, 338 B.R. 654, 662 (Bankr. D.N.J. 2006).

  16. Solfanelli v. Corestates Bank, N.A., 203 F.3d 197 (3d Cir. 2000).

  17. In re Montgomery Ward, LLC, 292 B.R. 49, 57 (Bankr. D. Del. 2003).

  18. 11 U.S.C. § 362(d) et seq..; F.R.B.P. 4001(a).

  19. 11 U.S.C. § 546(c)(1).

  20. 11 U.S.C. § 503(b)(9).

  21. See note 18, supra.

  22. 11 U.S.C. 546 (c)(l)(A).

  23. 11 U.S.C. 546 (c)(l)(B).

  24. 11 U.S.C. 546 (h).

  25. 11 U.S.C. § 501, F.R.B.P. 3001-3008.

  26. F.R.B.P. 3002(c).

  27. Pioneer Inv. Services Co., v. Brunswick Associates Ltd. Partnership, 507 U.S. 380 (1993); In re American Classic Voyages, Co., 405 F.3d 127(3d Cir. 2005).

  28. In re Rickel Home Centers, Inc., 209 F.3d 291 (3d Cir. 2000).

  29. In re Continental Airlines, 91 F.3d 553(3d. Cir. 1996)(en banc).

  30. 28 U.S.C. §§ 1441, 1452. F.R.B.P. 9014.

  31. Id.

  32. In re Crispino, 160 B.R. 749, 753(Bankr. D.N.J. 1993).

  33. See Notice to the Bar Regarding the Filing of Notice of Removal Pursuant to Fed. R. Bankr. P. 9027, available on the bankruptcy court's website at www.njb.uscourts.gov.

  34. Frequently, if the action is transferred to the district court in which the bankruptcy is pending, the case is automatically transferred to the bankruptcy court of that district pursuant to the order of reference. Accord, Tultex Corp. v. Freeze Kids, LLC., 252 B.R. 32, 35, n. 3 (S.D.N.Y. 2000).

  35. See In re Mid-Atlantic Handling Systems, LLC, 304 B.R. Ill, 121 (Bankr. D.N.]. 2003) (listing factors); In re Central Jersey Airport Services, LLC, 282 B.R. 176, 185 (Bankr. D.N.J.2002) (listing factors).

  36. 304 B.R. at 126.

  37. 28 U.S.C. § 1334(c)(1); F.R.B.P 5011;In re Telluride Income Growth, LP., 364 B.R. 390, 398 (10th Cir. B.A.P. 2007); In re Mid-Atlantic, 304 B.R at 126.

  38. Allied Signal Recovery Trust v. Allied Signal, Inc., 298 E3d 263 (3d Cir. 2002).

  39. Stoe v. Flaherty, 436 E3d 209, 216(3d. Cir. 2006) (In an action that was removed from Pennsylvania State Court to U.S. District Court for the Western District of Pennsylvania, Third Circuit ruled that case could still be remanded back to state court under Section 1334).

  40. Things Remembers, Inc. v Petraraca,516 U.S. 124 (1995).

  41. 28 U.S.C. § 157; In re G-I Holdings, Inc., 278 B.R. 376, 379 (Bankr. D.N.J. 2002).

  42. 28 U.S.C. § 157
    .
  43. In re PRS Ins. Group, Inc., 335 B.R. 77,
    84 (Bankr. D.Del. 2005).

  44. 28 U.S.C. § 157(b)(2).

  45. In re G-I Holdings, 278 B.R. at 380.

  46. Id., 278 B.R. at 379; 11 U.S.C. § 15 7(c)(1).

  47. 11 U.S.C. § 157(c)(1).

  48. Id., 278 B.R. at 382 ("Although an action filed in state court prior to the petition date may not automatically fail this circuit's core test, most such actions will likely fall beyond our core parameters").

  49. Id., 278 B.R. at 382.

  50. Abbey v. Modem Africa One, LLC, 305 B.R. 594 (D.D.C. 2004).

  51. In re Groggel, 305 B.R. 234 (Bankr.W.O. Pa. 2004).

  52. In re Paramount Hotel Corp., 319 B.R. 350 (Bankr. S.D.N.Y. 2005).


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