"What Every Community Banker Should Know About Bankruptcy Basics: Part 1 of a Series," by Julia A. Chincheck and Salene Mazur Kraemer

The Community Banker
Winter 2017

             Calculated Risks to Fuel the Economy.   As community bankers, you fuel our economy’s engines, enabling individuals to purchase first cars and dream homes.  You provide eager business owners with the capital that they need to upgrade to cutting-edge technology, buy essential equipment or inventory, or hire a workforce necessary to take a business to the next level.   Your bank truly becomes a cornerstone in our communities.

             As you know better than anyone, community banks, however, undertake calculated risks when extending credit to any individual or entity. 

            What happens when things don’t go as planned for the individual or the business?  The borrower trips loan covenants or causes a monetary default for weeks, for months.  Taxing bodies file liens.   Suppliers stop providing goods.  Judgment creditors garnish the borrower’s bank accounts.  Creditors start intercepting accounts receivables.   No matter how hard the community banker has tried to be patient, the writing is on the wall.  The borrower needs to restructure debt or file bankruptcy. 

This is the first of a series of articles regarding what every community banker should know about the basics of bankruptcy.   

        In the world of bankruptcy there are certain trigger events that are important.  Here is the timeline of a case:

Bankruptcy Timeline

         Pre-Petition:  Protect Your Secured Claim and Monitor the Borrower.   When a bank believes its borrower is slipping into bankruptcy, you must protect the bank’s interests.  Be certain that all steps have been taken to properly perfect and record the bank’s security interest in any collateral, and that such perfection has been continuous.  If possible, consider requiring an additional guarantor on the loan or expanding the scope of the bank’s collateral.  Double check any lien and title searches on collateral.  

         More often than not, resolving the matter outside of a bankruptcy case is the most efficient way to go.  When a commercial borrower files bankruptcy, a bank may be able to tack on legal fees to the loan at hand but the risk of non-payment still exists and is probably higher given the additional administrative costs of filing a case.  If there is some chance of a turnaround, consider a forbearance agreement with the borrower.   If the bank is unsecured and insists on substantially changing the terms of the loan agreement within 90 days prior to the bankruptcy filing, the bank may run the risk of being sued Post-Petition for the avoidance of preferential transfers.

           As a borrower swirls deeper in debt, he or she or the business borrower may take desperate measures, and the lender may be able to sue its borrower for gross mismanagement of collateral, fraudulent transfers, and/or breach of contract, to name a few.  Depending upon each borrower’s circumstances, swift action is usually necessary.  A secured lender may want out now and accelerates the debt along with the filing of a replevin action and/or utilizing any other Uniform Commercial Code Article 9 remedies it may have.  If the borrower is not generally paying debts as they become due, another option may be for a lender to team up with two other creditors to force an involuntary bankruptcy petition upon the borrower.   If the company has fewer than 12 creditors, a bank alone could file the involuntary petition. 

 Stay tuned for what a banker should know once a bankruptcy petition is filed.