Misconceptions about the U.S. Bankruptcy Code
By Michael C. Dennis, MBA, CBF
There are a number of widely held myths and misconceptions about
the U.S. Bankruptcy Code. In many cases, what trade creditors
do not know can and will hurt them financially. Here are some
of those myths and misconceptions:
Myth: The Bankruptcy Code is so complex that there is no way to understand it
unless you are a lawyer - so why try? Reality. The concepts are not so difficult
that you should avoid trying to understand them. The less you understand about
the bankruptcy process, the more chance there is to make an expensive mistake.
Myth: At the first sign of trouble, customers file for bankruptcy protection.
Reality: Filing bankruptcy is a serious decision and for most companies it is
a/the last resort.
Myth: A creditor must always file a proof of claim to receive a payment in a
bankruptcy. Reality: In a Chapter 11 case, a creditor may file a proof of claim,
but is not required to do so if the debtor's schedules of liabilities lists the
correct amount due and the correct classification of the debt [for example as
a general unsecured debt]. However, most trade creditors always file a Proof
of Claim - just in case.
Myth: All pre-petition debts are dischargeable. Reality: Not all debt can be
discharged. For example, a debtor will not be relieved of a debt arising from
a fraud perpetrated by the debtor against a creditor.
Myth: When a business files Chapter 7 liquidation, the assets of the company
are always sold piecemeal at "fire-sale" prices. Reality. A trustee
can liquidate the assets piecemeal, but if selling the business as a going concern
is feasible and will maximize the return to creditors, the trustee will try to
Myth: In a Chapter 11 bankruptcy, there is no risk to selling to a debtor in
bankruptcy. Reality. A bankrupt customer guarantees no one payment, and statistically
more than half of the companies that file Chapter 11 are not successful in reorganizing.
The Bankruptcy Code does not guarantee payment to any creditor.
Myth: Any payment received within 90 days of the bankruptcy filing date is a
preferential transfer that must be returned [disgorged] on demand. Reality. Not
all payments received within 90 days prior to the bankruptcy filing date are
preferential. There are a number of exclusions. Creditors that are not aware
of these exclusions may be refunding money that the creditor company is legally
entitled to keep.
Myth: Creditors are required to extend credit to a Debtor in Possession. Reality.
Creditors are under absolutely no obligation to extend credit to a DIP. Decisions
to do so are made at the sole discretion of the creditor.
Myth: It is a violation of the automatic stay to stop goods in transit when a
customer files for bankruptcy protection. Reality. Creditors are free to stop
shipments in transit once they learn that a bankruptcy has been filed.
Myth: When filing a Proof of Claim, creditors are not required to list [a] open
credits or [b] on-account payments on the Claim. Reality. The Code requires creditors
to file a Proof of Claim for the net balance owed by the debtor. Creditors that
do not include credit balances are filing fraudulent claims.
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