While corporate bankruptcies have declined in 2010 (only nine large, public companies filed in the second quarter), the explosion of filings in 2008 and 2009 is still reverberating. Almost two years on, the huge number of cases from that period is creating big headaches for one group: the suppliers to those bankrupt companies. Bankruptcy estates are now attempting to claw back monies paid to these suppliers during the 90-day run-up to the insolvent companies' filings.
Three hundred and forty-eight companies, with nearly $1.8 trillion in assets at the time of their filings, declared Chapter 11 or Chapter 7 in 2008 and 2009, according to BankruptcyData.com. The statute of limitations for these so-called preference claims is two years after the bankruptcy, so lawsuits arising from that surge in bankruptcies are just beginning to be filed.
"I have not seen this level of actions being filed ever before — and I've been doing this for 30 years," says Hal Schaeffer, president of D&H Credit Services, who often acts as an expert witness on either side of bankruptcy cases.
Enabled by Section 547 of the U.S. Bankruptcy Code, preference claims are intended to prevent near-insolvent companies from favoring one creditor over others in the run-up to a filing. The suits are brought to force vendors that were paid within the 90-day window to return the payments. Presumably, the money goes back into the estate, from which all unsecured creditors may get a settlement.
Not all bankrupt companies pursue preference claims, often for fear of damaging supplier relationships as the bankrupt entity continues as a going concern. The current cycle of claims, however, is atypically aggressive.
Compared with the 2001–2003 cycle of bankruptcies from the dot-com bubble, estates in the current wave are going after even the smallest payments made to vendors, whether it's "$50 million, $5 million, or even [a few thousand dollars]," says Schaeffer. The minimum claim allowed is $5,850, a number set by the five-year-old Bankruptcy Abuse Prevention and Consumer Protection Act and tied to a cost-of-living index. Schaeffer says the aggressiveness is a result of the "dry time" between 2004 and mid-2007, when trustees had very few dollars to go after because bankruptcies were rare.
The impact on smaller suppliers can be harsh. Larger companies, with armies of lawyers, can more easily intimidate trustees into taking pennies on the dollar. But if a small supplier is hit with a $30,000 preference suit, it can spend nearly that much to hire an attorney and an expert witness and to unearth invoices and records. The situation is often exacerbated by the fact that small companies selling to large ones often bend over backward to keep the business, to the point of loosening credit terms to customers on the brink of insolvency.