Think Your Debt is Dead in the Water? Think Again!
May 05, 2020
as published in the Spring 2020 issue of West Virginia Banker magazine
At Spilman Thomas & Battle, we talk with lending clients regularly about their collection options against borrowers who have defaulted in their obligations. Many are surprised to learn how varied and wide their toolbox actually is. Debts that look dead in the water may yet have air in the lungs. We thought you might find it worthwhile, as a result, to review a small primer on how to best position yourselves to widen your collection options and maximize recovery should a loan turn out poorly.
The first thing we generally advise is this: make sure you collect the full panoply of financial statements from your borrower and insist on getting a loan agreement that obligates the borrower to provide this information periodically. This requirement may seem trivial at first, but it often becomes important. We all have pushed borrowers into bankruptcy by a well-timed demand letter. At Spilman, however, we also have seen how far some of those borrowers might go to conceal assets.
The most important initial step, therefore, once a bankruptcy has been filed is to compare a borrower's schedules to the financial information provided by that borrower when trying to obtain the loan. Discrepancies often arise, and, generally, for obvious reason. When a borrower seeks money, that borrower needs to make himself look attractive to lenders. However, when a borrower files bankruptcy, his instinct will be to minimize his responsibilities. In the instances where that instinct gets the better of your borrowers, a detailed financial history becomes all-important. From that history, a lender can provide us with the ammunition we need to challenge a borrower's discharge.
While such bankruptcy-focused litigation may not always be justified--many borrowers file precisely because they have no assets left--bankruptcy litigators often have a knack for identifying the right cases to employ these measures. We have advanced these arguments in dozens of cases, and, in many, the investigation that results reveals assets that a bankruptcy trustee is more than willing to liquidate. In some cases, we have found, for example, Rolex watches, stock certificates, high-priced sports memorabilia, valuable jewelry, even heavy equipment.
In other cases, we successfully used the litigation to strike valuable compromise, recovering hundreds of thousands of settlement dollars generally paid from accounts that are otherwise exempt from the reach of creditors. In all but a few of these cases, the financial information provided by the borrowers was the critical foundation for those actions. As a direct result of this fundamental diligence on the lender's part, in other words, a bankruptcy litigator can breathe life into an otherwise empty credit.
In some commercial cases, lenders can avail themselves of similarly aggressive remedies before a bankruptcy is even filed. Indeed, lenders can often control the very filing itself. Again, this strategy starts by diligently seeking as much financial information as possible and by mandating periodic updates to that information. In commercial cases, lenders can use this routine information to get real-time snapshots of a commercial borrower's trends, and a lender can jump on negative trends before they become larger problems.
If those problems are unavoidable, however, a lender often can declare financial covenant defaults relatively early and start working on forbearance agreements that give lenders added control. For example, we often include language in our forbearance agreements concerning commercial borrowers that prohibit transfers and payments outside of the ordinary course of business without approval and that specifically allow the lender to appoint a receiver in the event of a default of the forbearance provisions. West Virginia courts have grown to more reliably appoint receivers and manage receiverships, particularly since the creation of the business courts. Using this remedy early and effectively can save precious dollars and assets from disappearing during the end stages of a commercial borrower's facing distress.
Even more, the appointment of a receiver generally removes control over bankruptcy filing decisions from a borrower and places them firmly in the hands of a receiver. Thus, if a lender gets into a forbearance agreement early enough, and, through that, identifies insider transfers or unauthorized creditor transfers early enough, counsel for that lender can employ receivership proceedings that ultimately allow the creditor and receiver to govern the logistics of any avoidance actions, whether in a bankruptcy or outside of one.
This mechanism also gives critical control to the receiver and lender over potential commercial tort actions or breach of contract actions that may be available to borrowers. In larger commercial debts, these cases typically have more merit than general threatened litigation that one might hear individual borrowers mention. The sooner a lender's lawyer can identify and grapple with those issues, the more realistic some recovery above the norm might be. And, make no mistake, we have dealt with several cases where commercial tort or contract actions ultimately provide a source of substantial recovery that otherwise would have been lost.
Both of these critical but underutilized tools in the kit require diligence on the lender's part at both the underwriting and monitoring stages. While we recognize fully that no lender, especially on the front end of a loan, wants to consider very seriously what might happen if a borrower does not perform, it is worthwhile to take the extra time through the process to ensure the lender gathers--and continues to gather--sufficient financial information from which critical decisions can be made. Without it, a debt might truly be dead in the water by the time it reaches recovery counsel. With it, however, counsel with experience in these matters might uncover these--or other--creative ways to maximize recovery well beyond the average.