Have you dreaded opening that envelope from the United States Bankruptcy Court addressed to Bank Lending Department to discover which of your credits is now in a bankruptcy proceeding and what that means for your institution? Anyone in business for very long has received that mailing and, after taking a deep breath, your mind races to whether the loan files are in order to transfer to special assets, assuming the loan is not already there. So, what are some ways to help protect against the bankruptcy heart attack? Here are a few reminders:
- What to retain in the loan file? Be proactive about the content and organization of the loan files. Whether on paper or electronically stored, gather the documents at closing or shortly thereafter to ensure that the drafts are collected and kept in one place and the executed documents in another. In the event there are questions about the language and intent of the final agreements, having the drafts and knowing who made changes and why may be helpful to sorting out a dispute on the back end, whether it be with the borrower, now a debtor in bankruptcy or the debtor’s trustee. Retaining key correspondences related to drafts and changes is also advisable since memories fade, loan officers change and a default may not occur for years after closing.
- Too busy for annual inventory? Don’t wait for an internal or external audit to ensure your loan files are in order. Even if a maturity date is not looming and no default has occurred to bring the file to your attention, plan for someone to touch each loan file once a year or every two years. Reviewing a file may reveal some defect that can be easily cured long before a default has occurred. Somewhere in the loan documents, a borrower is typically required to sign any additional documents or fix clerical errors to carry out the intent of the parties. If you wait until a default to try to cure any defects, the chances of “fixing” are low, and the opportunity to set aside the “fix” are high when the corrections are made near the bankruptcy filing.3
- What you don’t know can’t hurt you? Educating yourself about some basic bankruptcy information should help in making the credit in the first place. The stigma of filing bankruptcy may have been enough to keep your borrower from filing, but those days have passed. The question is not if one of your borrowers will file bankruptcy, but when you will be faced with a filing. Knowledge is power, and knowing some of the bankruptcy basics is essential, like:
- What does each chapter – 7, 9, 11, 12 or 13 – mean?
- Is the bank’s collateral included in the bankruptcy or out of the bankruptcy?
- What are the key bankruptcy documents that I should know about?
- What happens to the guarantor not in bankruptcy?
- Should the bank participate in the bankruptcy or not and, if so, how? Similarly, should the bank file a claim in the case and what are the other ramifications for filing the claim? Should someone attend the first meeting of creditors and, if so, who? What do all of the deadlines mean, and which ones are important to the bank?
- What is a preference (the most common action a debtor or trustee can file against a creditor)?
Although the answers to these questions can be complex, just knowing the issue is present is half the battle. The other half is having an experienced professional to guide you.
If you follow these three tips – organize and compartmentalize the loan file, review periodically to ensure I’s are dotted and T’s are crossed, and gain some basic knowledge about what might occur in bankruptcy – the next time you open the mail, you just might have a different reaction.