In this still-troubled economy, the majority of chapter 11 cases in the small- and mid-sized markets continue to lead straight into chapter 11 liquidation and/or 363 sales. In these cases, the court-appointed liquidating agent or trustee works to ensure that the interests of creditors, shareholders and employees are served according to the law in the most timely and efficient manner possible.
An agent who fails to conduct an orderly liquidation risks not only his or her reputation, but also his or her assets. For example, an agent who distributes all of the funds in an estate and overlooks expenses or taxes that are still due will be responsible for those unpaid costs. Here are a few “dos” and “don’ts” for liquidating agents to keep in mind.
Do try to assess—ahead of your appointment—what the estate will contain. As the liquidating agent, will you be saddled with a warehouse full of documents, old furniture, real estate or unpaid taxes? As a post-confirmation trustee, will you have multiple committees to deal with or have an interest in actions being driven by the debtor? Even in the most straightforward of cases, you should expect the unexpected. Being prepared to handle the issues you do know about—by having an appraiser, auctioneer or real estate broker ready to go—will save you time and effort that you can use to address the surprises.
Do enter into an agreement with legal counsel for representation. You are invariably going to need legal assistance and insight to help wind the estate down, provide the appropriate notices and the like. For a liquidating agent, this would typically be one of the firms involved in the case from the start (usually the debtor’s counsel). You will want to confirm details such as their hourly rate and how they will apply any unused retainer. In a post-confirmation trustee setting, it is typical to retain the former unsecured creditors’ committee counsel, as this group is typically the prime beneficiary of the trustee’s efforts.
Do keep a transition checklist. This complex process demands a thorough list. Spell out responsibilities by team member for each task, set timelines for resolution of each item and make sure that the list is regularly reviewed by the liquidating team (weekly at the beginning, then monthly as the case winds down). The checklist should be a living document, as some tasks will be removed while others are added. A good transition list will keep you from missing a critical detail down the road.
Don’t wait to collect key documents. Debtors do not always keep careful records, and sometimes the story told in the records is different from the one that the debtor tells the trustee. Pre-petition checks sent during the preference period may have bounced—so there is no real preference claim—or invoice amounts may be smaller than the debtor reported. There is no point spending time pursuing claims that are not legitimate or impossible to prove, so be sure to collect key documents as early as possible before they “disappear” or become inaccessible. Are those invoices holed up in a warehouse somewhere? Get them now, before the warehouse owner blocks access to them due to unpaid rent and you must obtain a judge’s order to get them, incurring additional time and expense—or worse yet, they disappear, forcing you to request them from the defendant in your preference lawsuit.
Do take care of former employees. The rules and regulations for winding down 401(k)s and other plans are subject to ERISA regulations, and a mistake can be costly. A liquidating agent often discovers that a 401(k) or pension plan has not been properly terminated, or money has not been properly appropriated. The rules are specific as to distribution letters and tax notices that must be sent to employees. If there are more than 100 participants in a 401(k), an audit must be performed and an annual 5500 form filed. Make sure to also follow the rules for termination of health benefit plans and to prepare final payroll tax returns and W-2s.
Also remember to withhold the appropriate taxes when you make a plan-related distribution to a former employee for a wage-related claim. Otherwise, the estate (or the trustee) could be liable for penalties for failure to withhold what the taxing authorities may see as income. If there’s a committee of former employees, make sure that you fully understand their constituents’ priority claims, as they will take precedence over those of the unsecured creditors.
Don’t lose track of key employees. Chances are you will have questions to ask of key employees even after they leave the debtor’s employ, but once they’re gone, these employees have no obligation to return your calls—and skilled professionals may find new employment quickly. Consider establishing a temporary consulting arrangement with these former employees to ensure that you have the ability to access a few hours a month of their attention until the case is closed, or perhaps beyond. It can be critical for maneuvering through the minutiae and addressing issues you never anticipated.
Do settle tax liabilities quickly, and pay careful attention to taxes already paid and due. Chances are, compliance with all state and federal tax requirements was not done and there are holes to be filled. Take care of these quickly, and then ask taxing authorities to send you a statement attesting that all taxes have been paid. Also, remember that there may be tax forms to file and taxes due after the estate is closed. Make sure you have adequate funds to cover them and the costs to prepare and file.
If the debtor utilized a payroll-processing company, make sure its records show that all relevant taxes were paid or appropriate claims have been made against the estate. Too often, a trustee will receive a notice from a taxing authority requesting past-due taxes from quarters or years before the petition date. If these requests are legitimate, fighting them in court can delay a case for months and force the estate to incur further costs. Make sure that the approved plan distinctly addresses unfiled priority claims and discuss the merits of contesting them with counsel. This is where getting a tax closure letter from the Internal Revenue Service and the appropriate state taxing authority is critical.
Don’t overlook “hidden” asset sources. Deposits are a classic example of an easy asset to overlook. For example, the debtor signed up for electric service for an office. When that office closes, the debtor may be due a refund of a deposit to the utility, which could become the basis of an additional distribution to creditors or shareholders.
Do pick your battles. When it comes to preferential claims, the biblical saying, “Ask and ye shall receive” often applies. A certified letter (or two) may prompt a check from a claimant who would rather not explore the niceties of tussling with a trustee who may reside in a different state. Other claimants will fail to respond, offer to settle or insist that they owe you nothing. Here is where it becomes important to pick your battles, and your choice must be done on the basis of a careful cost/benefit analysis that balances the potential return to the estate against the cost to extract that value.
Some claims may be so small that any pursuit is fruitless. In the small- and mid-sized markets, there may be many vendors with claims under $1,000. In these cases, even bothering to educate claimants about the system may not be worth your time.
For larger claimants, you must factor in the strength of their anticipated defense(s) and the amount of time and money you would spend litigating the case. You will typically want to come up with a recovery threshold, beyond which you will pursue litigation. For example, a claimant owes you $10,000 and you estimate that it would cost you about $2,500 to litigate and collect, netting you $7,500 from litigation. If you can get a settlement for $8,000, then you just saved the trust $500. If you cannot get the claimant to settle for $7,500 or more, then litigation may not be worthwhile. All cases need to be reviewed individually to insure that every potential for recovery has been uncovered and investigated.
Don’t show your hand. Remember that your duty is to the trust, not to the claimant. You have done your own cost/benefit analysis and analyzed what you believe to be the claimant’s best defenses, and the claimant has likely done the same. Do not assume that the claimant has reached the same conclusion as you. Claimants may have different perspectives or priorities, and you have an obligation to deal honestly with them, such as responding to requests for copies of checks cashed or invoices paid—but not to do their work for them. They may not want to expend the effort to prove their defenses and offer a settlement even if they believe their defenses are appropriate.
Make your claim and push for a favorable settlement even if you think the other party has valid defenses. Do not assume that the claimant will offer the defense you have identified, and if they do make a defense, ask them to back it up. You may be surprised to find that they did not identify the defense you had expected, are unwilling to pursue it, or cannot present it properly. The result could be a larger settlement than you had anticipated.
Do prepare to horse trade. Some parties are both unsecured creditors and preferential claims targets. These parties may be willing to make a deal that involves both sides of the equation. For example, they may agree to settle the preferential claim for 50 cents on the dollar in exchange for reducing or waiving their unsecured claim on the estate. This sort of option is appealing to parties that are short on free cash, and the more you can reduce unsecured claims, the more that will be left for the remaining unsecured creditors. It is often left to the trustee to propose this kind of solution.
Conclusion
Effective trusteeship clearly requires careful planning, close attention to detail and creativity to be a successful court-appointed fiduciary. Knowing the pitfalls will help you stay on track and stay out of trouble.