24 February 2016

Getting Paid by the Bankrupt or Almost Bankrupt Client

Given what is going on in the Houston economy right now, we are anticipating a substantial increase in the number of companies that end up in bankruptcy (“BK”). You likely have clients or customers that are really struggling to survive and/or are actively preparing to file BK.

If a client is preparing to file BK, they will likely need your assistance to gather the information needed to file.  This typically brings up 2 questions:

  1. How can I get paid for work already done (“Old Work“)?
  2. How can I get paid for work to be done (“New Work“)?

Old Work
It is not unreasonable to ask that you be paid for Old Work before doing New Work. Often payment of past invoices is a condition to taking on New Work. Keep in mind, however, that those payments for Old Work may have to be returned if they are deemed preferences. Oh the dreaded preference.  There are 4 elements to a preference:

  1. Payment on an antecedent debt;
  2. Made while the debtor was insolvent;
  3. To a non-insider creditor, within 90 days (or in the case of a payment to an insider within 1 year) of the BK filing; and
  4. That allows the creditor to receive more on its claim than it would have through the bankruptcy proceeding.

There are defenses to a preference, which is beyond the scope of this discussion; however, they can be very helpful in negotiating with a trustee or debtor in possession to retain at least some of the payment.

When dealing with a distressed client (whether they are going to file BK or not), it is always better to get as much paid as you can on Old Work with the risk being that it could later be clawed back as a preference but not necessarily at 100%.

There is a saying that goes: “What’s worse than having a preference?  Not having one!”

New Work
New Work falls into two categories:  work done before the BK filing (“Pre-Petition”) and work done after the BK filing (“Post-Petition”).

  1. Pre-Petition New Work

Doing Pre-Petition New Work is not for the faint of heart.  There are risks that you may not get paid or, if you do, you may have to give it back.  There are ways to try to minimize, but not eliminate, these risks such as:

  • Get a deposit and a new engagement letter from the client that specifies that Pre-Petition you will apply the deposit against invoices for New Work at very frequent intervals (weekly or even daily).  The engagement letter should also set forth the scope of the New Work, the services or deliverables you will provide, and a statement that in the event invoices are not timely paid, you have the right to fully withdraw and decline to provide any services.
  • The deposit should not be used for Old Work and Post-Petition you may not offset against the deposit for New Work without obtaining BK Court approval.
  1. Post-Petition New Work

In order for a professional to be hired to provide Post-Petition New Work, the trustee or debtor in possession must file an application with the BK Court.

Once approved, in order to get paid, you will need to file a fee application with the BK Court which can be filed on an interim or final basis.  Fee applications can be cumbersome because they require a detailed statement of the services rendered, time expended, expenses incurred, and the amounts requested.

After the fee application is filed, a hearing will occur in BK Court and you will need to present evidence to prove up the claim for payment.  The parties in interest (which includes other creditors) have the right to object to the application and present evidence to support the objection.  This all means that the fee application may be subject to Monday morning quarter-backing.  There is some risk that in the end you may not receive 100% of what it has requested in the fee application.

Oftentimes the client will ask you to keep working Post-Petition and not worry about getting paid because they will make sure to take care of you.  The client does not have the authority to retain your services much less pay you without BK Court permission.  Be careful here!

As always, this post discusses general rules and is not specific legal advice for you to rely on. Please consult a qualified advisor to discuss your specific situation.