Articles Posted in Debtor & Creditor Rights

It’s no secret that years of corporate research indicate that strategic debt can be beneficial for a business. Taking on corporate debt may confer certain tax benefits, and debt can be used to grow earnings and increase the value of the company. Companies may also be able to create higher returns on the borrowed money than the interest rate they are paying on the debt. However, too much debt or a poorly structured or executed financial strategy also negligently impact the marketability and value of a company, including Silicon Valley startups. In addition, both California startups and creditors alike must be mindful of the federal and state laws that apply to debtor/creditor relations.

Commercial Debt and The Fair Debt Collection Practices Act (“FDCPA”) 

The primary federal legislation governing debtor and creditor rights is the FDCPA; however, this legislation typically does not apply to business debts. It may apply to certain late payments of commercial debts. California’s version of the FDCPA, the California Fair Debt Collection Practices Act (“CFDCPA”), while broader than the FDCPA, also typically does not apply to business debts. As such, business debtors aren’t afforded the same protections as consumers but business and their creditors also have more latitude to negotiate and structure the financial arrangement they deem most appropriate. There are few, if any, state and federal laws that regulate business-to-business debt, but the FDCPA can provide some guidance for creditors. For example, creditors should generally not:

Fotolia_79495533_Subscription_Monthly_M-300x200Any business that deals with customers – meaning all businesses – has customers that are habitually slow to pay for the goods or services that they purchase. Unlike retail transactions such as those that occur at a grocery store, many business-to-business transactions are not immediately completed. Customers don’t necessarily have to pay before the goods or services leave the building. Payment terms might be 30 days net or 60 days net, but the customer has time to pay for what they have purchased. But what can you do when those 30 or 60 days pass by without a payment? And what can you do if that time continues to drag on and months go by without a payment from your customer?

Don’t Delay with Delinquent Customers

There are many reasons – and excuses – for delayed payments or nonpayment by customers. If you invoice by mail, it is possible that the invoice was not delivered, or that it was lost internally at the customer’s business. Depending upon the size of the business, it is possible that no one at the customer’s business knows that a bill has not been paid. Reasons and excuses aside, your business cannot afford to operate without being paid.

Many Los Angeles business owners find themselves forced into litigation in order to enforce their legal rights as creditors. There are many legal tools available to enforce these rights: liens, levies, garnishments, and charging orders are just a few of many examples. These and other tools can be used to allow a creditor access to a debtor’s assets in order to satisfy debts that have been recognized by a court. An experienced Los Angeles corporate attorney can help you determine which tools will best enforce your company’s legal rights against its debtors.Asset-Protection-300x200

A writ of attachment is a particular tool which is used to protect specific assets from being disposed of before a judgment is reached. The writ of attachment is a legal order issued by a court to a law enforcement agent. A writ of attachment is typically requested soon after a case is filed (in order to freeze the defendant’s assets while the case is pending).  A writ of execution is issued at the end of a case after the judgment is reached, in order to enforce a judgment debt that has been awarded to the creditor. The California Code of Civil Procedure establishes the procedures for obtaining a writ of attachment. Section 487.010 specifies the property which is subject to a writ of attachment, including interests in real property, accounts receivable, equipment, farm products, inventory, final money judgments, money on the premises of the debtor’s business, negotiable documents of title, instruments; securities, and natural resources (such as minerals, oils, or gases) on the debtor’s property.

How a Writ of Attachment Can Help Your Business

Fotolia_178717790_Subscription_Monthly_M-300x125California creditors have a variety of tools available to enforce their legal rights. The appropriate tool will depend on the circumstances. For example, in some instances, a lien may be placed on real and/or personal property in order to protect or enforce a creditor’s rights.  In the case of a debtor’s interest in an LLC, a charging order may be obtained creating a lien against the debtor’s membership interest in the LLC. Learn more about what a charging order is, how it works, and when it is the best tool for a creditor. An experienced San Jose corporate attorney can help your business find the best tools for enforcing creditors’ rights against any debtor.

What is a Charging Order and When is it Appropriate?

When a creditor has obtained a judgment against a debtor, the creditor may obtain a variety of different orders or liens to enforce the judgment against the debtor’s assets. These can include a garnishment of the debtor’s wages, a levy of the debtor’s bank accounts, or the creation of a lien against the debtor’s real estate and personal property. When the debtor possesses an interest in a limited liability company (LLC), a court may issue to the creditor and against the debtor a charging order in order to allow the creditor to try to enforce the judgment against the debtor’s membership interest in the LLC.

Businesses are subject to many types of liens, such as civil judgments, tax liens, and mechanic’s liens.  These liens, and many others, can impair your company’s ability to turn a profit.  Protect your business assets by being proactive and contacting a San Jose corporate attorney.

What is a Lien?

A lien is a type of security interest on real or personal property, granted to a third party, that secures a debt payment or performance of an obligation.  Until the debt represented by that interest is paid, or performance completed, the third party that owns the lien can and will prevent the property owner from enjoying the full legal rights associated with the property in question.Lien-300x225  For example, if a business does not pay its taxes, the IRS or the California Franchise and Tax Board may place a tax lien on its assets.  As mentioned earlier, the lien can affect both real and personal property, so the lien could conceivably be placed on a company’s buildings and even its bank accounts.

Section 544 of the Bankruptcy Code, commonly referred to as the “strong arm” clause, gives the bankruptcy trustee the rights of a secured creditor.  This allows the trustee to avoid for the benefit of the debtor’s creditors transfers or obligations that could have been avoided by an unsecured creditor under nonbankruptcy law, provided such creditor exists.  Generally, this allows the trustee to avoid unperfected liens and fraudulent transfers.

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Section 544 of the Bankruptcy Code sets out the strong arm clause in full.  Section 544 provides in relevant part that “[t]he trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor” that could have been avoided by certain judicial lien holders or bona fide purchasers. The Bankruptcy Code can be confusing and intimidating to some.  An experienced San Jose bankruptcy lawyer can help creditors understand their rights, options and risks not only with the “strong arm” clause, but the entire Bankruptcy Code.

What Claims Can Be Avoided?

A commercial landlord is confronted with a number of issues when a tenant files bankruptcy. When a tenant files bankruptcy with an unexpired lease, the debtor tenant is given the option to “assume” or “reject” the lease. If the debtor elects to assume the lease, it agrees to be bound by all terms of the lease and it must cure all defaults and provide the landlord with “adequate assurance of future performance” under the lease. If the debtor rejects the lease, the rejection constitutes a breach of the lease, giving the landlord claims for damages.

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Assumption or Rejection. The first question that a commercial landlord will want to know is whether the debtor will assume or reject the unexpired lease.

If the debtor assumes the lease it means that the debtor intends to remain at the property as a tenant (or possible that it plans to assign the lease to a third party). In order for a debtor to assume a lease, the debtor must either not be in default under the lease or it must cure all pre- and post-petition defaults; it must give the landlord “adequate assurance of future performance under the lease,” and it must obtain bankruptcy court approval to assume the lease.

Venture capital financing can be an extremely important asset to startups that do not have access to other types of traditional business financing, such as bank loans or the public markets. There can be many benefits to venture capital financing for entrepreneurs, including the following:

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  • Venture capital involves equity capital, so it does not leave a startup with substantial debt from the start;
  • Venture capitalists often take greater risks on young and unestablished companies because they see the potential for extensive growth and, therefore, higher returns;

Foreclosure of a Charging Order

Limited liability companies (LLCs) provide their owners (members) a number of protections that do not exist for partnerships or sole proprietorship’s. One critical protection is limited liability protection.  Because an LLC is considered a separate legal entity and its assets and debts are separate and distinct from any assets or liabilities that its owners may have, a creditor of an LLC member typically cannot reach or interfere with the LLC and vice versa. However, California law does provide a tool for creditors to try to reach a judgment debtor’s LLC interest. The tool is called a charging order.

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A charging order is roughly akin to a wage garnishment, but instead of directing an individual’s employer to pay over a portion of the individual’s salary to the creditor, it directs an LLC in which the individual judgment debtor has a membership interest to pay over any distributions that would otherwise be made to the member to the creditor. Notably, a charging order ordinarily cannot compel an LLC to make a distribution to a member and does not confer any management rights, instead extending only to distributions made to a member. For this reason, charging orders do not always result in payment to the creditor. Nonetheless, a charging order can still be effective because they can cut-off an LLC member’s rights to receive any distributions from the LLC and may impact the member’s dealings with the LLC and its other members.

When the shareholder of a corporation files bankruptcy, the shareholder’s stock becomes part of the debtor’s bankruptcy estate and will generally be subject to liquidation by the bankruptcy trustee for the benefit of the debtor’s creditors.

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However, when a limited partner in a limited partnership (LP) or a member of a limited liability company (LLC) files bankruptcy, the debtor’s ownership interest may well be treated differently because interests in LPs and LLCs are typically considered and treated as more contractual in nature.

Membership Interests in LLCs