Banking and Finance Law Report : Banking & Finance Lawyer & Attorney : Porter Wright Morris & Arthur Law Firm : Bankruptcy, Commercial Lending

•   Locate bank accounts.  First, if you have a financial statement, it should provide bank account information.  You should also keep copies of the checks your judgment debtor used to pay you during the course of the relationship in the event you later need to garnish that account.  There are also companies that specialize in locating debtor bank account information for a fee.  Check applicable laws before engaging such a company.  If you know where your judgment debtor banks and have an account number, call the bank, inquire about the balance of account, then proceed with non-wage garnishment as discussed below.

•   If your judgment debtor has assets that are in your state, but in a county other than the county that issued your judgment, you can file your judgment in that other county for a nominal fee.  This will facilitate your recovery of assets in that other county.

•   If your judgment debtor has assets in a state other the state where you obtained judgment, retain an attorney in that state to domesticate your judgment under the Uniform Enforcement of Foreign Judgments Act, which will permit you to pursue the judgment debtor's out-of-state assets.  

Foreclose on Property

A judgment creditor may foreclose on real property or on personal property.  Such actions are conducted through the appropriate court and county sheriff, and a judgment creditor will first have to verify whether other creditors, whether by virtue of secured loans or judgments, will have a prior claim to the property and whether after such prior claim there will be any value left for the judgment creditor.  

Obtain the Appointment of a Receiver

Although you usually see the appointment of a receiver pursuant to a mortgage of rental property, a receiver can be very valuable if the debtor engages in the business of selling products to companies on account and refuses to turn over the proceeds of the collection of its receivables to a creditor holding a security interest therein or to a judgment creditor.  Most states permit the appointment of a receiver in a number of circumstances, including the following:

•   in an action by a vendor to vacate a fraudulent purchase of property;

•   In an action by a creditor to subject property or a fund to its claim;

•   In an action by a party whose right to or interest in the property or fund, or the proceeds of the fund, is probable, and when it is shown that the property or fund is in danger of being lost, removed, or materially injured;

•   In an action by the holder of a mortgage, for the foreclosure of the mortgage and sale of the mortgaged property, when it appears that the mortgaged property is in danger of being lost, removed, or materially injured, or that the condition of the mortgage has not been performed, and the property is probably insufficient to discharge the mortgage debt;

•   After judgment, to carry the judgment into effect;

•   A corporation has been dissolved, is insolvent, in imminent danger of insolvency, or has forfeited its corporate rights; or

•   After judgment, to dispose of property, to preserve property pending appeal, or when an execution is returned unsatisfied and the debtor refuses to apply property to satisfy the judgment.       

Although the powers of a receiver will vary by the state, a receiver can generally bring and defend actions, take and keep possession of property, receive rents, collect and compromise demands, make transfers, and do such acts respecting the property as the court authorizes.  

Garnishment – A garnishment is a legal proceeding in which a creditor attempts to obtain payment of a debt out of property of the debtor in the hands of a third person.  The most common example is a bank account, which is why creditors are advised to keep copies of the checks that your debtor used to pay you during the course of the relationship.

Injunctive Relief - There are certain situations in which injunctive relief is available from a court to assist a creditor in a collection action.  Under Ohio Civil Rule 65(A) and analogous civil rules in other states, a temporary restraining order may be granted without written or oral notice to the judgment debtor or its attorney only if it clearly appears that the party requesting such relief will suffer immediate and irreparable injury, loss or damage, which is typically defined as an injury which is not capable of being remedied by money damages.  

There are a number of avenues a judgment creditor may take to collect a judgment, but the best way to be prepared to collect a judgment is to compile and retain information about your customer's financial situation and its banking relationships during the course of your dealings with them.  In the unfortunate event you go from being a vendor or a service provider to being a judgment creditor, you will be armed with information about what assets are available to satisfy your judgment, and will then be able to determine how to collect them in the most cost-efficient manner possible.

•   Verify that your documents and the accounting of the balance that you claim is due from your customer are in order.

Determine Your Time Constraints. 

•   What are your deadlines? Are you subject to any time constraints that will affect your decision making, such as the desire to get income from the settlement into the current fiscal quarter or bank reporting deadlines?

•   Determine the applicable statute of limitations for bringing suit. Note that in Ohio, effective September 28, 2012, the statute of limitations for suit on a written contract was recently reduced from 15 years to 8 years. 

File Suit

•   Determine whether your written agreements with your customer require that you provide the customer with written notice of the default, including the delivery method, such as certified mail or hand delivery, and determine whether you must give your customer a specified amount of time after you notify the customer of its default in order to pay you, also known as "curing" the default.

•   Determine where to file suit, also known as determining the jurisdiction. As recommended in a prior blog post in this series (see Structuring Sales to Ensure Payment), your written agreement with your customer should contain the customer's agreement that if a suit is necessary, the customer consents to be sued in your home state and agrees to pay your attorney fees. These consents to jurisdiction and to pay legal fees are powerful agreements. A non-paying customer will think twice about forcing a collection lawsuit if it has consented to jurisdiction in the vendor's home state and county and to pay the vendor's attorney fees.

•   If the customer does not answer the complaint within the time established by your jurisdiction, seek judgment by default. The exact procedure will vary by jurisdiction, but generally involves filing a motion with the court with an affidavit stating the balance due. If the customer does file an answer to your complaint, it still might be possible to avoid a trial in court by using a procedure called summary judgment, which it does by written motion. It is rare for collection suits to go to trial where no real defenses are presented as to payment or the quality of the product or service sold. 

Conclusion

You never want to file suit- it's not your core business. However, if your customer is not paying and not responding to your demands for payment or your offers to restructure their balance due, assess your options, analyze any defenses that your customer could assert to a payment demand and determine your obligation to give notice. In order to make litigation as convenient as possible, have your customer agree at the onset of your relationship that litigation will be in your jurisdiction, and that the customer will pay your legal fees.

Access Public Information

Much of the information you need to obtain on your customer is available as public information.

Ohio and other states offer a wealth of free on-line information, including the following: 

1.      UCC filings with the Ohio Secretary of State’s Office. Has your customer granted someone a security interest in all of their assets?

2.      Lien information is available at most County Recorder’s offices (this covers consensual liens such a mortgages, and non-consensual liens like mechanic’s liens and tax liens).

3.      More formal certified tax and lien searches are available through title companies for a fee.

4.      You can search many court dockets for free and determine if your customer is being sued, particularly for non-payment.

Workout Options

Vendors generally prefer restructuring a distressed credit to having the customer seek protection from its creditors under the Bankruptcy Code, especially if the receivable is unsecured or undersecured. Vendors prefer the predictability of restructuring a distressed credit to participating in the protracted and arcane world of bankruptcy proceedings. In contrast, if the vendor and customer cannot restructure an existing receivable, the parties may face many months (or years) of litigation or bankruptcy proceedings.

Before agreeing to restructure a customer’s existing obligation, a vendor must be satisfied that the customer will be able to meet the terms of the rewritten agreement. Among the items a vendor should consider before approving any workout are the following:

1.   The customer's ability to apply adequate resources toward repayment of restructured credit;

2.   The customer's ability to provide collateral;

3.   Obtaining guaranties or additional guaranties; and

4.   The competence and trustworthiness of customer's management team.

The key to a successful workout is good communication. The customers’ management should expect to provide immediate answers to the vendor’s questions and should make itself available to meet or speak with the vendor at the vendor’s request. Management’s goal is to convince the vendor that the workout is necessary, prudent and will succeed by permitting the customer breathing room to reestablish its fiscal health.

If the customer hopes to successfully restructure its existing obligations, its management should expect increased scrutiny from the vendor. Management should expect the vendor to actively review the company’s financial position, its sales or production figures, its aged receivables and its obligations and liens extended to other lenders or suppliers. The vendor, or its agents, may conduct site visits, talk to the company’s vendors, inspect its audited financial statements and interview key management. 

Accounting and Financial Reporting

A vendor considering a restructure should obtain copies of the customer's financial statements, preferable audited statements, and should require copies of future accounting and financial reports at regular intervals, whether monthly, quarterly or semi-annually. These intervals should be included in the terms of the restructuring. By reviewing these reports, the vendor can monitor the customer's fiscal health and can determine if the customer is meeting any benchmarks established by the terms of the restructure agreement. If the vendor senses the company is not performing as anticipated after the restructuring, the vendor needs to be able to quantify its concerns and inform management of the non-performance.

Termination of Negotiations

If you have reached an impasse, if further negotiation appears fruitless or if you or your customer lack authority to continue, set a time limit for further negotiations. Do not let yourself be strung along by a customer who is promising to reach a settlement, but is in the mean time secreting or transferring assets.

In contrast, if you have reached a settlement, immediately send a confirming email or letter stating the full amount of the claim, the settlement amount, the date by which it will be paid, and any other terms. Request that your customer contact you immediately if it does not agree. Follow up promptly with documentation, including:

1.      A note representing the old balance. Converting an aged receivable to a promissory note may also benefit you as vendor, to the extent the aged receivable could not count toward your borrowing base with your lender; 

2.      Admission of balance/ waiver of defenses;

3.      Interest;

4.      Warrant of attorney- this is language in a note that permits a lender/ vendor to take judgment against a borrower without notice, and is a very powerful tool. Warrants of attorney are permitted in Ohio and a few other states, are limited to commercial (not consumer) transactions, and must be used in strict compliance with the applicable statutes; and

5.      A security agreement, mortgage or guaranty.

In this economy, many providers of goods and services are finding that their customers are stretching payments, thereby making the vendor an involuntary bank, providing a kind of line of credit. Don't be the bank. In the event of a customer default, assess your rights, communicate promptly and determine if a restructure is possible. If your customer is not responsive to your reasonable requests for information, is not honest or does not have the ability or willingness to repay even a restructured obligation, it may be time to go to court. Tune in to next week's blog for a discussion on use of litigation to recover your receivables.

Where the debtor's interest is in an SMLLC however, there are no other members to consent to the assignment of the debtor's management rights. In such circumstances, whether a charging order will provide the same level of asset protection to a SMLLC as it would to a multi-member LLC, and thus prevent a creditor from satisfying its judgment through the sale of the SMLLC's assets, depends upon the statutory framework of the state in which the LLC is organized.

Recent Case Law

 The Kansas Revised Limited Liability Company Act ("KRLLCA") specifically provides that where the member of an SMLLC assigns its interest, "the assignee shall have the right to participate in the management of the business and affairs of the limited liability company as a member." (Kan. Stat. Ann. § 17-76, 112(f)). In October 2011, a court interpreting this provision held that it applies to a judgment creditor who becomes an assignee pursuant to the entry of a charging order. (Meyer v. Christie, No. 07-2230-CM (D. Kan., Oct. 13, 2011)). This explicit provision of the KRLLCA makes it clear that in Kansas a charging order does not provide the same level of asset protection to a SMLLC as it would to a multi-member LLC. Under the Kansas framework, a creditor can use a charging order to reach the assets of its member's SMLLC to satisfy its judgment. 

The Supreme Court of Florida's 2010 determination of the issue, on the other hand, hinged on whether or not the statutory charging order was the sole remedy through which a creditor could reach its debtor's SMLLC interest. (Olmstead v. FTC, 44 So. 3d 76 (Fla. 2010)). Although the court found that Florida's charging order remedy "clearly does not authorize the transfer to a judgment creditor of all an LLC member's 'right, title and interest' in an LLC," it also held that the charging order was not the judgment creditor's exclusive remedy. (Id.) Florida's generally applicable law subjecting a judgment debtor's corporate stock to levy and sale under execution, combined with the "uncontested right of the owner of the single-member LLC to transfer the owner's full interest in the LLC," permitted the court to order the debtor to surrender all right, title and interest in its SMLLC to satisfy an outstanding judgment. (Id.) While the Florida charging order remedy protects the rights of non-debtor members of a multi-member LLC, the availability of this additional remedy allows a creditor to go beyond the charging order protections and reach its debtor's full SMLLC membership interest, including management rights.

Similarly, a U.S. Bankruptcy Court applying Colorado law has held that "the charging order limitation serves no purpose in a SMLLC, because there are no other parties' interests affected." The court found that without the protections of a charging order as an exclusive remedy, a debtor's bankruptcy filing effectively transferred her full membership interest in her SMLLC, including her management rights, to the bankruptcy estate. (In re Albright, 291 BR 358 (Banker. Court D. Colorado, 2003)). This allowed the Bankruptcy Trustee to obtain management rights and to cause the SMLLC to sell its assets and distribute the proceeds to the estate, without being hindered by the protections of a charging order.

Ohio Proposed Amendment

While Ohio courts have not addressed whether the same charging order protections offered to multi-member LLCs are also available to SMLLCs, changes to Ohio law recently discussed in the Ohio Senate Judiciary Committee begin to address this issue. If enacted, proposed amendments to Section 1705.19 of the Ohio Revised Code, to be contained in HB 48, would expressly provide that a charging order is the exclusive remedy of a creditor seeking to satisfy judgment against the LLC membership interest of a debtor. Furthermore, the amendment would prohibit any creditor of a member of an LLC from having any right to obtain possession of, or to exercise legal or equitable remedies with respect to, the property of the LLC. The proposed amendment does not differentiate between SMLLCs and multi-member LLCs.

Under the analysis used in the above cases, this change would most likely prevent a judgment creditor from obtaining management rights in an SMLLC, since there would be no specific statutory exception for SMLLCs and the charging order would be the exclusive remedy available to the creditor to reach the debtor's membership interest. If the amendment is enacted and Ohio courts interpret the statute to provide SMLLCs with the same charging order protections as multi-member LLCs, creditors will be unable to recover judgments by forcing the sale of their debtors' SMLLC assets and distributing proceeds.

Bankers should be aware of this possibility and take necessary precautions to avoid relying on unreachable assets of the debtor's SMLLC as security for the credit they extend. In most cases, the straight-forward solution is prepare loan documentation reflecting the SMLLC as a borrower.