When a Business Partner Goes Bankrupt: What to Do on the Day You Receive Notice of Commencement of Bankruptcy Proceedings

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

When a notice of commencement of bankruptcy proceedings arrives from a business partner's attorney or from the court, it is not uncommon to be unsure how to proceed. Decisions pile up all at once: how to file the receivables you hold, whether they can be set off against payables, whether you may retrieve your own goods left with the counterparty, and so on. If you check the deadlines in the notice and your internal contract documents early on, you can avoid delays in the proceedings and more calmly begin examining set-off and the right of segregation.

Items Stated in the Notice and Confirming Claims and Obligations

A notice sent by the court generally states the case number, the contact details of the appointed bankruptcy trustee, and the period for filing proofs of claim. However, in cases of simultaneous discontinuance and in cases where the bankruptcy estate may be insufficient to cover the costs of the proceedings (Article 31, Paragraph 2 of the Bankruptcy Act), a period for filing proofs of claim may not be set at the outset of the proceedings. In the case of Paragraph 2 of that Article, a filing period is set later once the risk of insufficient funds has been eliminated. Also, a notice of engagement, by which an attorney announces preparation of a petition, and a notice of commencement, issued after the court has made its decision, differ in legal status. The filing period is set by the court for each case under Articles 31 and 111 of the Bankruptcy Act. Article 20, Paragraph 1, Item 1 of the Rules on Bankruptcy requires that, absent special circumstances, the period be set within a range such as not less than two weeks and not more than four months from the date of the commencement decision (not less than four weeks and not more than four months if there is a known creditor without a domicile or the like in Japan), but creditors cannot choose their own deadline. Rather than estimating the number of days from the date of receipt, start by directly checking the date clearly stated in the notice in hand.

Once you have grasped the deadline, identify the company's claims and obligations in parallel. In addition to receivables and loans you hold against the business partner, confirm the legal relationship if there is consigned inventory, and gather the contracts, invoices, delivery notes, and acceptance records that prove the amounts and causes. At the same time, check whether the company has any payables or deposits it owes to the counterparty. Where both claims and obligations exist with respect to the same business partner, organizing when and why each arose at this stage leads directly to the later judgment on set-off.

In a trustee case in which a bankruptcy trustee has been appointed, the point of contact from then on is consolidated in the bankruptcy trustee. After confirming the trustee's contact details in the notice, direct inquiries and communications to the trustee. After bankruptcy proceedings have commenced, juridical acts performed by the bankrupt with respect to property belonging to the bankruptcy estate cannot be asserted against the parties to the bankruptcy (Article 47 of the Bankruptcy Act). For this reason, the policy should be to avoid negotiating directly with the business partner's former contact person without going through the trustee, and to avoid receiving partial payment or collateral that way. This is distinguished from avoidance of payments and the like made before commencement. The acts subject to avoidance are not limited to those before the petition.

Procedure for Filing Proofs of Claim and Materials to Submit

Filing a proof of claim is a declaration made by a bankruptcy creditor in order to participate in the distribution procedure. The proof of claim states the amount and cause of the claim, whether it is a priority bankruptcy claim or a subordinated bankruptcy claim, the subject matter of any security (right of separate satisfaction), the deficiency expected to remain unrecovered through exercise of the right of separate satisfaction, and so on, and is submitted to the court (Article 111 of the Bankruptcy Act). For general claims such as receivables, copies of supporting documents, such as the contract documents and delivery records that form the basis of the claim, are attached. For where to submit and the format of the filing form, follow the enclosed guidance and the instructions of the court or the bankruptcy trustee.

As a rule, the proof of claim is filed within the filing period stated in the notice, and if the proceedings move forward without a filing, the creditor may be unable to receive distributions. Article 112 of the Bankruptcy Act provides an exception allowing a supplementary filing, limited to within one month after the cause ceases, where a creditor was unable to file by the expiration of the general investigation period or the end of the general investigation hearing due to a cause not attributable to the creditor, but this does not extend the period without limit. There is room for a late filing to be handled if it is made before the investigation period ends, but in practice the person in charge should proceed to finalize the amount and gather materials as soon as the notice arrives, on the assumption of completing the filing within the original deadline.

If the insolvency proceeding is civil rehabilitation rather than bankruptcy, voting on the proposed rehabilitation plan, the mechanism for investigating claims, and the approach to repayment differ greatly from bankruptcy. Understanding at the outset which proceeding the document received relates to makes it easier to anticipate the subsequent response.

Legal Risks of Individual Collection and Self-Help

Right after receiving the notice, there is a tendency, out of anxiety over unrecovered amounts, to contact the former contact person and try to collect, but careless actions can actually be detrimental.

First, refrain from collecting receivables by agreement with the former contact person without going through the bankruptcy trustee, or from having new collateral provided for the company's claims. If the bankrupt, after becoming unable to pay or after a petition for commencement of bankruptcy proceedings has been filed, makes payment of an existing obligation or provides collateral to a specific creditor, and that creditor knew of the inability to pay or of the petition, the bankruptcy trustee may avoid the act as a preferential act (Article 162 of the Bankruptcy Act). If avoidance is granted, the return of amounts received and the effectiveness of the collateral become issues, so individual collection after the notice is checked, including the timing of the act.

Another response to avoid is going to retrieve goods owned by the company that are stored in the counterparty's warehouse or factory without consent. For property the company owned before the commencement of bankruptcy proceedings, the law provides a right to recover it from the bankruptcy estate (right of segregation) (Article 62 of the Bankruptcy Act). However, the fact that the company has ownership does not mean it may enter the counterparty's premises without permission to retrieve the goods. Furthermore, goods sold with a retention of title may, depending on the terms of the arrangement securing the purchase price claim and whether perfection requirements are met, be treated in bankruptcy proceedings as subject to a right of separate satisfaction (a security interest), so it cannot be assumed that all goods under retention of title are automatically subject to the right of segregation. Including cases where the company holds security interests such as a special statutory lien, a pledge, or a mortgage (rights of separate satisfaction, Article 65 of the Bankruptcy Act), proceed with the method of exercising rights and the delivery of goods through consultation with the bankruptcy trustee. Also keep in mind that even with a right of separate satisfaction, the company cannot necessarily make the subject property its own automatically.

Judging Set-Off When There Are Both Receivables and Payables

For a company that has both receivables and payables with a business partner, recovery through set-off in equal amounts is a powerful means. If a bankruptcy creditor owes an obligation to the bankrupt at the time of commencement of bankruptcy proceedings, it may set off without going through the bankruptcy proceedings (Article 67 of the Bankruptcy Act). However, legal restrictions apply to this right of set-off.

Specifically, there are provisions prohibiting set-off with respect to obligations incurred after the commencement of bankruptcy proceedings, obligations incurred through contracts for the disposal of property or the like solely for the purpose of set-off while knowing of the inability to pay, bankruptcy claims acquired with knowledge of the circumstances of inability to pay, and so on (Articles 71 and 72 of the Bankruptcy Act). On the other hand, set-off may be permitted for claims acquired or obligations incurred based on statutory exceptional causes. Therefore, do not jump to the conclusion that set-off is possible based on the figures in the books; confirm from contracts and order records when and for what cause the company's claims and its obligations to the counterparty each arose. If you conclude that set-off is possible, giving a written declaration of intent to set off to the bankruptcy trustee and keeping a record of delivery of the notice is a means of preventing future disputes.

Flow of the Proceedings and the Outlook for Distribution

After proofs of claim have been filed, the proceedings move through the bankruptcy trustee's investigation, such as approving or disputing claims, and the realization of the bankrupt's assets, and finally to the distribution procedure. The timing and rate of distribution vary from case to case. Distribution may proceed in stages according to the progress of realization, or there may be few realizable assets so that distributions to unsecured general creditors remain minimal, or the proceedings may end without any distribution at all. Filing a proof of claim does not guarantee full recovery, so rather than treating waiting for a distribution as the only means of recovery, it helps to examine at an early stage the legal means available to you, such as set-off and the exercise of security interests.

For Companies Considering an Initial Response to a Business Partner's Bankruptcy

Filing proofs of claim, judging whether set-off is possible, and handling security interests after receiving a notice of commencement of bankruptcy proceedings are tasks that require gathering internal materials and conducting legal analysis in parallel within a limited period. At LegalAgent, in addition to handling restructuring, insolvency, and debt collection, you can consult us through legal outsourcing on building a legal structure that includes day-to-day contract management and credit management of business partners.

When reviewing ongoing contractual relationships with business partners, it is also useful to check provisions on transfer restrictions and the assignment of contractual status. Please also see the review perspectives on anti-assignment clauses and on the basic transaction agreement, which sets out the basic terms for continuous transactions.

Frequently asked questions

When we receive a notice of commencement of bankruptcy proceedings, what should we check first?

Check the period for filing proofs of claim stated in the notice and the status of your company's claims and obligations. This is because the filing period is set by the court for each case, and creditors cannot choose it themselves. Organizing when and why accounts receivable, accounts payable and consigned inventory arose is also thought to bear directly on later decisions about filing proofs of claim and whether set-off is available.

Can we take back goods we own that are on the business partner's premises without their consent?

You cannot take back goods without permission. Even if the property belongs to your company, you must not enter the counterparty's premises without permission to recover it. In addition, even goods sold with a retention of title may be treated as subject to a right of separate satisfaction in bankruptcy proceedings, and it is understood that the right must be exercised through consultation with the bankruptcy trustee.

If we have both accounts receivable from and accounts payable to a bankrupt business partner, can we set them off in equal amounts?

Although there are legal restrictions, set-off in equal amounts is possible without going through the bankruptcy proceedings. This is because Article 67 of the Bankruptcy Act recognizes a right of set-off. However, set-off is prohibited for obligations incurred after the commencement of bankruptcy proceedings and for obligations incurred, with knowledge of the inability to pay, through a contract to dispose of property or the like solely for the purpose of set-off, among others. It is therefore thought that, after closely examining how the obligations arose, giving notice of set-off to the bankruptcy trustee in writing and keeping a record of the notice's delivery is a way to prevent future disputes.