Becoming a Creditor in a Bankruptcy Case Triggers a Duty to Preserve Documents
A litigator in bankruptcy court is challenged with mastery of a trial lawyer’s skills as well as the developing substantive law, jurisdictional and otherwise, governed by the Bankruptcy Code. Who hasn’t heard of Stern v. Marshall?
Thousands of articles and blogs have touched on the litigator’s duty to advise a client about its duty to preserve documents, including electronically stored information (“ESI”), once there is reasonable anticipation of litigation. A lawyer’s professional duty is to competently represent and advise the client. Failure to appreciate the duties of document and information preservation and to advise the client accordingly is incompetent and unprofessional.
So, when does a creditor’s duty to preserve documents commence? The answer depends, in large part, on (1) whether the creditor’s claim is listed correctly as to amount and is not listed as disputed, and (2) whether the creditor has received payments within the specific periods allowed for avoidance of the transfers as preferential or fraudulent (constructively or actually).
If the bankruptcy is a Chapter 11 case and the creditor’s claim is listed accurately and not disputed, there should be little anticipation of an objection to the claim and litigation over the allowance of the claim. On the other hand, if the claim is listed as disputed, or if the case requires the filing of a proof of claim, the anticipation of an objection to or litigation over the allowable amount of the claim is greater and the documents relating to the validity and amount of the claim must be preserved, or the creditor runs the risk of adverse inferences affecting the allowance of the claim.
If the creditor has received payments on the debt within 90 days of the bankruptcy petition (1 year if the creditor is an insider), preference avoidance litigation should be anticipated. While some Chapter 11 cases do not result in wholesale pursuit of preference claims for reasons that the reorganized debtor recognizes valid defenses, the plan pays creditors 100%, or the business relationships with creditors outweigh the benefit of pursuing avoidance actions, until a waiver of such claim is declared through the Chapter 11 plan, the creditor should be prepared to defend the claim and retain the relevant documents for ultimate production. Pursuit of preference actions by liquidating trustees in Chapter 11 and Chapter 7 trustees is the norm, not the exception.
If a preference claim is possible, what should be retained? Given the available affirmative defenses, the creditor defendant may well need:
- Communications concerning demands for payments;
- Billing or invoicing documents;
- Shipping and delivery documents;
- Payment information; and
- Financial statements reflecting solvency of the debtor.
Preference defendants bear the burden of establishing their affirmative defenses by a preponderance of the evidence. Failure to maintain the requisite documents may result in the creditor’s inability to satisfy the burden. Retention of some, but failure to preserve other, relevant evidence on these defenses either calls into question the affirmative defenses and opens the creditor up to an adverse inference as to what the unpreserved information would have shown.