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March 1, 2004
Charles Willing Rath, Young and Pignatelli Concord, N.H.
LANDFILL OWNERS SHOULD TAKE PRECAUTIONS to ensure they aren't pulled into the undertow if a company they have contracted with (counterparty) goes bankrupt. In most cases, contracts are designed to establish and protect your legal rights, but such legal documents do not always protect against bankruptcy. Bankrupt companies do not have to honor all contracts, and often do not. And when this happens, landfill owners want to ensure others' failings do not hurt the bottom line.
One key to keeping assets intact is to consider the risk of counterparty bankruptcy before signing any important agreements. For example, landfill owners should research a potential contractor's financial stability, past work history and references. Yet even these precautions do not provide absolute protection because companies that appear financially strong one year may be insolvent the next.
When a company files for bankruptcy, all parties that have contracts with the business might be claimants in the bankruptcy. The bankruptcy filing triggers an “automatic stay” on creditor collection claims. This means creditors cannot:
Sue the debtor company;
Continue a suit;
Proceed with nonjudicial hearings; or
Create or act on liens against a debtor's property. A business cannot terminate a contract with the debtor even if the right to terminate is unconditional. But a business can ask the court for relief from the stay.
The court will decide whether all of the debtor contracts will be assumed or rejected. If a contract is assumed, the bankrupt estate becomes a party to the contract. The creditor then is entitled to all benefits and both parties, including the estate, are subject to all contract obligations. However, if a contract is rejected, the estate is not liable under the contract and the creditor is not entitled to a contract's benefits. Consequently, the landfill owner will have a general unsecured claim in the bankruptcy and will stand last in line for any fund distributions from the bankrupt estate.
A nondebtor has more rights if his contract with the debtor is a lease. For example, a lease must be assumed or rejected at an early date, and a nondebtor is entitled to full performance by the debtor, e.g. payment or rent, until a decision has been made to reject the contract.
To be paid, claims must be filed or deemed filed, and then approved by the bankruptcy court. Approved claims will be paid and/or discharged in whole or in part. Most claims are:
Secured claims, which are entitled to be paid in full up to the value of the collateral securing the claims before unsecured creditors are paid;
Priority unsecured claims, such as for administrative expenses, or
General unsecured claims, such as unpaid obligations or claims for damages, which usually are paid at cents on the dollar, if at all.
The following illustrate how counterparty bankruptcies might affect landfill owners:
Customer Bankruptcy (i.e. waste hauler)
If a company that hauls waste to a landfill under a long-term contract files for bankruptcy, the site owner will have a general unsecured claim for unpaid tipping fees before the bankruptcy filing. Most likely, the debtor will have to pay any post-filing tipping fees to maintain the right to dispose. The landfill owner probably cannot terminate the contract, but the hauler could reject the contract. The best ways to mitigate the risk of customer bankruptcy are to ask for prepayment when appropriate and to diversify the customer groups or revenue sources the site receives.
Construction Contractor Bankruptcy
Landfill owners must anticipate bankruptcy issues in construction contracts. Owners usually outlay money ahead of contractor deliveries. If the contractor files for bankruptcy before making deliveries, there is little an owner can do to compel delivery. Additionally, subcontractors might abandon their work or file mechanics liens if they are not paid. Owners may have to pay the subcontractors to release liens, even if they already have paid the general contractor.
To avoid putting themselves in jeopardy, landfill owners should consider holding contractor payments until deliveries are made. Owners also could require a contractor to obtain a payment bond, pay subcontractors directly, or ask for the contractor's parent company for a guarantee. However, this might make the contract more expensive.
Landfill Operator Bankruptcy
Bankruptcy is a concern with any long-term operations contract because an operator's performance may suffer if he lays off employees. It is difficult to terminate a contract with a bankrupt company. To alleviate concerns, consider using short-term operations contracts that do not automatically renew.
Some landfill owners might lease part of their sites to a landfill gas recovery project or composting operation. The lessee must continue to make payments to the landfill owner if he wants to retain the lease. The lessee could reject the lease, but must make an early decision to do so. If necessary, consider asking for front-loaded payments or a security interest in unencumbered lessee property to secure the payment stream.
Landfill owners should carefully review all contracts, including the risk of counterparty bankruptcy before signing. Research a company's financial stability and obtain a security interest if the circumstances warrant or allow it. Landfill owners cannot make every contract or deal bankruptcy-proof, but taking some simple steps can help to reduce the risk or increase the level of protection.
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