5 things CPAs need to know about bankruptcy

January 1, 2021

By Arlene M. Hibschweiler, J.D.; Timothy P. Lyster, J.D.; Martha L. Salzman, J.D.; and William F. Savino, J.D., Journal of Accountancy

The economic duress unleashed by the global pandemic has attorneys scrambling to meet an expected surge in bankruptcy cases. While CPAs may not be directly involved in preparing bankruptcy petitions and handling the legal aspects of cases, they are likely to be immediately affected, whether working as a chief accounting officer or in some other leadership position for a business or serving clients in practice. For accountants, bankruptcy issues can arise because of a company's or individual's own financial distress or because a company's customer appears to be headed for insolvency. In either case, CPAs will probably be sought out for advice.

This article examines some basic bankruptcy issues that are likely to arise as CPAs manage the economic challenges caused by COVID-19. While not intended to supplant the role of legal counsel, this article offers observations and guidance that may help CPAs navigate bankruptcy cases and better partner with clients, colleagues, and attorneys in bankruptcy matters.

MY CLIENT HAS FILED BANKRUPTCY. WILL I BE PAID?

The question of payment is an obvious issue for CPAs in practice. Accountants can be hired, with court approval, by debtors, bankruptcy trustees, and Chapter 11 creditor or equity security holder committees. Fees for work done by the CPA as part of the bankruptcy qualify as administrative expenses. Administrative expenses are entitled to payment priority from estate assets (11 U.S.C. §507(a)(2)). In a Chapter 7 case, which is a liquidation proceeding, this means the CPA will share in any assets that may be left after secured creditors take their collateral or are otherwise satisfied and any claims associated with domestic support obligations (if the debtor is an individual) are paid (11 U.S.C. §507). Practitioners need to consider the risk of not being compensated, in whole or part, before accepting Chapter 7 bankruptcy estate work. While a position as a priority creditor in a Chapter 7 bankruptcy makes payment more likely, it is not certain.

During a Chapter 11 reorganization (typically used by corporations), a CPA can expect to be paid for bankruptcy services as the case progresses. In order for a court to confirm a plan of reorganization, the plan must provide that professional fees and other allowed administrative expenses will be paid on confirmation of the plan, except to the extent that the holder of a claim for these expenses has agreed to a different treatment of the claim (11 U.S.C. §1129(a)(9)).

Chapter 13, which provides for individual reorganizations if debts are below certain thresholds, also requires full payment of priority debts such as administrative expenses, but the payments can be in deferred cash; the plan is not required to pay post-petition interest (11 U.S.C. §1322(a)).

The possibility of significant payment is much more tenuous when a CPA in practice seeks compensation for work that was done earlier and not as part of the bankruptcy filing. In these cases, the amount owed will most likely be general unsecured debt. In Chapter 7 this debt is paid only if assets remain after the secured creditors receive payment or other satisfaction and distributions are made to those holding priority obligations (11 U.S.C. §726(a)). Similarly, some or most prepetition fees owed a CPA by Chapter 11 or Chapter 13 clients are likely to go unpaid. This means it is important to monitor receivables due from clients and take steps to keep accounts reasonably current regardless of the type of bankruptcy that may be anticipated.

There is a further concern involving fee payment. The Bankruptcy Code allows the bankruptcy estate to recover "preferences," which are payments or transfers made on old debt within 90 days before a bankruptcy filing (or within one year for insiders), where the creditor receives more than it otherwise would have in a Chapter 7 liquidation (11 U.S.C. §547). The bankruptcy trustee, or the debtor in a Chapter 11 case, can claw back these payments or transfers. Preferences can apply in both liquidation and reorganization cases. No preference exists if the transaction is a transfer in the ordinary course of business, like a routine payment for utilities provided the previous month, or a substantially contemporaneous exchange for new value (11 U.S.C. §547(c)).

In Trauger, a bankruptcy trustee recovered as preferential transfers fees that were paid to an attorney for professional services (In re Trauger, 105 B.R. 120 (Bankr. S.D. Fla. 1989)). The bankruptcy court held that all payments necessarily were for past services since none of the attorney's statements were ever paid in full and balances were carried over to each following month, and therefore the payments were preferences and could be clawed back. As the outcome of this case suggests, where a client is in arrears and bankruptcy may be looming, the practitioner should insist on current payment for any new services performed, to try to qualify the transaction as a substantially contemporaneous exchange for new value. Further, as noted below in more detail, payments should be applied to the most recent payable to minimize preference exposure.

A final point regarding payment of fees is that a professional working in a bankruptcy matter must file a verified statement of all connections with parties in interest. This is to ensure that the CPA does not have a disqualifying conflict of interest. Thus, CPAs seeking to be retained in a bankruptcy matter who are owed monies from services performed prepetition and hold unsecured claims, or who have received payments that may be considered preferential, will need to consider the waiver of the claim and the disclosure of the potential preference amounts in a retention certification.

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