With increasing frequency, I am being asked by class action plaintiffs lawyers about what to do before, during and after a bankruptcy filing by the defendant corporation. Issues commonly begin to arise during settlement negotiations when the defendant asserts its purported inability to pay any substantial judgment.

When a bankruptcy scenario becomes likely, class action plaintiffs must be aware of their options and potential strategies. Here is a brief overview of the challenges that class action plaintiffs counsel should keep in mind in a threatened or actual bankruptcy scenario.

Settlement negotiations and bankruptcy: If a defendant threatens bankruptcy in settlement negotiations, counsel for the class action plaintiffs should get as much financial information as possible. In the event a mediator is involved, the mediator can facilitate obtaining this financial information. If the threat of a bankruptcy filing appears real, plaintiffs counsel should take precautions. Once the defendant has put its financial situation at issue, the door is open for the plaintiffs to demand that a settlement involving payments, over time, be secured by a perfected lien or be backstopped by a third-party guaranty, line of credit, or other third-party source. Obtaining these protections will mitigate or eliminate the risk of losing the benefits of the settlement if a bankruptcy if filed.

Chapter 7 liquidation: Sometimes a bankruptcy filing is unavoidable. Often class action plaintiffs are well along in their litigation when the defendant files a bankruptcy case. Of course, upon the filing of a bankruptcy, the class action litigation is immediately halted by the automatic bankruptcy stay. If the defendant files a Chapter 7 petition — in which a trustee is appointed to liquidate the bankrupt company's assets — there are often no assets to pay to unsecured creditors. If the class action had already settled and there are other third-party sources of recovery, those can and should be pursued. If not, class action plaintiffs should carefully examine whether pursuing their claim in a liquidating Chapter 7 case has any chance for a recovery from the bankruptcy estate.

Automatic stay: In a Chapter 11 reorganization case — especially in a situation in which the company is seeking to restructure its debts and continue as an operating entity — additional options are presented. If, after weighing the costs and benefits of continuing the litigation, the plaintiffs wish to pursue their litigation, questions arise as to when and whether the plaintiffs should seek relief from the automatic stay to pursue their claims in the nonbankruptcy forum. If the class action litigation has proceeded to a point where the parties are preparing for trial or trial has already commenced, then I usually recommend that the plaintiffs file a motion for relief from stay early in the bankruptcy case. Bankruptcy courts will tend to defer to nonbankruptcy forums to litigate claims grounded wholly in nonbankruptcy law, especially if the litigation is at or near the trial stage. Because the class action claims must be liquidated in connection with any reorganization plan, and due to considerations such as comity, right to a jury trial, the administrative burdens of class action litigation, judicial economy and abstention doctrines, the bankruptcy court may determine that the disposition of the class action in a nonbankruptcy forum is appropriate as early as possible. Filing a motion for relief from stay early in a case, even if a court is not inclined to grant it at that time, can still create significant leverage for class action plaintiffs and may reinvigorate stalled settlement discussions. Commonly, if the bankruptcy court is not inclined to grant the motion at the beginning of the bankruptcy case, courts will allow the motion for relief from stay to trail, as opposed to entering an order denying the relief entirely.

"Claw back " of settlement payments: Another issue that comes to the fore after the filing of a bankruptcy case for those plaintiffs who have received settlement payments prior to the filing is whether such payments can be "clawed back" as preferential transfers. Although this issue only pertains to payments received by noninsiders within the 90-day "preference" period prior to the filing of the case, this type of exposure could add insult to injury.

In the case of structured settlements, there may be defenses available. For example, if the underlying dispute between the plaintiffs and the defendants arose out the ordinary course of business, then an "ordinary course of business" defense may be available under the U.S. bankruptcy code. In addition, if the settlement payments are secured by a lien, those payments may be shielded from recovery because a payment is preferential only if the recipient received more than it would have if the bankrupt company were liquidated.

Committee membership: Often in Chapter 11 cases, the U.S. trustee will appoint an official committee of unsecured creditors, usually chosen from the list of the top 20 creditors submitted by the bankrupt company with its bankruptcy petition. It can be highly advantageous for one or more class representatives (or one of the lead plaintiffs lawyers) to secure a seat on the creditors committee. The committee is generally the strongest voice for the treatment of general unsecured creditors, and its counsel is paid from the assets of the debtor's bankruptcy estate. Again, depending on the size of the class action claims, the amount of debt represented on the committee, and the overall size of the case, sitting on the committee can afford class action plaintiffs a bird's-eye view of how the case is proceeding. As a member of the committee, the class may be able to have substantial influence in encouraging the debtor to continue or commence settlement negotiations, if that is a goal. In addition, it allows that class to play an active role in helping to increase the value available for general unsecured creditors in general.

Proof of claim: Importantly, a creditor can only receive distributions from a bankruptcy estate if it has an allowed claim in the bankruptcy case. Obtaining an allowed claim is generally accomplished when the debtor schedules the claim as undisputed, liquidated and not contingent, or when the creditor files a proof of claim. Of course, a debtor will never list a class action claim as undisputed; consequently, class action plaintiffs must file proofs of claim. Technically, each member of a class — whether or not the class was certified in the nonbankruptcy forum — must file his or her own proof of claim. Case law has developed in most jurisdictions addressing the ability of a class representative to file a single proof of claim for the entire class. Jurisdictions that have permitted it require a class to satisfy Federal Bankruptcy Rule 7023, which incorporates Federal Rule of Civil Procedure 23 and sets forth the requirements to certify a class action in federal court. A class that wishes to file a single class proof of claim generally does so using three different methods: first, filing a motion with the bankruptcy court requesting authority to do so, setting forth the evidence and law demonstrating that class certification is appropriate under Rule 23 with respect to the claims allowance process; second, filing a single proof of claim, and then addressing the Rule 23 requirements if or when the claim is objected to; and third, obtaining a stipulation from the debtor or trustee to do so. Of note, a deadline ("bar date") to file proofs of claim is established in every case. Often counsel for the class will obtain an extension of the proof of claim bar date to afford the parties an opportunity to explore settlement or administrative options to ease the burden of determining whether filing a single proof of claim is appropriate.

Because there are considerations unique to certifying a class in bankruptcy cases when applying Rule 23, counsel should carefully review case law in a particular jurisdiction when formulating a strategy. Two cases addressing these unique bankruptcy issues are Teta v. Chow from the U.S. Court of Appeals for the Fifth Circuit in 2013 and In re Ephedra from New York's Southern District in 2005. Notably, even though a class has been certified in federal court under Rule 23, this may not be res judicata with respect to the ability of the class to file a single class proof of claim under Bankruptcy Rule 7023, as noted in an unpublished slip opinion by New York's Southern District in Lucas v. Dynegy.

Of course, there are many other aspects of a bankruptcy case to consider with respect to litigating issues in bankruptcy court and obtaining the most favorable result possible for class members. Consultation with experienced bankruptcy counsel is always recommended.

Daniel H. Reiss is a partner at the bankruptcy boutique Levene, Neale, Bender, Yoo & Brill in Los Angeles. Before practicing as an attorney, he was a certified public accountant at KPMG. He regularly represents debtors, creditors committees and trustees in bankruptcy actions.