My Customer Just Filed for Bankruptcy! Now What?

Even if your company is thriving in these challenging economic times, you may find yourself with a pressing need to understand the US Bankruptcy laws.  If one of your customers files for bankruptcy what should you do?  In such a situation there are many issues that you may need to address, too many to cover in this single blog post.  The following are some of the more important factors to consider.

Under what chapter of the bankruptcy code did your customer file? 

If  a chapter 7 was filed, this means your customer has decided to go out of business, liquidate any assets and pay whatever creditors they can under the protection of a bankruptcy trustee.  If your customer filed a chapter 7, I hope they did not owe you too much money.  If they did owe you money, was the debt secured?  If it is secured you are much more likely to be repaid than if the debt is unsecured. 

A word of caution about secured debt, if your customer offers to give you a mortgage on some real property (e.g. their home of the business location) make sure you know what other mortgages are already on the property.  If your customer has a house worth $500,000 and there are already two mortgages on the property totaling $600,000, a mortgage on that property won’t give you any protection unless the value of the property increases dramatically.   

If a chapter 11 was filed this means that your customer wants to reorganize with the protections and benefits of the US Bankruptcy code and continue in business (think General Motors).  If a company continues in operation then you need to determine if you want to continue to do business with them.  In some circumstances such as where you have an agreement with your customer you may be required to continue the relationship by the bankruptcy trustee (see below).  In general, it is better if a company files a chapter 11 bankruptcy compared with a chapter 7, but a chapter 11 filing is no guarantee that you will be paid what you are owed. 

On the date your customer files for bankruptcy do they owe you any money?

If the answer to this question is yes, and the customer files under chapter 11, the debt that is owed before filing is called pre-petition debt.  If you continue to do business with the customer and you continue to extend credit (something you should not do without seriously considering if that is good idea) any amount you are owed after the filing is called post-petition debt.  If you have a contract with the customer and the terms of the agreement require payment within 45 days, you should be able to demand that the customer go to COD payment terms on any post-petition transactions.   

If the customer wants you to continue and do business with you under the terms of an  agreement, and they owe your company pre-petition debt, you do not have to agree to the extension of this agreement unless the customer can provide you with adequate assurances that all the pre-petition debt will be paid.  This should put you in a better position than other unsecured creditors and should be used to your advantage if at all possible.

Is there anything I need to do after I get the notice from the bankruptcy court?

Yes, if you receive notice from the bankruptcy court that your customer has filed for bankruptcy, this means that you have been listed as a creditor.  You should review the bankruptcy petition to determine the amount of the debt that the customer claims to owe you.  You also need to “file a proof of claim” with the bankruptcy court.  You need to file this proof of claim in both a chapter 7 or chapter 11 case.   If you fail to file the proof of claim your company will not receive any payments from the bankruptcy trustee.

What does it mean to have debt “discharge?”

If the debt that your customer owes you is “discharged” by the Bankruptcy Court, this means that the customer no longer has a legal obligation to pay the debt.  A discharge does not prevent your customer from voluntarily making the payment, however it does prohibit you from taking any action to collect the debt.

Is there any basis to fight a discharge?

Yes, the bankruptcy code does provide some reasons to deny a discharge in certain circumstances.  In general, if you extend credit to a customer in the normal course of business and the customer is not able to pay its bills, this debt will probably be discharged.  If you extended the credit because of fraudulent acts by your customer, this may provide a basis deny a discharge.  Assurances by your customer to “don’t worry, you will get paid,” without more will normally not provide any basis to argue fraud should prevent the discharge. 

Should I just give up and forget about ever getting paid?

That depends, if you are owed a significant amount of money, the last thing you should do is spend a significant amount of additional money in legal fees if the chances of ever getting the money back is very slim.  However, depending on the situation there may be an opportunity to recover some or all of the funds you are owed and you should speak with an attorney who is knowledgeable about the bankruptcy laws.

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