There is little doubt that the Coronavirus (COVID 19) will force many companies to seek the protections afforded under the United States Bankruptcy Code while they fight to get back on their feet after the crisis. It is also likely that one of your customers will be in this group of businesses. Therefore, knowledge of the bankruptcy process will help your company while it attempts to get paid for the services it performed for the insolvent customer.
When A Bankruptcy Hits Your Company’s Accounts Receivables
Sometimes the first time you learn that a customer who owes you money is in trouble is when you receive notice that it has filed for bankruptcy. This notice is generally in the form of a letter you receive in the mail from the United States Bankruptcy Court. This notice contains quite a bit information and you should read it carefully and keep it for future reference. Give a copy of it to whomever handles your receivables and mark any dates contained within the notice on your calendar.
After you have posted the bankruptcy dates the next step is to stop all efforts to collect from the customer – who in the bankruptcy case is called the “Debtor.” The reason you have to stop collection efforts is because the second the Debtor files its bankruptcy it is protected by the overarching principle of bankruptcy known as “the Automatic Stay.” The Automatic Stay prohibits anyone or anything from attempting to collect monies from the Debtor and forbids most attempts to recover property in the possession of the Debtor. One example of what the Automatic Stay prohibits is where the seller of property to the customer/debtor attempts to recover the goods it sold to the customer after it learns that the customer has filed for bankruptcy. With very rare exceptions, once goods have been delivered to the Debtor they cannot be repossessed without first getting permission to do so from the Bankruptcy Court that is presiding over the case.
After you have stopped the collection process, the next step to examine your account with this customer-turned-debtor. Do you have a signed credit agreement with the Debtor? Does that credit agreement include a personal guarantee of payment from a third party, such as an owner? Do you hold a security interest in any property that could be leveraged in order for you to get paid? Is there another entity that is also indebted on the account, such as joint venturer? Was there bond issued under which you could make a claim outside of bankruptcy? You will want to ask your accounting department to prepare a history of the billings and payments from this customer going back for about five years, depending upon the length of time you have been doing business with the Debtor. You will need to know the current balance and what kind of sales were the basis of open balance. Also, you need to make a decision as to whether you will immediately stop selling to this customer on credit. Most of the time the answer will be yes, but there are rare occasions when creditors will continue to sell on an open account (you will probably want to consult a bankruptcy attorney if you desire to take this course of action). Often a creditor will continue to sell to a bankrupt in a reorganization bankruptcy, but only on a COD basis.
The next question you will want to ask is what type of bankruptcy did your customer file? The answer to this question is contained in the notice you received from the Bankruptcy Court (remember I said to hold on to that notice?). If they filed a Chapter 7 (see definitions below), then if you do not have an alternative source for payment (see the preceding paragraph) then the chances of you getting paid any of the money you are owed by this customer are very low. If the customer filed either a Chapter 11 or Chapter 13 (see below) then be sure to file a Proof of Claim (also defined below).
Finally, ask yourself if your company provides something unique to the customer that it may need going forward (if the Debtor is going to attempt to reorganize its business)? If so, you will want to obtain legal advice on how you can turn this fact to your advantage.
As you can see, there are a lot of issues and questions facing your company as the holder of a claim against a bankrupt. What are your best options are dictated by the facts relating to your claim and the type of bankruptcy that is filed. Below are definitions of twelve bankruptcy terms you may encounter and an abbreviated checklist of what you should do when you receive that initial bankruptcy notice.
Key Bankruptcy Terms:
CHAPTER 7 – Tradition/liquidation bankruptcy Trustee appointed to evaluate assets and liquidate any non-exempt unencumbered assets. In the rare case where there are unencumbered assets after liquidation the proceeds are distributed, first to the professionals that handled the various aspects of the bankruptcy and then to creditors on a pro rata basis.
CHAPTER 11 – Restructuring or reorganization bankruptcy, filed usually by a business, but can be filed by an individual with large debt. In most instances the debtor remains in control of its business operations as a debtor in possession, and is subject to the oversight of the United States Trustees Office and jurisdiction of the bankruptcy court.
CHAPTER 13 – Wage Earner’s Plan – For individuals only. Debtor proposes a plan to pay back some or all of his/her debt over a period of 5 years by paying his/ her excess monthly income to a trustee for subsequent distribution to their creditors.
THE AUTOMATIC STAY – Section 362 of the U.S. Bankruptcy Code prohibits virtually any type of activity by a creditor against a bankrupt after it files a bankruptcy.
PROOF OF CLAIM – A form filed with the Bankruptcy Court which indicates the type and amount of debt the Creditor is owed. Creditor should file one in every bankruptcy (even Chapter 7 no asset cases) in which it holds a claim. NOTE: There are strict deadlines as to when your claim must be filed. Carefully read any notices you receive from the bankruptcy court and look for the deadlines for filing Proof of Claims. If you do not receive any notice from the bankruptcy court, call the bankruptcy clerk’s office and ask if there is a “proof of claim bar date” in your customer’s bankruptcy.
MEETING OF CREDITORS – A meeting conducted by the Trustee in which Trustee and Creditors interrogate Debtor about Debtor’s assets, finances and bankruptcy schedules.
REAFFIRMATION – The bankrupt debtor voluntarily agrees to repay otherwise dischargeable debt.
PREFERENCES – Payments received by a creditor from a bankrupt within 90 days of filing a bankruptcy that may have to be returned by the creditor, depending upon the facts of the case (more on this in a later edition of the Wright Toolbox).
MOTION FOR RELIEF FROM THE AUTOMATIC STAY – The procedure whereby a creditor can request permission from the bankruptcy court to enforce certain rights it holds against the property of the bankrupt’s estate or against co-debtors.
PRE-PETITION – Any events occurring up to and immediately prior to the bankruptcy filing.
POST-PETITION – Any events occurring immediately after the bankruptcy filing.
DISCHARGE – A decree from the Bankruptcy Court which absolves the Debtor from any further liability on many, if not all, of Debtor’s pre-petition debts.
Below are some of the things you should do when a bankruptcy rears its ugly head.
Checklist for When Bankruptcy Hits:
- Cease all collection activities – see the “Automatic Stay” above.
- Get your Accounting and Sales departments to give you reports on sales and payments from this customer.
- Is there a personal guarantee?
- File a Proof of Claim (get date-stamped copy back from the Bankruptcy Court after it is filed) TIME IS OF THE ESSENCE ON THIS ITEM.
- Decide whether to consult a bankruptcy attorney (see above).
- Have a representative attend the Meeting of Creditors. Consider becoming a member of the Unsecured Creditor’s Committee if your company’s claim is large and the customer filed a Chapter 11 bankruptcy. These committees are often formed immediately after the Chapter 11 Meeting of Creditors.
While being proactive with your bankruptcy accounts will not guarantee your company will be paid all of what it is owed in every bankruptcy, it most certainly will increase your odds of being paid more than if you did nothing.
Visit our COVID-19 Resource Page for more updates.