Bankruptcy filings have spiked in the pandemic era, and if you’ve received notice that a customer with an outstanding balance is seeking debt relief through bankruptcy court, you’re not alone.
When dealing with an insolvent client or customer, it’s important to understand your rights as a creditor and the remedies available to you to mitigate continuing losses and improve your chances for recovering the money you are owed.
If you learn that a client with past due invoices has filed for bankruptcy, take these steps to help you preserve all available remedies to recover what is owed to you:
- Stop goods in transit and arrange for return to your warehouse: Creditors have the right to stop goods in transit when notified of a client’s bankruptcy, provided products have not been prepaid or delivered to the customer or its agent. Shipments received by customers after a bankruptcy petition has been filed may become part of the bankruptcy estate unless creditors exercise reclamation rights.
- Stop all collection efforts. It may seem counterintuitive to stop payment demands, but debtors in bankruptcy are protected by an automatic stay. Much like an injunction, an automatic stay orders creditors to cease debt collection actions, garnishment, and repossession. Failure to do so could land you in litigation.
- Document, document, document. Creditors should organize and preserve all documentation pertaining to their relationship with an insolvent client. This includes records of supplied products or services, returned goods, and received payments. These records are important to court proceedings (including the 341 Meeting of Creditors) and for defense against future litigation, as debtors and trustees have two years to bring claims against creditors over pre-bankruptcy transactions.
- Consult a creditors’ rights attorney. After receiving notice of a customer’s bankruptcy filing, businesses will need to take decisive steps to preserve their rights as creditors, assess the viability of any future relationship with the client, and ensure compliance with special rules and procedures. Because missteps can have real consequences, you should consult an experienced creditors’ rights lawyer to identify the best course of action based on your unique situation and contractual obligations.
- File a proof of claim, if necessary: If your claim is not listed on the schedule of debts filed by the debtor; is listed incorrectly; or is designated as disputed, unliquidated, or contingent, you will need to file a written proof of claim to preserve their right to payment. Though brief, these forms must be accurate and timely as courts will deny incomplete and untimely claims.
- Get in line for repayment: Bankruptcy courts prioritize certain debts for repayment first. Secured debt (such as mortgages) and administrative and trustee fees get paid before unsecured debt. Post-petition claims for goods or services critical to the survival of the business are also given higher priority status as long as the costs are reasonable. Some debts (including yours) may qualify for a discharge, meaning the debtor is no longer legally required to pay the debt, and you, as the creditor, are barred from taking any form of collection action.
Should I Do Business With a Client in Chapter 11?
If your client is a Chapter 11 “debtor in possession” (i.e., in possession of property and continuing to do business as usual), that client is legally permitted to pay for services and goods in the ordinary course of business after a bankruptcy petition is filed.
Depending on the size of the client, contractual terms, and nature of your relationship, you will have to determine whether to continue business with your client or terminate the relationship. As a creditor, you will also need to know the rules for dealing with clients in Chapter 11 and how you are paid for any post-bankruptcy sales or service.
- Beware of contractual obligations: Creditors with material obligations to perform under an executory contract established prior to the customer’s bankruptcy must continue performance unless the debtor rejects the contract, and the court approves their non-performance.
- Make a demand for adequate assurance: Suppliers have the right to demand adequate assurance of a client’s future performance / ability to pay and to suspend performance of a contract until such assurance is provided (UCC § 2-609). Creditors that make these demands typically file a motion seeking adequate assurance with the court simultaneously.
- No contract in place? Creditors that provide goods or services via individual transactions and purchase agreements without an overarching contract may generally to choose if they wish to continue business after a bankruptcy filing and may negotiate terms, such as requiring cash in advance. In any situation where business continues after a bankruptcy filing, creditors should seek approval from the court prior to delivering goods or services – especially for post-petition transactions with terms outside the scope of “ordinary course,” such as an unusually large purchase.
It is best practice for creditors to evaluate if customers have sufficient liquidity to satisfy post-petition claims, and to ascertain the client’s financial situation before furnishing goods or services or extending post-petition credit. Notices, meetings of creditors, and monthly financial reports filed with the court can provide this type of information. An attorney can help review your contract and ensure compliance with bankruptcy rules.
Discuss Your Rights & Options with a Proven Creditors’ Rights Lawyer
Receiving notice that a client has filed for bankruptcy starts the clock for creditors who’ll need to navigate what are often unfamiliar proceedings. At Hendershot Cowart P.C., our award-winning attorneys provide personalized support to business owners, general counsel, corporate directors, and executives who must address a customer’s bankruptcy and the related financial and regulatory fallout.
To discuss your case with a member of our team, call or contact us online.