Two businessmen in a meeting discussing a bankrupt client

My Client Filed for Bankruptcy: What Are my Rights as a Creditor?

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.

In this blog, we breakdown the business bankruptcy basics and the key rights and responsibilities of creditors.

The 3 Types of Business Bankruptcy

Bankruptcy proceedings are designed to help struggling businesses and individuals restructure and discharge debts through repayment plans or liquidation of assets. There are generally three types of bankruptcy a business may file:

  • Chapter 11 is used primarily for corporations. Itallows businesses to keep assets and remain in business while restructuring debt. The debtor’s debts are restructured through a plan or reorganization which often provides for certain pools of money to be distributed to classes of creditors and redistributes the ownership of the business. Some creditors may be able to recover all debts, others recover only a percentage, largely depending on whether creditors have secured or unsecured claims.
  • Chapter 13 is for individuals or sole proprietors. It is a reorganization bankruptcy that functions like Chapter 11 but for individuals or sole proprietors who have sufficient income to pay creditors in full or in part. Debts are restructured and a three- to five-year payment plan is created. At the end of the payment plan, remaining debt owed to unsecured creditors can be discharged.
  • Chapter 7 is available to both individuals and businesses and involves the liquidation of any available non-exempt assets to be used in payment of debts. A court-appointed trustee is responsible for liquidating assets and distributing proceeds among creditors. If debts outweigh the value of assets, any liquidation proceeds will be split among creditors. However, again, some creditors made be able to recover a greater percentage of their debts, depending on whether the creditor is secured.

What Are my Rights as a Creditor?

If your client or customer has filed for bankruptcy, you should receive a Notice to Creditors that clarifies your rights as a creditor, important deadlines, and your client’s financial situation. The notice will disclose:

  • Whether your client has filed for Chapter 7, Chapter 11, or Chapter 13 bankruptcy;
  • The court where the bankruptcy case is filed and the date of filing;
  • The deadline for filing a proof of claim;
  • The date and location of the first meeting of creditors; and
  • The rules for collecting what you are owed.

This information is critical for taking the necessary steps to protect your rights as a creditor and determine whether to continue providing products or services to your client. Pay special attention to the deadline to file a claim. Failure to do so means your claim will have no chance of getting paid.

What Happens If I Don’t Receive a Notice to Creditors?

If you learn that a client with past due invoices has filed for bankruptcy and you have not received a Notice to Creditors, contact your client immediately to ask for the bankruptcy case number and the court in which the bankruptcy was filed. Time is of the essence as creditor’s rights in bankruptcy proceedings are limited by various deadlines, and we want to help you preserve all available remedies to recover what is owed to you.

6 Things To Do When a Client Files for Bankruptcy:

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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.

What Type of Debts Can Be Discharged?

Most of a bankruptcy filers debts are discharged as part of the bankruptcy proceedings. Some types of debt cannot be discharged, which means they will exist even after bankruptcy proceedings are complete and if appropriate and timely steps are taken once the creditor receives notice of the bankruptcy. Altogether, 18 types of debt are nondischargeable under the United States Bankruptcy Code.

Some common debts that cannot be discharged include:

  • Child support and alimony
  • Fines, penalties, and restitution for breaking the law
  • Certain tax debts
  • Debts arising from death or injury as a result of intoxicated driving
  • Secured debt or liens – a creditor can simply reclaim the property used as security, although any deficiency balance will likely be discharged
  • Debts incurred as result of false pretenses, a false representation, or actual fraud
  • Debts incurred because of fraud or misappropriation while acting in a fiduciary capacity
  • Debts incurred from embezzlement or larceny
  • Debts result from willful and malicious acts by the debtor to another entity or to the property of another entity

How Quickly Are Debts Discharged in Bankruptcy?

The timing of the discharge depends on the type of bankruptcy:

  • Dischargeable Debt under Chapter 7. Individuals in Chapter 7 may discharge their debts promptly (within a matter of months of filing bankruptcy) unless a creditor files an objection. Corporations and partnerships may not generally discharge debts. Instead, assets are liquidated, and the proceeds are dispersed among creditors.
  • Dischargeable Debt under Chapter 11. Debtors may discharge debts once a reorganization and repayment plan has been confirmed.
  • Dischargeable Debt under Chapter 13. A chapter 13 debtor is entitled to a discharge upon completion of all payments under the chapter 13 plan and if the debtor: “(1) certifies that all domestic support obligations due before certification have been paid, (2) has not received a discharge in a prior case within designated time periods, (3) has completed an approved course in financial management if available.” (11 U.S. Code § 1328)

How Do I Object to the Discharge of Debt Owed to Me?

As a creditor, you may object to the dischargeability of a debt, especially if you believe the debt was incurred due to fraud, willful and malicious acts, breach of fiduciary duty, or other illegal activities. If that is the case, you have two options:

  • File a Section 727 Complaint. A creditor may object to the discharge of a debtor’s entire debt obligations under Section 727 of the U.S. Bankruptcy Code. This type of complaint, if successful, benefits all creditors and, once again, you may find yourself in line to collect the money owed to you.
  • File a Section 523 Complaint. As a creditor, you may object to the discharge of your specific debt under Section 523 of the U.S. Bankruptcy Code. Obviously, the burden of proof is much lower since you are only addressing your specific debt, and you are the only creditor who will benefit from your complaint.

A complaint objecting to the dischargeability of a debt must be filed no later than 60 days after the 341 Meeting of Creditors.

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.

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