What to Do and Not Do When Your Customer or Vendor Files for Bankruptcy
Receiving notice that a customer or vendor has filed for bankruptcy can be alarming. Bankruptcy proceedings can be complex, but understanding common issues can help you navigate the situation more effectively. This article addresses the six (6) most frequent scenarios businesses face when a customer or vendor files for Chapter 7 (liquidation) or Chapter 11 (reorganization) bankruptcy.
- Can I Continue Doing Business With the Debtor, and What Are the Risks?
Chapter 11 Bankruptcy: The debtor usually continues operating its business and managing its assets. While the business is allowed to function as usual, any transactions outside the ordinary course of business require bankruptcy court approval. Extending credit to a Chapter 11 debtor may actually be less risky than it was before the bankruptcy filing, as new debts incurred after the bankruptcy was filed are considered priority “administrative claims” and must be paid in full before most other creditors receive any payment on their pre-bankruptcy claims.
Chapter 7 Bankruptcy: The debtor ceases operations, and control of its assets is transferred to a Chapter 7 trustee for liquidation. For individual debtors, certain assets may be exempt from creditor claims. One of the goals of bankruptcy is to provide a debtor with a “fresh start,” meaning their debt incurred before bankruptcy is wiped out and does not continue after the bankruptcy. Creditors receive payment only from the assets available at the time the bankruptcy is filed. Unfortunately, in most cases, the result is little or no payment on these pre-bankruptcy debts.
When a bankruptcy is filed, an “automatic stay” immediately goes into effect. This stay halts any action against the debtor or its property, including collection efforts with severe penalties for creditors who violate that stay.
- If I Have an Ongoing Contract With the Debtor, Do I Still Have to Perform?
Typically, yes. If you are a non-debtor party to an executory contract (a contract with ongoing obligations), you are generally required to continue performing your part of the contract. The debtor has the option to “assume” or “reject” the contract during bankruptcy proceedings. Until a contract is officially rejected, you must fulfill your obligations to avoid potential breach of contract claims.
- The Debtor Owes My Company Money for Goods or Services. What Should I Do?
If the debtor owes you money for services or goods provided before the bankruptcy petition was filed, you should file a Proof of Claim. This form, which you can obtain from the bankruptcy court’s website or receive by mail with the initial case notice, must be filed within the deadline set by the court, often 90 days after the “Meeting of Creditors.”
- The Debtor Paid My Company in the Last 90 Days. Could This Be a Problem?
Payments received from the debtor in the 90 days prior to their bankruptcy filing are considered part of the “preference period.” You could be at risk of having these payments “clawed back” if the bankruptcy trustee believes they were preferential (i.e. you received a higher payment on that debt than the amount you (and other creditors) would have received in the bankruptcy case. This means you might be required to return these funds, even if you were paid for legitimate services or goods, and even though the debtor may still owe you payment for other goods and services.
- I Have Been Sued for a Preference. What Are My Defenses?
One common defense against a preference claim is proving that the payment was made in the ordinary course of business. This can be demonstrated through either subjective evidence (past transactions between you and the debtor) or objective evidence (industry standards, often supported by expert testimony). This defense, and others, are rather technical and usually require legal guidance from counsel in resolving these claims.
- When Can I Expect a Distribution on My Proof of Claim?
Distributions on claims occur towards the end of a bankruptcy case and can be delayed for months or even years. The general priority order for claims is: (1) secured claims, (2) priority administrative claims, (3) priority unsecured claims, (4) general unsecured claims, and finally, (5) equity interests in the debtor.
Conclusion
Understanding these common issues can help you better manage the impact of a bankruptcy filing by a customer or vendor. However, each case is unique, and navigating bankruptcy can be complex. You can take steps to minimize the risk associated with the bankruptcy of a vendor or client. For personalized advice and assistance, please contact the attorneys at VRS to ensure you understand your rights and obligations should your customer or vendor file for bankruptcy.