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The Six Most Common Bankruptcy Issues Facing Our Clients

Have you received notice that your company’s customer or vendor has filed for bankruptcy? What should you do? Bankruptcy proceedings can be complex and intimidating. This article is intended to address the six most common situations a company may find itself in when a customer debtor files for Chapter 7 (liquidation) or Chapter 11 (reorganization) bankruptcy.

1. Can I Still Do Business With the Debtor and What Are My Risks?

In Chapter 11 bankruptcy, the debtor remains in possession and control of its assets and can continue to operate its business in the ordinary course of its business. Transactions outside the ordinary course of business require advance approval by the bankruptcy court. There may be less risk extending credit to a Chapter 11 debtor, because all debts it incurs after it files a bankruptcy petition constitute priority “administrative claims” that are paid in full prior to any distribution to unsecured creditors.

In Chapter 7 bankruptcy, the debtor ceases operating its business and ownership and control of its assets are transferred to a Chapter 7 trustee for liquidation. The only exception is for individual debtors who can claim some property is “exempt” or not subject to creditor claims under applicable law.

Upon any bankruptcy filing, the “automatic stay” under 11 U.S.C. § 362 immediately goes into effect and prohibits any action against the debtor or its property, including sending a simple demand letter to the debtor.

2. If I Have an Ongoing Contract With the Debtor, Do I Have to Perform?

Generally yes. A non-debtor party to a contract is not excused from performance merely because the other party filed for bankruptcy. A contract that has ongoing obligations on both sides (called an “executory contract”) can be “assumed” or “rejected” by the debtor during its case. Until then, the non-debtor party must continue to perform or risk becoming liable for breach. Performance is excused only when the contract is rejected by the debtor.

3. The Debtor Owes My Company Money for Goods or Services.

If the debtor owes your company for goods or services provided prior to the petition date, you can file a Proof of Claim (“POC”) and attach supporting documentation. A POC form is mailed to creditors with the initial case filing notice or can be downloaded from the bankruptcy court’s website. The deadline for filing a POC varies by jurisdiction but is usually 90 days after the date scheduled for the “Meeting of Creditors.”

4. The Debtor Paid My Company for Goods or Services in the Last 90 Days.

If you were paid by the debtor in the 90 days prior to its bankruptcy filing (the “preference period”), you are at risk of being sued for the recovery of a preference. In other words, you can be sued AFTER you are paid by someone who owes you money, but has filed for bankruptcy!

5. I Have Been Sued for a Preference, What are My Defenses?

The most common defense to a preference claim is that the payment was made and received in the ordinary course of business (“OCB”). The OCB defense can be proven either subjectively (based on prior transactions between the debtor and that creditor) or objectively (using an industry standard often established through expert testimony).

6. When Can I Expect to Receive a Distribution on My Proof of Claim?

Distributions on claims is the last thing to occur before a bankruptcy case is closed and may not occur until several months or years after a Chapter 11 debtor has confirmed its plan or sold its assets in bankruptcy. The general priority scheme for making distributions on claims under bankruptcy law is as follows: (1) secured claims up to the extent of the value of the collateral, (2) chapter 7 post-conversion priority administrative claims if applicable, (3) Chapter 11 priority administrative claims within the order of their priority under 11 U.S.C. § 503, (4) general, unsecured claims, and (5) equity interests in the debtor.


The above tips should help you to navigate some of the most common issues facing companies who have done business with a person or entity who later files for bankruptcy. They are meant as a brief overview, and are certainly not comprehensive! It is important that you consult with the attorneys at VRS if you receive notice of a bankruptcy filing of a customer or vendor in order to understand your rights and obligations.