When a Customer Files for Bankruptcy
By: Crystal H. Thornton-Illar, Esq.
You received a notice in the mail that a customer has filed bankruptcy. What should you do? Is there a way to get paid the outstanding balance? Can you continue communications with the customer? Do you have to continue to supply product or services to this customer?
The answer to these questions may depend on the type of bankruptcy filed. Chapter 11 and chapter 13 are reorganizations. In those bankruptcies, a portion of debt owed to unsecured creditors is often repaid pursuant to the plan of reorganization, and the debtor will often continue to operate its business. A chapter 7 bankruptcy is a complete liquidation. A chapter 7 bankruptcy may or may not result in a payment to unsecured creditors depending on the value of the assets being liquidated.
Contact with the Customer
After the filing of any bankruptcy, you should cease any attempts to collect the debt owed to you by the customer, who is now the bankruptcy debtor. If you attempt to collect the debt, you will violate the automatic stay and may be sued or sanctioned. It is best to avoid any contact with the customer unless you are continuing to supply the customer with goods or services.
Continuing to Supply Goods or Services
Should you continue to supply goods and services to the customer? If you have an ongoing contract with the customer, you may have to continue doing business with the debtor. The contract should be reviewed carefully with experienced bankruptcy counsel. If there is no contract and you want to continue the business relationship, you should demand cash in advance. If you extend credit to the debtor after the filing of the bankruptcy, you will have an administrative claim for the amounts owed post-petition. While administrative claims are paid prior to general unsecured claims, there is no guarantee that funds will be available to pay administrative claims.
Proof of Claims
You should review the bankruptcy notice to determine the bar date for filing proofs of claim. Whether or not you need to file a claim will depend on the type of bankruptcy filed.
• If the bankruptcy is a chapter 7, the bankruptcy notice may indicate that claims should not be filed, and you will receive a new notice if the filing of claims becomes necessary.
• If the bankruptcy is a chapter 13, you should file a claim as you will not receive a distribution without filing a claim.
• If the bankruptcy is a chapter 11, you should find out if the debt is listed in the debtor’s schedules. If the debt was listed correctly, you may not need to file a claim. If the debt was listed as less than the amount owed or listed as unliquidated or disputed, you will need to file a claim to receive a distribution on the full amount of your claim. Make sure the proof of claim is timely filed. Proofs of claim that are filed late generally do not receive distributions.
Check your records to see if any goods were delivered to the customer within 20 days of the bankruptcy filing. Any goods delivered to the debtor within 20 days of the bankruptcy filing are administrative claims, which are paid prior to distributions to general unsecured creditors. Administrative claims are generally paid in full pursuant to a plan of reorganization. However, you must file an administrative claim, and you must adhere to the procedures set by the bankruptcy court for filing such a claim, which may be different than the procedures for filing proofs of claim. Further, the filing of an administrative claim often requires filing a motion with the bankruptcy court so you should seek experienced bankruptcy counsel if you have an administrative claim.
A creditor may assert a reclamation claim for goods sold to the customer in the ordinary course of business within 45 days if the customer was insolvent when it received the goods. Review your records to determine if you have such a claim. A reclamation claim requires a written demand sent to the customer within 45 days after the customer received the goods. If the customer files bankruptcy within the 45 day period, the reclamation notice must be sent within 20 days of the bankruptcy filing.
Debtors in possession in a chapter 11 case generally are not allowed to make payments to creditors on prepetition claims outside of a plan of reorganization. However, bankruptcy courts will occasionally approve prepetition payments if the goods or services provided by that particular vendor are essential and necessary to the viability of the debtor, and it would be impossible to find a substitute vendor. If you are considered a critical vendor, you may receive payment on your prepetition claim, but you will likely be required to provide the customer with product or services during the bankruptcy case on credit terms similar to those provided to the customer prior to the bankruptcy filing.
If the unpaid invoices were not bad enough, creditors may also have to deal with avoidance lawsuits. Under the Bankruptcy Code, the bankruptcy trustee or the debtor can file lawsuits to avoid and recover transfers made by the customer to the creditor just before filing bankruptcy, such as fraudulent or preferential transfers.
• Fraudulent transfers are transfers made with the intent to defraud creditors or made in exchange for less than reasonably equivalent value made while the debtor was insolvent.
• Preferential transfers are transfers made within 90 days of the bankruptcy filing.
The debtor or trustee has approximately two years to bring avoidance actions so an avoidance action may surface long after you have forgotten about the customer’s bankruptcy. If a creditor is faced with an avoidance action, there may be defenses that you can assert so be sure to maintain complete records. You should immediately seek experienced bankruptcy counsel if faced with an avoidance action.
The creditors’ committee is formed to protect the interests of unsecured creditors, generally. Shortly after a chapter 11 case is filed, the United States Trustee will mail questionnaires regarding forming a committee to the largest unsecured creditors. If you are interested in serving on the creditors’ committee, you should promptly complete and return the questionnaire. If there is sufficient interest in forming a creditors’ committee, the United States Trustee will determine who sits on the creditors’ committee. The creditors’ committee will ordinarily retain counsel at the expense of the bankruptcy estate. If you have a large claim in a bankruptcy case, you should consider serving on the creditors’ committee because you will have some influence over the bankruptcy case and will be kept current on the status of the case.
Bankruptcy is a specialized area of the law, and this article is just an overview of the various considerations that may arise when a customer files bankruptcy. If one of your customers has filed bankruptcy, it is best to reach out to experienced bankruptcy counsel, such as Leech Tishman for assistance.
Crystal Thornton-Illar is a Partner in the Bankruptcy & Creditors’ Rights Practice Group and focuses on both commercial and consumer bankruptcy matters. Crystal can be reached at 412.261.1600 or by email at firstname.lastname@example.org.
Leech Tishman is a firm dedicated to providing full-service commercial legal services to individuals, businesses, and institutions. We combine a deep understanding of our clients and their businesses with skilled legal counsel to find solutions. Headquartered in Pittsburgh, PA, Leech Tishman also has offices in Chicago, Los Angeles, New York and Wilmington, DE. For more information call 412.261.1600 or visit us at www.leechtishman.com.