When a customer files for Chapter 11, an open receivable stops being a routine collections matter and becomes a legal claim that must be actively managed. Whether your business recovers anything — and how much — depends on where your claim ranks in the bankruptcy proceedings, what the debtor’s assets look like, and how quickly you move.
Timing is critical: deadlines in bankruptcy cases are court-imposed and largely unforgiving, and creditors who don’t act promptly can lose rights they would otherwise have.
Legal procedures
When you hear about a customer’s bankruptcy, contact your attorney. Then gather contracts, invoices, delivery confirmations and payment records. You or your legal counsel will want to find out the customer’s filing date and track court notices and deadlines.
Bankruptcy generally triggers an “automatic stay,” which prohibits most collection efforts for debts arising before the filing. So you shouldn’t make collection calls, pursue litigation or repossess property without legal guidance. However, if you’re a secured creditor, you may ask the court for permission to enforce your collateral rights.
Determine how the debtor lists your business’s debt in its bankruptcy schedules. If your claim is omitted or listed as disputed, contingent or unliquidated, you generally must file a proof of claim to participate in any financial distributions.
Also, review any payments you received from the customer during the 90 days before they filed. Certain payments may be recoverable by the debtor as “preferences,” but repayment isn’t automatic. You may have legal grounds to keep a payment even if the bankruptcy trustee asks you to return it. Preserve supporting records and have counsel evaluate any repayment demand.
Special protections
Your business should always track order delivery dates because the priority of your claim can depend on when a customer received an order. An order might fall into one of two categories that allow for special protections:
1. Administrative expense claims. These are goods the customer received within 20 days before filing for bankruptcy. The goods may qualify for administrative expense priority if they were sold in the ordinary course of the customer’s business. This priority generally places the claim ahead of general unsecured claims. It only concerns the receipt of goods, not services.
2. Reclamation demands. You may have a right to reclaim goods received by an insolvent debtor within 45 days before their Chapter 11 filing. You usually must make a written demand within 45 days after delivery. If that period expires after the customer’s bankruptcy filing, you’re allowed to make a demand within 20 days after filing. Prior secured interests can limit your recovery.
Note that neither of these protections guarantees that your customer will make a full or immediate payment.
Unsecured creditor committees
In some Chapter 11 cases, unsecured creditors form a committee to investigate the debtor’s affairs and help develop a repayment plan. Membership often includes creditors holding the largest unsecured claims and must be appointed by the trustee.
If your business is appointed to a committee, know that it doesn’t give your claim special priority. Committee members represent all unsecured creditors collectively.
Protecting your financial position
A customer’s bankruptcy is a good excuse to review your business’s cash flow, customer concentration and credit extension practices. If warranted, implement new policies that will help prevent future losses. Also be sure to weigh your likely financial recovery against the expense of pursuing it. Legal matters call for an attorney’s advice. But your Rudler, PSC advisor can help you adjust financial projections, update controls and make loss remediation plans.
RUDLER, PSC CPAs and Business Advisors
This week's Rudler Review is presented by Missy Heist, Client Accounting Manager and Mark Benson, CPA, CVA.
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