The economic fallout stemming from the global pandemic placed substantial financial stress on a diverse array of industries, prompting many to file for bankruptcy. Successfully handling a customer bankruptcy can be a challenging and nuanced process for a creditor. Having a comprehensive understanding of your rights and remedies as a creditor enables you to develop and implement a strategic contingency protocol to mitigate losses and ultimately recover from this unfortunate scenario.
Here is an overview of your rights as a creditor when a customer files for bankruptcy and recommended actions to achieve recovery.
Classifying Types of Bankruptcy Filings
The initial notification that a customer has filed for bankruptcy will indicate the specific chapter of the Bankruptcy Code the case was filed under. In cases where the debtor is considered a business entity, filings are made under Chapters 5, 7, or 11. Generally speaking, any Chapter 11 bankruptcies will also incorporate Chapter 5. Chapter 7, the most utilized filing, is used for businesses undergoing liquidation. Businesses planning a widescale restructuring process will pursue a Chapter 11 bankruptcy. Individual debtors can file under either Chapter 7 or Chapter 13, the latter of which includes a formal repayment plan.
Creditors should know the type of bankruptcy a customer files since this will dictate which rights and remedies are available. For Chapter 7 filings where you have no collateral, you can do little other than submit a proof of claim— understand unsecured creditors often do not see recovery in these situations. On the other hand, for Chapter 11 bankruptcies where the customer retains possession of their assets, creditors have more potential avenues toward recovery—let us take a closer look at these options.
Imposing an Automatic Stay
When a customer files a bankruptcy petition, the affiliated creditor is automatically enjoined from attempting to recoup the outstanding debt balance or repossessing the collateral. After learning a debtor has initiated bankruptcy proceedings, you should cease all debt collection efforts implemented before the filing and avoid any new litigation external to the bankruptcy timeline. Note there are a limited number of exceptions to this default stay on a creditor’s debt collection options; however, be sure to consult with a knowledgeable bankruptcy attorney to avoid any unnecessary sanctions.
Maintain Business Dealings with Customer
Creditors may continue to conduct business with debtors filing under Chapter 11. There are certain scenarios—typically when there is an enforceable contract still in place—when creditors have no other option but to fulfill their obligations to the debtor despite the ongoing bankruptcy proceedings. However, if there is no contract in place but the debtor forces you to perform per established norms, you have the option of deviating from previous dealings. For instance, you can demand advance payment or immediate payment on delivery instead of offering credit. The goods and services you delivered to the customer before the bankruptcy filing are deemed “administrative claims,” which are prioritized over pre-filing unsecured claims assuming that they are “actual, necessary costs and expenses of preserving the estate…” per Section 503(b)(1)(a) of the Bankruptcy Code. Ordinarily, the routine operating costs of a business meet this standard, which means vendors typically maintain business with a debtor if their administrative claims are reimbursed.
Right to Reclaim
Creditors have the option, according to the Bankruptcy code, to exercise their reclamation rights established under the Uniform Commercial Code (UCC) to recoup goods provided on credit to a debtor unable to make payments. To pursue this recourse, you must send a written demand to the debtor within 45 days following the debtor’s receipt of the goods or within 20 days of when the bankruptcy was filed if it took place during that 45-day timeframe. You are also afforded an administrative expense claim for goods provided to the customer in the 20 days preceding the bankruptcy petition if purchased in the ordinary course of its operation.
Critical Vendor Designation
Under certain circumstances in Chapter 11 filings, the judiciary will permit the customer to establish a critical vendor program, in which the debtor names “critical vendors” whose pre-filing reclamation claims will be fully reimbursed in exchange for continuing to sell goods based on credit through the duration of the bankruptcy proceeding. If you anticipate the court extending your customer critical vendor status, you should immediately consult with legal counsel as to what actions you can take to best position yourself as a critical vendor. Making this list ensures your claim will be fully repaid and avoids any losses associated with the bankruptcy.
Proof of Claim & Preference Actions
Creditors submit proof of claim by completing a standardized bankruptcy document indicating the outstanding balance owed to them by the customer at the time of the filing. Although there are times when the customer has already acknowledged the claim amount and is not disputing the numbers, you should still complete a proof of claim to protect your rights. Be sure to work with a trusted attorney to ensure that all the information is correct and that you maximize your odds of recovery without having to worry about costly oversights or errors.
In certain scenarios, debtors can seek to take back payments they made immediately prior to filing for bankruptcy. Section 547 of the Bankruptcy Code permits a debtor to recoup payments provided to creditors within 90 days of the petition. Do not assume the worst if you receive a preference action notice. Contact your bankruptcy lawyer promptly for insight, as there are several effective defenses to these recoupment efforts.
Confidently Navigate Bankruptcy
The most effective approach in handling a customer’s bankruptcy filing is to safeguard your rights. If you feel that a debtor is undergoing financial hardship, halt any further extension of credit. Bankruptcy can be a complicated process, but you do not have to go through it alone. Geraci Law Firm has years of experience successfully guiding clients through customer bankruptcy filings. Contact us today to learn more about how we can assist you.
