Chapter 11 bankruptcy filings can threaten businesses across all industries. If a customer to whom you have extended credit files for Chapter 11 bankruptcy protection, the company risks losing most of what it is owed (and can even have to return payments received in the period prior to the bankruptcy filing).
Some of the most common issues when a customer files for bankruptcy are:
Large discounts on unsecured credits.
If a customer owes money when it files for bankruptcy protection, a creditor will typically receive only a small fraction of what it is owed (often as little as 10%). This means close to 90% of the receivable can be lost. Making matters worse, the fractional payment will most likely not be paid until the customer’s plan of reorganization has been approved. This may mean waiting 12-24 months or possibly longer to get your money.
Potential preference lawsuit.
In addition to losing most of the receivable, a company may also have to return certain payments received from the customer before the bankruptcy petition was filed. The United States Bankruptcy Code allows such a customer to “recover” any payments made to a supplier within the 90 day period before the date of filing for bankruptcy. These payments are commonly referred to as “preference payments.” The Bankruptcy Code also provides certain exceptions to the bankrupt customer’s rights to recover prior payments.
Loss of ability to terminate the customer’s contract.
If a company has a long-term supply agreement with the bankrupt customer, the company may not be able to terminate the contract. Even if the customer owes money for supplies delivered and invoiced prior to the filing, as long as the customer remains current on the contract for post-bankruptcy petition invoices, a company may still be required to honor the contract.
Fortunately, there are some steps that a company can take before a bankruptcy filing to protect itself in the event a customer does file for bankruptcy. These steps are discussed in a separate article on the MLBMO Business Leader Resource Center, which can be accessed by clicking here.