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The Six Steps to Take If a Client Files for Bankruptcy

Lucere Legal helps small business owners when their client declares bankruptcy

Whether you call them customers or clients, you depend on them for everything. The money they put into your business is its lifeblood—and probably that of you and your employees, as well. But, just as a clog in an artery can lead to a heart attack, so too can the bankruptcy of a large client cut off what your business needs to survive.

Unfortunately, protecting your business is not nearly so simple as regular exercise and eating right. As a small business attorney, I have supported a number of my clients through the unexpected effects of a client’s bankruptcy and come away with sixt steps that will save your business a great deal of pain:

  1. Cut off contact

    If your client is in arrears on their account and has just declared bankruptcy, end all contact. Creditors are strictly prohibited from taking any collections actions or communicating with debtors about their debt under bankruptcy law. Instead, you must contact their attorney or court-appointed trustee to see if the money they owe you is listed on the bankruptcy petition. If the debt to you is listed, you will need to discuss how the case will be handled. If you are not listed, it will be possible to pursue collection after the prohibition on collections is lifted.

  2. Do the math

    It is important that you learn the extent of your clients resources versus their obligations. That way, you can establish whether it will be worth continuing to pursue the amount they owe, or if it would be better to simply take a bad debt deduction on your taxes.

  3. Discern the bankruptcy type

    Depending on the type of bankruptcy, you will want to adjust your calculations.

    • Under Chapter 7, the business will be completely liquidated and the proceeds will be distributed to the creditors. There’s a system for the order of payments, though, so if there are a number of secured creditors or priority unsecured creditors and not enough to go around, you might not get paid at all.
    • Under Chapter 13, the debtor pursues a court-approved plan to pay back all (or most) of the group of creditors. It is likely that you will (mostly) get paid, but over time.
    • If a Chapter 11 reorganization, your business may have longer to wait, but is more likely to get back what is owed.
  4. File a proof of claim

    Want to get paid? Then file a proof of claim before the deadline listed on the bankruptcy petition. Procrastination here means you get nothing.

  5. Attend the creditors meeting

    A “341” creditors meeting brings together the trustee, the debtor, and any creditors that exist. This can be enormously valuable, as it offers you the opportunity to not only hear the debtor’s repayment plan, but voice your own objections, as well. If you get the impression you have been treated unfairly, this is the time to speak up.

  6. Review the repayment plan

    Approval of the debtor’s repayment plan by the court-appointed trustee is then immediately followed by the submission of copies to all listed creditors for comment. The plan should detail exactly how much the debtor plans to pay you.Those creditors who hold a greater portion of the debt wield proportionally greater vote count—a vote which requires at least half of the debtors to vote for accepting the deal.

While there is no guarantee that you will never get stiffed by a client, other than not ever extending credit in the first place, there are a couple of things you can do to make it less likely that you will be left with a large receivables balance to write off.

File a UCC form before giving credit

One of the two best safeguards you can erect against a customer’s bankruptcy filing is to file a Uniform Commercial Code 1 form with your state or county. The form will create a security interest in the personal property that is tied to the debt, and this places you at a higher priority than unsecured creditors, making it more likely that you will get something, even if there’s not enough to go around.

Do your due diligence

The other best preventive measure? Finding out ahead of time that your customer can actually pay what they will owe you before you extend them credit. A background or credit check should give you notice of any unusual payment behavior and, if you do find something, run another check. Don’t miss the warning signs: slow payment from a customer that has typically paid on time should warrant your attention. Pay close attention—you should always be aware of who has not paid on time and track whether the trend continues.

What you can do

If you’re a small or mid-size business owner, call us today at 651-206-3701 or reach out via our online contact form to schedule a small business consultation session.

Image Courtesy of David Castillo Dominici| FreeDigitalPhotos.net

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