The rights and obligations of all parties are determined by the U.S. Bankruptcy Code. Two business professionals discussing bankruptcy with a judge’s gavel on the table.

Your Customer Filed for Bankruptcy: Now What?

You held up your end of the deal by providing the services or goods your customer requested. But, after informing you they cannot pay or you’ve heard they filed for bankruptcy, how do you get the money you’re owed? 

Unfortunately, the sad truth is that it may not be possible to get paid. An individual or business that files for bankruptcy (a debtor) is afforded certain protections from the people or businesses who they owe (their creditors). The rights and obligations of all parties are determined by the U.S. Bankruptcy Code. Once a debtor files for bankruptcy and a trustee takes over control of their assets, bankruptcy law determines how those assets are distributed among creditors—assuming the bankrupt debtor has any assets to distribute. Creditors might get everything they’re owed, they might get pennies on the dollar, or they might get nothing. Every case is unique, and the laws and procedures differ depending on whether a debtor files for Chapter 7, Chapter 11 or Chapter 13 bankruptcy. Consulting local bankruptcy attorneys about your specific situation is the best way to maximize your chance of getting paid what you’re owed. There are also some precautions you can take to avoid getting burned by a customer who files bankruptcy.

What Happens When a Debtor Files for Bankruptcy

First things first: Don’t panic about a debtor’s bankruptcy until you know it’s real. Bankruptcy attorneys often hear from clients who are worried about the possibility of someone going bankrupt. Maybe the client has been trying to collect on a customer’s outstanding balance, and the customer threatens to file bankruptcy in an attempt to stop the collection calls. Creditors do have certain obligations once a debtor is in bankruptcy, including ceasing collection activities—but these obligations don’t begin until the customer actually filed its petition, becomes a debtor, and the creditor is notified that a debtor has filed. 

In other words, the threat of bankruptcy doesn’t equal bankruptcy. You don’t need to act like a debtor is in bankruptcy until you’ve received notice that they’ve filed with the bankruptcy court. Debtors must provide a list of all creditors when filing for Chapter 7, Chapter 11 or Chapter 13 bankruptcy. Assuming you’re on that list, the bankruptcy court should mail you a notice of the filing. Or the customer could tell you it was filed and give you the case number. (If you don’t get notice for some reason, contact your bankruptcy attorney for guidance about how to proceed.) Once the debtor has filed for bankruptcy, their assets are put into a bankruptcy estate and managed by a trustee.

Your rights and obligations as a creditor begin at this point. One of those obligations is to respect the automatic stay. It’s an injunction that prevents creditors from taking any collection action against a debtor without the court’s permission. If you’ve been calling or emailing your debtor about the money they owe you, or attempting to collect on the debt in any other way, you must stop as soon as you receive notice of their filing. The bankruptcy code does allow for certain exceptions to the automatic stay, but they’re not applicable in most cases unless the creditor has a security interest in the debtor’s assets. Once that stay begins, you can’t get paid by going directly to your debtor to collect prepetition debt — that is, debt for goods and services supplied before the bankruptcy.

Getting Paid by Someone in Bankruptcy

Receiving notice of your debtor’s filing starts the clock for creditors to file a proof of claim. It’s essentially evidence of the debt, so the bankruptcy court can take your claim into account when the debtor’s bankruptcy estate is being settled. Filing a proof of claim is in most instances imperative if you’re going to get the money you’re owed. It’s not a guarantee that you’ll ever see a single penny of that debt, but you’ll be unlikely to get paid without filing a proof. The notice you receive will include the filing deadline; don’t miss this window. 

When the bankruptcy case is completely administered or when the trustee in charge obtains court permission, they will begin distributing money to creditors (in all but a few chapter 11 cases relying on proofs of claim filed in the case). How much money you’ll get, if any, is largely determined by the nature of your claim and how many other claims there are. Creditors with secured claims have the right to be paid the value of collateral before creditors with unsecured claims. Having a secured claim essentially means the debtor agreed to put up some kind of collateral when entering into an agreement with you way back when you started delivering goods or services. Unsecured claims are much more common than secured claims. 

In what order are creditors paid? Secured creditors (like a bank that has a lien on some or all the debtor’s property) are first in line to get paid from their collateral. This is why banks take collateral. Second in line to get paid is the IRS; taxes owed by the debtor are paid with money from the bankruptcy estate before unsecured creditors are paid. General unsecured creditors come next.  As a vendor, this is likely the category you fall into. If there is any money remaining after paying secured creditors, tax obligations, and general unsecured creditors a debtor gets to keep the rest. This rarely happens.   

Filing a proof of claim isn’t terribly difficult, so bankruptcy attorneys will generally advise clients to do it even if it seems unlikely that there will be any money left. You never know what will happen. Say you’re owed money by an individual who files Chapter 7 and seems to have nearly no assets. Maybe you don’t get anything now, but a few years down the road the bankruptcy trustee discovers that your debtor had hidden his ownership of a million-dollar home. When the case is reopened, you want your claim on file so you can collect your share of those hidden assets. 

There’s not much to do after filing your proof of claim except to wait for word from the bankruptcy trustee. It may take anywhere from months to years for bankruptcy cases to be fully settled. 

What You Can Do to Protect Yourself 

You can’t predict a customer’s financial future. The business that seems stable now could announce a surprise bankruptcy next year, leaving your last invoice unpaid. If that happens, you’re going to want to have some protections in place to increase your chances of getting your money. A written agreement that includes a clear fee schedule for services, signed by your customer, is one important piece of evidence to support your case. If you supply goods, you want an accurate inventory of the goods sold and the partial payments, if any, made.  You’ll want to include this agreement when you file your proof of claim. In certain circumstances, creditors can create security agreements giving them rights to a debtor’s collateral in the event of bankruptcy. These contracts must be designed by business attorneys who have experience creating enforceable security agreements. 

The bankruptcy attorneys at Sassoon Cymrot Law, LLC are here to help individual and business clients protect their interests, from drafting fee agreements to navigating bankruptcy court proceedings. For help getting paid in a bankruptcy dispute, contact me today!

Jeffrey Cymrot is a Partner at the firm and concentrates his practice in representing bankruptcy trustees, business law, corporate reorganization through the bankruptcy court, and commercial law. He has practiced in the Bankruptcy Court for almost 25 years.

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Sassoon Cymrot Law and Grossman & Associates have joined together into one firm under the Sassoon Cymrot Law name effective May 1, 2021.