What to Do if a Company Goes Bankrupt and Owes You Money
Suppose you delivered expensive equipment to another company or provided a service to them that took hours of your precious time. Then you find out that the organization on the other side of these transactions files for bankruptcy. Suddenly a pit begins to form at the bottom of your stomach.
Even in this unfortunate scenario, there is a silver lining: Creditors like you often get back some of what they are owed in bankruptcy, even if it is not the full amount owed. Nonetheless, whether and how much you get paid depends on what type of creditor you are and whether you are taking the appropriate legal steps to get that money. The more proactive and knowledgeable you are about the process, the better your chances of coming out relatively unscathed.
Key points to remember
- When a business files for bankruptcy, the court will usually send you a notice and a proof of claim form that will allow you to request payment.
- If you do not receive a notice of bankruptcy from the court, it is important to contact the clerk promptly to receive your proof of claim.
- The outstanding debt of the bankrupt company is prioritized, with preferred creditors and secured debts paid first.
Types of bankruptcy
The first thing to realize is that not all bankruptcy filings are the same. This is because how the business decides to file can make a significant difference in how creditors are paid.
In a Chapter 7 bankruptcy, the owners determined that there was no viable way to keep the business afloat. The goal is to shut down the business and liquidate all tangible assets, so they can pay off their creditors. A bankruptcy court appointed trustee — all bankruptcies are handled by the federal system — assumes responsibility for selling those assets and paying off creditors in the order set out in the Bankruptcy Code.
Some entities file for bankruptcy in an attempt to reorganize and stay in business, a process known as Chapter 11 bankruptcy. Unlike a Chapter 7 bankruptcy, creditors vote on the business plan, which includes a repayment strategy for unpaid debts. Ultimately, the plan must also be approved by the bankruptcy court.
Whether a business files for Chapter 7 or Chapter 11 bankruptcy will affect your ability to get paid.
Regardless of the type of deposit, courts require that creditors be paid in a certain order, depending on the type of debt. Preferred creditors, sometimes referred to as “preferred creditors”, have top priority. These include company employees as well as local, state and federal tax authorities.
Next come secured debts, where the creditor has a lien on a particular asset. Common examples include mortgage providers or other lenders who demanded collateral before paying the business money.
Unsecured debt is the lowest in the pecking order, which means that these creditors always assume a higher level of risk when providing products or services to a business. It is important to note, however, that not all unsecured debt has the same status. For example, a supplier who delivers goods or services after filing for bankruptcy may request that the administrative costs be paid in full or threaten to reject the reorganization plan. Likewise, individuals and businesses who supply goods to the business within 20 days of filing may also be entitled to a full claim.
Most of the other claimants fall under the umbrella of general unsecured creditors, who, given the struggling company’s limited assets, often receive a tiny fraction of what they are owed.
Proof of claim
Once the business has filed for bankruptcy, the court sends a notice to the registered creditors. At this point, it is absolutely essential to file what is called a “proof of claim”. It is essentially an official written statement that tells the court why the debtor company owes you money. Typically, you’ll also want to provide all documentation, including invoices, contracts, and account statements, to support your claim. The official claim form and instructions will be included in the bankruptcy notice.
After filing your claim, you have the right to attend a meeting of creditors – sometimes referred to as a “341 meeting” – with reference to the applicable section of the Bankruptcy Code. Here, the creditors and the trustee can ask questions to the debtor in order to gain insight into his financial situation.
When a business files for bankruptcy, an automatic stay goes into effect, which means creditors like you can no longer attempt to recover your debt amount outside of bankruptcy court. This means that you will have to stop any lawsuit, garnishment or seizure from the moment the business files its case.
Creditors can ask the court to lift the automatic stay, allowing them to resume collection activities. Acceptance of the motion depends on meeting certain criteria. For example, the presiding judge may grant a suspension exemption if the value of an asset is likely to decline as the bankruptcy proceeds, thereby reducing the amount a creditor will be repaid.
Creditors not listed in a file
In some cases, a business may remove you from the court case even though it owes you money. Because you are not listed in bankruptcy, the court will not send you a filing notice.
If you learn about bankruptcy through an unofficial channel, you will want to contact the company and ask for the bankruptcy case number. You can then contact the clerk and have him verify that the deposit has taken place. Assuming you are still within the time limit for accepting a proof of claim, the clerk should be able to send you the necessary form.
Of course, sending a proof of claim does not guarantee that you will be paid by your creditor. It does, however, allow you to stand in line, so to speak, when the company makes a repayment plan or the court-appointed trustee distributes available assets.
Two important tools for protecting yourself against business bankruptcy are trade credit insurance (CCI) and a retention of title clause in your contract.
Protect your financial interests
Unfortunately, creditors often receive pennies on every dollar owed to them, especially if their debt amount is pooled with the company’s general unsecured debt. Nonetheless, there are several ways that individuals and businesses can protect themselves against bankruptcy losses, apart from eliminating business partners known to be in financial difficulty.
One of these safety nets is to insert what is called a “retention of title” clause in your sales contract. Such clauses give sellers like you the right to retain ownership of the goods you sell until you are paid in full. Otherwise, you could be listed as an unsecured creditor who is at the mercy of the trustee and the company’s remaining tangible assets to pay its debts.
Suppliers who do significant business with a particular customer may also consider purchasing Trade Credit Insurance (CCI), which protects the creditor in the event the buyer fails to pay due to bankruptcy or other reasons.
Typically, TCI covers a certain portion of the unpaid debt, depending on the policy you purchase. In addition to recovering unpaid debts, some TCI policies offer liability protection preferably, where the trustee can recover payments that a creditor received from the distressed debtor within 90 days of filing for bankruptcy.
The bottom line
While the bankruptcy of a business to which you have sold goods or provided services is never good news, it is often possible to get at least some of that money back. To do this, you must file a proof of claim as soon as possible, so that the trustee overseeing the payment to creditors can put your claims in the queue.