Your Major Customer Files for Bankruptcy! Now What?

Lowell E. Rothschild

Because business operations today can be national or even global, a business filing can have a "ripple" effect in almost every area of the country. For companies dealing with the business filing for bankruptcy, that "ripple" can become a "tidal wave." Of all Chapter 11 reorganization cases, only approximately one-fourth are successful. Because of the potential impact of a business failure by a customer, it is crucial for creditors to develop a contingency plan before a major supplier or customer files for bankruptcy. If that happens, here are some steps to be taken:

Do not attempt to collect any outstanding payments from the Debtor. The filing of a bankruptcy case means there is an automatic injunction which prevents you from pursuing the company.
Stop all shipments to the Debtor even if you have to literally "turn the trucks around."
If your goods or products have been very recently delivered, send your customer a notice by fax and letter that you intend to use the reclamation provisions of the Uniform Commercial Code. Arizona law allows you to reclaim goods delivered to the Debtor within ten days before the filing if notice is timely provided. The injunction issued by the court does not prohibit you from this "self help" action. You should not, of course, cause any breach of the peace (including fist fights).
If goods are delivered to the Debtor after the filing and cannot be reclaimed, you should file an administrative claim in the Bankruptcy Court.
After you have received notice of any sort of bankruptcy filing, determine whether the filing has been made under Chapter 7 or Chapter 11, since this affects the steps you must take in the future.
Do not rely on your customer's record of the goods that are at his or her business site and reported on the schedules. Visit the site and make an inspection of your own.
Make sure you preserve your own records. Some companies have a record retention policy that could result in the destruction of records before the bankruptcy case has ended. Sometimes bankruptcies last for years; make sure all records relating to the Debtor are not destroyed while the case is pending.
You are at risk if you sell goods to a Chapter 11 Debtor until some sort of financing arrangement is in place with the Debtor. Even after financing is arranged, you should constantly monitor the Debtor. Limit extending credit to the Debtor.
Under Chapter 11, a Debtor can affirm or reject any executory contract. If you have a contract with a Debtor, consider asking the court to order the Debtor to either reject or affirm it very early in the case. That way you are not left with uncertainties.
If you hear that a supplier or customer is having financial difficulties or may be planning to file for bankruptcy, you need to reexamine your relationship. Make sure any security agreements that you have to protect your business are properly perfected under state law.
Consider getting personal guarantees or letters of credit from the customer. This is unlikely to happen if the company really is in trouble. If the rumors of impending bankruptcy persist, you may need to restrict credit terms. You might require payment within ten days of delivery to make sure you are within the reclamation period under the UCC and the Bankruptcy Code.
If within the 90-day period prior to the bankruptcy filing the Debtor makes a payment to you that results in a preference to you under the Bankruptcy Code, you may be required to return the money to the bankruptcy estate. The test of whether there has been a preference is whether a creditor receives more because of the payment than it would have received if the Debtor had been liquidated under a Chapter 7 proceeding.

Finally and foremost, contact an attorney who specializes in bankruptcy. Bankruptcy is a specialty field and without competent advice your principal supplier or creditor's bankruptcy could start a "tidal wave" which could drown you.

Additional Articles:

A Bankruptcy Lexicon
A Debtor's Bankruptcy Planning Checklist
As if Worrying About Your Job Isn't Enough... How Your Employer's Bankruptcy Will Affect Employee Benefits
Bankruptcy as a Negotiating Tool and a Business Strategy
Chapter 11 Reorganization – A Business Planning Tool
Chapter 11 Reorganization, An Overview
It's a Whole New World:
Understanding the Radical Changes to the Bankruptcy Code
Protecting the Under-Insured Defendant
Receiverships, Assignments for Creditors, and Bankruptcy: A Comparison
Sidestepping a Preference Lawsuit
The Impact of Giant Bankruptcy on the Average Consumer
The Ninth Circuit's Post-Travelers Award Of Attorneys' Fees For Unsecured Creditors