Imagine you've just delivered an expensive piece of equipment or a time-sensitive service to another business, only to find out that this business is now filing for bankruptcy. It's natural to feel panicked in this circ*mstance.
Unfortunately, it's one that is becoming more common. In the year up to September 2023, the U.S. experienced a 13% increase in overall bankruptcy filings, with business bankruptcies alone rising by nearly 30%, ending a long period of declining bankruptcy rates.
However, even in this challenging scenario, there's some hope. Creditors like yourself often recover part of the owed amount during the bankruptcy process. The amount you can recoup varies, and depends on your status as a creditor and the legal actions you undertake. Being proactive and well-informed about the bankruptcy process may increase your chances of recouping any losses.
Key Takeaways
- Different bankruptcy filings (such as Chapter 7 or Chapter 11) have different implications for creditors.
- When a company files for bankruptcy, the court will typically send its creditors a notice and a proof of claim form that allows them to petition for payment.
- Any creditor who doesn't receive the bankruptcy notice from the court should contact the clerk promptly to receive their proof of claim document.
- The bankrupt company’s outstanding debt is prioritized, with preferred creditors and secured debts paid first.
Learn the Type of Bankruptcy
The first thing to realize is that not all bankruptcy filings are the same. The type of bankruptcy filing can significantly affect how or when creditors get paid.
Chapter 7 Bankruptcy
In a Chapter 7 bankruptcy, the owners have determined there’s no viable way to keep the business running. The goal is to shut the company down and liquidate any tangible assets to repay the company's creditors. Administrative and legal expenses get paid first, and the remainder goes to creditors.
A trustee, appointed by the bankruptcy court, oversees this entire process, and all bankruptcy cases are managed under the federal legal system. The trustee's role includes selling these tangible assets and then repaying creditors, following a specific order of priority as established in the Bankruptcy Code.
Chapter 11 Bankruptcy
Some entities file for bankruptcy with the goal of reorganizing and staying in business, a process known as a Chapter 11 bankruptcy. This type of bankruptcy is different from Chapter 7 because it allows the company to remain in operation while reorganizing its finances, and it may not need to liquidate its assets.
Unlike a Chapter 7 bankruptcy, the creditors in a Chapter 11 bankruptcy get to vote on the company’s plan, which includes a strategy for repaying any outstanding debts. However, for the plan to be implemented, it must also receive approval from the bankruptcy court, meeting all legal requirements.
Whether a business is filing for a Chapter 7 or Chapter 11 bankruptcy will affect your chances of getting paid. Each bankruptcy follows different procedures and rules for handling outstanding debts. Creditors are generally more likely to get paid in a Chapter 11 than in a Chapter 7 bankruptcy.
Learn How the Debt to You Is Prioritized
Regardless of the type of filing, courts require creditors to be paid in a certain order, depending on the type of debt. Creditors with the highest priority—sometimes called preferred creditors or preferential creditors—are paid first. These include employees of the company as well as local, state, and federal taxing authorities.
Next in line are secured debts, for which the creditor has a lien on a particular asset. Common examples include mortgage providers or lenders requiring collateral before fronting the company money.
Unsecured debts are the lowest in the pecking order, meaning those creditors always assume a higher level of risk when providing products or services to a business. But not all unsecured debts have equal standing. For example, a supplier who delivers goods or services after the bankruptcy filing can request that administrative expenses be paid in full or threaten to refuse the reorganization plan. Likewise, individuals and businesses that provide goods to the company within a 20-day window before the filing may also have a right to a full claim.
Most other claimants fall under the umbrella of general unsecured creditors, who, given the troubled business’s limited assets, often receive a tiny fraction of what they’re owed.
File a Proof of Claim
When the company files for bankruptcy, the court sends a notice to the listed creditors. At this point, it’s critical that you file what is called a proof of claim. It's a formal written statement that tells the court why the debtor business owes you money.
Typically, you will also want to provide any documents—including invoices, contracts, and account statements—that support your claim. The official claim form and directions will be included in the bankruptcy notice.
After filing your claim, you’re entitled to attend a creditor’s meeting—sometimes called a 341 meeting in reference to the applicable section of the Bankruptcy Code. Here the creditors and the trustee can ask the debtor questions in order to obtain insight into its financial state.
When a business files for bankruptcy protection, an automatic stay goes into effect, which prevents creditors like yourself from attempting to recover their receivable amount outside of the bankruptcy court. That means you’ll have to halt any lawsuits, garnishments, or foreclosures from the moment the business files.
Creditors can petition the court to lift the automatic stay, which allows them to resume collection activities. Whether the motion is accepted depends on meeting specific criteria. For example, the presiding judge may grant relief from the stay if the value of a property is likely to decrease while the bankruptcy plays out, thus reducing the amount that a creditor will be repaid.
Make Sure You're Listed in the Filing
Sometimes, a business may leave you off the court filing even though it owes you money. Because you’re not listed in the bankruptcy, the court won't send you notice of the filing.
If you learn of the bankruptcy through an unofficial channel, you’ll need to contact the company to request the bankruptcy case number. You can then contact the court clerk and have them verify that the filing has, in fact, occurred. Then, assuming you’re still within the allowable time frame for accepting proof of claim, the clerk should be able to send you the necessary form.
Sending in a proof of claim does not guarantee that your debtor will pay you. However, it lets you get in line (so to speak) when the business formulates a repayment plan, or the court-appointed trustee distributes the available assets.
Two important tools for protecting yourself against a business’s bankruptcy are trade credit insurance (TCI) and having a retention of title clause in your sales contracts. TCI provides protection against the risk of nonpayment by your customers due to bankruptcy. A retention of title clause may give you the right to reclaim your goods if the customer has not paid for them.
Use Insurance to Protect Your Financial Interests
Unfortunately, creditors often receive pennies on each dollar they’re owed, especially if their receivable amount is lumped in with the business’s general unsecured debt. Nevertheless, there are a couple of ways that individuals and companies can protect against bankruptcy losses, aside from weeding out business partners who are known to be in financial distress.
One such backstop is inserting something called a retention of title clause in your sales contract. Such clauses give sellers like yourself the right to retain ownership of the goods you sell until you’re paid in full. Otherwise, you could be listed as an unsecured creditor who’s at the mercy of the trustee and whatever tangible assets the company has remaining to pay its debts.
Suppliers who conduct extensive business with a particular customer may also consider taking out trade credit insurance (TCI), which safeguards the creditor in case the buyer fails to pay because of bankruptcy or other reasons.
Typically, TCI covers a certain portion of the unpaid debt, depending on the policy you take out. In addition to recouping unpaid receivables, some TCI policies provide protection against preference liability, wherein the trustee can recover payments that a creditor has received from the distressed debtor within 90 days of filing for bankruptcy.
How Many Types of Bankruptcy Are There?
The U.S. Bankruptcy Code has six types of bankruptcy: Chapters 7, 9, 11, 12, 13, and 15.
What Happens If a Company That Owes Me Money Goes Bankrupt?
Your debt is categorized and ranked alongside all other outstanding debts based on a defined hierarchy. The type of bankruptcy filed (Chapter 7 or Chapter 11) will affect your chances of getting paid, with different priorities set for different types of creditors. Secured debts are typically prioritized, followed by unsecured debts.
What Type of Bankruptcy Is for Companies?
Businesses can file for Chapter 7, 11, or 13 bankruptcy, depending on the size of the company and goals for filing.
What Type of Bankruptcy Is Best for an LLC?
Chapter 7 bankruptcy is used to liquidate and close a company, while Chapters 11 and 13 are used to reorganize it. Which is best depends on what the owner of the LLC wants to do with their company.
The Bottom Line
Though the bankruptcy of a company to which you’ve sold goods or provided services is never great news, it’s often possible to get back at least some of what you are owed. Doing so requires you to file a proof of claim promptly, so the trustee overseeing the payment to creditors can put your receivables in the queue.Then, make sure to involve yourself as much as possible in the rest of the process.
