Coping When A Customer Goes Bankrupt - obtaining payment

J. Tol Broome Jr.

J. Tol Broome Jr., a credit-risk manager for a Greensboro. N.C., bank, writes on financial matters.

Dealing with a client's insolvency; deciding whether to manage your stocks; exploring private mutual funds; evaluating index funds' performance.

Sitting at his desk last June, Kit Kiefer was overcome first with a sick feeling--and then with anger. His company, Professional Hobby Consultants Inc. in New London, Wis., had just received notice that its largest client had filed for Chapter 11 bankruptcy.

As a consultant providing services in the volatile sports-card industry, it was not the first time that Kiefer had seen a major customer file for bankruptcy. But he had never before been so reliant on a single company Pinnacle Brands accounted for 80 percent of Kiefer's business.

"When I found out Pinnacle had filed for bankruptcy, we were owed a lot of money from them, and I wondered if we would be paid," says Kiefer. Even so, he continued to provide services to Pinnacle and eventually collected nearly all the money he was owed.

In fact, Kiefer's company has generally escaped the effects of bankruptcy filings by multiple customers and suppliers during the 1990s. He attributes this to one key factor.

"In every case, we have had a good rapport with either the bankruptcy trustee or the person left in charge of the company," Kiefer explains. "I am convinced from the experience that we have had that maintaining these good personal relationships with honest people goes a long way in collecting what you are owed when a customer files for bankruptcy."

Following are tips from experts on protecting your interests if a customer files for bankruptcy:

Getting the ball rolling: Under the Federal Bankruptcy Act, individuals and organizations can file for bankruptcy through one of various chapters. The chapters most frequently used are 7, 11, and 13.

A Chapter 7 bankruptcy generally leads to full liquidation of a company's assets.

Under Chapter 11, the most common form of bankruptcy, the debtor company files a reorganization plan that generally allows it to remain in control of its business and assets while it tries to get back on its feet. Chapter 11 also frees the debtor from the threat of lawsuits by creditors--provided that a majority of the creditors agree to the reorganization plan.

Chapter 13 is used by individuals and sole proprietorships. The debtor agrees to pay back as many creditors as possible.

If you're notified that a customer has filed for bankruptcy, respond immediately with a "reclaim demand"--a document filed to recover all or part of what you are owed. It must be filed with the bankruptcy court "no later than 20 days after the goods have been delivered," says Joe Bodoff, an attorney with Shechtman, Levy and Halpern in Boston and a director of the American Bankruptcy Institute, a Washington, D.C.-based trade association for bankruptcy attorneys and professionals.

Validating your claim. Creditors file a "a proof of claim" to validate debts they are owed in a bankruptcy proceeding. There's no need to file the document, however, if your customer files for bankruptcy under Chapter 11 and the notice you receive is accurate concerning the amount your firm is owed and any collateral the customer might have put up.

In a Chapter 7 bankruptcy Bodoff advises creditors to file a proof of claim only if they expect to be paid back.

Some contact is OK. Don't call the customer for payment after you receive notice of the filing. You can be held in contempt of court or even jailed if you pursue a debtor after bankruptcy has been filed. But some contact is permissible. Says Bodoff: "You can call the debtor for information about the bankruptcy case, financial performance, and even prospects for payment."

Feeling unsecured. If you did not secure collateral from your customer, as is the case with most business creditors, a bankruptcy filing under Chapter 11 or Chapter 13 gives you a better chance of collecting at least a fraction of what you are owed. If your customer files under Chapter 7, you likely will receive nothing if you are an unsecured creditor.

Quick liquidation. A secured creditor might be better off if the customer files under Chapter 7. Sometimes it is best for the creditor if the debtor liquidates quickly--the creditor might have to take some lumps, but the value of the collateral will not have a chance to deteriorate.

Paying attention to notices. You may want to attend creditor meetings and court hearings to stay informed about your prospects for repayment. You should also watch your mail for notices of discharge or dismissal.

A notice of discharge in a Chapter 7 bankruptcy case means that the liquidation is complete; in a Chapter 11 case, it means that the debtor has met all the terms of the reorganization plan. If a case is discharged, you will receive no more payments.

A notice of dismissal means that a Chapter 11 reorganization plan has not been followed or that the debtor has committed fraud. If a case is dismissed, you can go after the debtor for the full amount owed.

Joining a creditors committee. In most Chapter 11 cases, a creditors committee is formed. Bodoff advises his clients that if a lot of money is at stake, they should try to gain a spot on the committee.

Alice Magos, an analyst with CCH Inc., a business-advisory firm in Riverwoods, Ill., says that "by joining forces with other creditors [on a committee], you can save money on attorneys' fees and ensure professional representation in following the case, filing claims, etc. And acting as a group, you might be more successful in getting paid."

Selling to a Chapter 11 debtor.

Think twice before selling to a debtor that has filed for Chapter 11, but in some instances it might be appropriate.

If the debtor company's reorganization plan seems viable, you might stand a better chance of collecting what the debtor owes your firm by selling more goods to the debtor and helping it stay in business.

Bodoff says many post-bankruptcy sales of goods are restricted to cash on delivery.

Magos says that selling after a Chapter 11 bankruptcy petition "is pretty risky. But when you do sell post-petition, at least you have the court watching over you and protecting your position. If you think it will help you collect your pre-petition debt owed, then it's probably a good idea."

Hiring an attorney. For claims of $10,000 or more, a creditor should at least consult an attorney. If the bankruptcy involves a major customer, Magos says, "I definitely would hire an attorney."

Finally, if one of your major customers has filed for bankruptcy, don't panic. You can take actions to improve your chances of collecting.

"We've learned that working with a bankruptcy judge or trustee isn't the worst thing in the world," says sports-card consultant Kiefer. "If you take steps to protect yourself and try to add value to the bankruptcy proceeding [as he did by continuing to provide services to Pinnacle after it filed for bankruptcy], you just might get paid."

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