How to Mitigate Risk When a Customer Files for Bankruptcy

As small businesses experience economic challenges an increase in bankruptcy petitions can be expected. But do you know if your customers are on the verge of financial failure? Probably not.

More importantly, do you know what to do when a customer or client files for bankruptcy?

A bankruptcy notice from your client can help you understand the nature of their business problems. But first you must recognize the type of bankruptcy your client is filing. For example:

Chapter 7: This type of bankruptcy is the liquidation of remaining assets to distribute among its creditors.

Chapter 11: This is a financial reorganization of a business, which allows your client to function while they follow court ordered debt repayment plans.

Chapter 13: Similar to Chapter 11, but rather than a business filing bankruptcy it is the individual reorganizing and following a debt repayment plan.

Ideally, it’s more favorable for your business if a client files for either Chapter 11 or 13. These types of bankruptcy give your client a breather until they figure out how to repay. However, if your client files for Chapter 7 not only will your chances of getting paid be reduced, but you also may be waiting for a long time (even years) for this type of case to be completed.

My Customer Filed for Bankruptcy — What’s Next?

Once you find out that your customer has filed bankruptcy — at this point you are probably frustrated. The seemingly logical next step would be to call someone and attempt to collect your money.

Stop right there! Your collections actions can get you in deep trouble. For example, if you call your client’s accounting department, send collection letters, or attempt to file a lien, your small business will face penalties.

Assuming you do have a good chance of recovering money owed to you, you will have to wait in line. This is the second item you must understand — payment order:

1. Lawyers, administrative expenses, and other professional services that are involved with the work of filing bankruptcy.
2. Secured claims including mortgage holders.
3. Priority claims including wages and taxes.
4. Unsecured claims which is where most small businesses offering a service or product may be categorized.
5. Equity claims including stockholders.

So curb your frustration and embrace the reality: all you can do at this point is wait.