Manufacturers & Distributors ARTICLE -

How to deal with customer bankruptcy

Target Audience: Manufacturing and Distributing Companies, M&D Industry Employees, Manufacturing Distributors

In this economy businesses are doing all they can to keep their general ledgers in the black. But some may not make it. If you have customers who are hovering on the brink of bankruptcy — or even wallowing through it — don’t panic. But don’t just sit there either. You need to take certain steps to ensure your customer’s bad fortune doesn’t cause your business to suffer too. Here’s how.

Different types of bankruptcy

Debtor companies typically file for bankruptcy so a court will cancel or reorganize some of their debt and allow them to pay off noncancelable debts gradually. The bankruptcy chapters businesses most frequently file under are either Chapter 7 or Chapter 11. These are common terms, but many people don’t understand what they truly mean.

When a business files under Chapter 7, it typically must liquidate all of its nonexempt assets, and use the proceeds to pay creditors who have timely filed a proof of claim with the court. This chapter doesn’t involve filing a plan of repayment. Unsecured creditors often receive little in a Chapter 7 liquidation.

With a Chapter 11 bankruptcy, however, the debtor company can reorganize its debts and pay them off over time. The company also is allowed to continue operating the business while repaying its debts to creditors and may reject leases, stay lawsuits, reduce interest, extend the repayment period and eliminate some debts.

First steps When Customer Files for Bankruptcy

After a debtor files for bankruptcy — regardless of the type — an automatic stay goes into effect that requires all creditor collection efforts to cease, with minor exceptions. So once you know that your customer filed for bankruptcy, halt collection efforts. Also try to reclaim any goods currently in transit to the customer. Then determine whether you’re going to pursue repayment or write off the debt.

To help make that decision, review the paperwork the debtor filed with the court to see how much money is available for distribution to creditors. Identify other creditors and compare what they’re owed against the debtor’s listed property.

The importance of participating

Collecting most of the debt owed to you usually requires that you participate in the proceedings — particularly under Chapter 11, where debtors reorganize and pay off their debt. However, even in a Chapter 7 filing, a secured creditor will be able to proceed against the collateral with permission of the court.

Attending all court-mandated creditors’ meetings ensures you have a voice in the proceedings and gives you an opportunity to ask the debtor questions about your claims. You can also inquire about circumstances that might affect the amount of assets available for payment, such as underreported income, overstated expenses or the discovery of hidden assets.

In addition, make sure you speak to a bankruptcy attorney about filing a proof of claim with supporting documents such as contracts and other agreements.

debt Resolution takes time

Before creditors can vote on the debt reorganization plan, the bankruptcy court must approve the disclosure statement. The statement should include sufficient information about the debtor’s assets, liabilities and financial affairs to help creditors decide whether to accept or reject the plan of reorganization.

After court approval of the disclosure statement, a copy is sent to creditors with the plan and a ballot. Creditors who will receive less than their full claim under the plan may vote against the plan.

If there are sufficient votes in favor of the plan and it satisfies the bankruptcy requirements, it’s confirmed as a consensual plan. If not, the bankruptcy court determines whether to “cram down” the plan if creditors object to it.

If a plan is approved, you’re entitled to a tax-deductible write-off of any amounts owed that exceed planned future payments.

Preventive measures

As you can tell, once a customer enters the bankruptcy process, it’s hard to regain what’s rightfully yours. But you can protect yourself against future customer problems through preventive measures like these:

• Require customers to submit preloan disclosure of credit and other relevant financial information,

• Ask for personal guarantees of corporate accounts, which can give you a recovery option against the guarantor in the event of bankruptcy filing or default.

• Structure customer transactions to minimize the impact of a customer’s future bankruptcy, such as eliminating credit accounts, requiring cash on delivery (COD) payments or obtaining some sort of collateral.

Remember, when it comes to customer bankruptcies, the old adage holds true: The best defense is a good offense.

Don’t go it alone

Although hearing of a customer bankruptcy can be unnerving, keep in mind that you don’t have to go it alone. Your CPA, along with your attorney, can help you get through the process and recover as much as possible.

Find out how our M&D accountants can add value to your business. Email us or call us at 1 (888) 875-9770.

related links

M&D Newsletters & Articles 

Tax Services

Audit Assurance and Accounting

Industries

Tax and Business Updates