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How to Handle Accounts Receivable When the Account Files for Bankruptcy

There is inherent risk whenever you extend credit to a business. Managers must perform their due diligence to determine whether that risk is justified. Unfortunately, unforeseen circumstances can arise that may force a company to declare bankruptcy, resulting in unpaid debts. Those circumstances will likely become more prevalent as the COVID-19 pandemic continues to ravage the global economy. How can a company recover money owed when the debtor goes bankrupt or closes its doors?

What type of bankruptcy did the company file?

As your company works to retain its cash flow, the last thing you want to see is a notice that a company with an outstanding debt has filed for bankruptcy. In this event, you’ll need to act quickly; and the appropriate actions will depend greatly on the type of bankruptcy filed.

Chapter 7 bankruptcy means that the company’s debts are so great that it must shut down the business. Typically, a court-appointed trustee will be responsible for selling the company’s assets. The proceeds are then used to pay off the company’s debts. Typically, with Chapter 7, the company receives a discharge of most of its debts and you are unlikely to receive full payment for what you are owed.

Chapter 11 bankruptcy allows the company to attempt to restructure its debt and reorganize its operations. The company attempts to work out the bankruptcy and negotiate terms with the creditors, with court approval. Under the confirmed plan, the debtor typically can reduce its debts by repaying a portion of its obligations and discharging others. The goal is to pay a negotiated payment to as many creditors as possible, while reorganizing and attempting to return to profitability.

With both Chapter 7 and Chapter 11 bankruptcy filings, creditors should receive a proof of claim form, which is a written statement that states why you are owed money by the bankrupt company. It simply puts you in line for consideration of payment by the bankruptcy trustee. If you don’t receive notice of the bankruptcy filing within a few weeks, contact the company and ask to be listed as a creditor. You also can download a proof of claim form from the U.S. Bankruptcy Courts website. Make sure you respond by the due date listed in the bankruptcy filing or you will be denied your claim.

What type of creditor are you?

Your likelihood of getting paid from a company in bankruptcy will depend on your creditor status. Preferential creditors are employees that are owed wages or tax authorities. Secured creditors are those who have liens against a debtor’s property, such as a building or car. Preferential and secured creditors will be paid before unsecured creditors, such as suppliers and contractors. Whether you are a secured or unsecured creditor, you must cease all collection activities when you receive notice of the filing; however, it’s important for you to remain involved. File your proof of claim, show up for the 341 meeting (i.e., a creditors’ meeting, during which the debtor is questioned under oath by creditors, a trustee, or an examiner about the company’s financial affairs), and attend any subsequent hearings or meetings.

When the business closes

Chances of getting paid when a business is defunct are not good, but there’s still hope. If the company has filed for bankruptcy, you can take the steps outlined above. If there has been no notice of bankruptcy, do some research to determine whether the business has truly closed. The appearance of a business shutting down doesn’t mean the legal entity is gone for good. There may be other corporations, legal entities, or personal assets involved in a business. From these additional entities, you may be able to collect some, or all, of what is owed.

As with bankruptcies, when a corporation dissolves, assets often are liquidated and used to pay off debts to avoid lawsuits against owners and executives. Creditors need to act quickly and submit a claim for debts owed, which will be filled by order of priority. Laws can vary by state and it can be a complicated process. A commercial collections agency can help you navigate these murky waters and improve your chances of getting paid.

Need help managing your commercial credit risk? MSCCM financial experts can assist you. Contact us today.