How Another Business Going Bankrupt Can Affect You

If you find yourself in this situation, keep your cool, pay attention and don’t expect a miracle.

How Another Business Going Bankrupt Can Affect You


Your business is humming along when one day you get the news that a key supplier — or perhaps one of your biggest customers — has filed for bankruptcy. You’re just a bystander in all of this courtroom drama. How could it affect you?

If you’re lucky, your supplier has delivered your most recent order and doesn’t owe you anything. You only need to find a new vendor to take its place. 

Or, if it’s your customer, you can be thankful if they’ve paid your last bill in full and carry a zero balance on your books. You simply need to figure out whether they plan to keep going and will still want your services — and whether you’ll consider them a reasonable risk. If not, you merely need to go out and find new customers.

Life is seldom so smooth, of course. So what do you do if a supplier or customer goes into bankruptcy court and owes you money? 

Attorney Christopher Combest is a partner in the Chicago office of the national, full-service law firm Quarles & Brady. Combest practices in the firm’s commercial restructuring, bankruptcy and creditors’ rights group and works with both creditors and debtors in bankruptcy as well as other insolvency cases. 

Everyone’s circumstances are different. No matter what you read here, consult your own trusted legal and financial adviser before taking any action that would affect your own business. But if there’s a short bottom line to Combest’s advice, it might be this: Don’t panic, pay attention, follow the rules — and don’t expect miracles. 

For either a person or a company behind the financial eight ball, bankruptcy court really is the court of last resort. It helps put things in order for everyone, but if you’re a creditor, don’t count on getting back all you may be owed.

Two chapters

Business bankruptcy comes in two flavors — Chapter 7 and Chapter 11— that are named for the section of the federal bankruptcy code that defines them.   

“Chapter 7 is what we call the liquidation chapter,” Combest says. “A company that files Chapter 7 is essentially throwing in the towel.” 

Top of Form

Bottom of Form

When a company files under Chapter 7, the court appoints a trustee whose job is to collect all the company’s assets, turn them into cash (by selling company property, inventory or equipment ), and then see that creditors are repaid in the order in which they’re entitled. 

First in line are secured creditors — lenders who have collateral against the company’s debt, such as lien on the debtor’s property. The collateral is sold, and those creditors are paid from the proceeds. 

Next in line is the trustee, who gets a fee for administering the case, and lawyers representing the trustee. They’re followed by employees whose wages have gone unpaid and certain government taxing authorities.

Back of the Line

Last in line are unsecured creditors. Most likely, that’s what you are, whether you are providing a service to the business in bankruptcy or you are that company’s customer. 

Unsecured creditors have the smallest chance of getting back what the debtor company owes them.

“In Chapter 7, particularly, there’s often little or no money to pay general, unsecured creditors,” Combest says. 

When the debtor is flat broke with no assets to speak of, that’s called a “no-asset case,” Combest says. Barring some unexpected turn of events, you won’t see a penny of what you’re owed. “Don’t throw good money after bad,” he says. “Just write it off as a bad debt and move on with your life.” 

By the way, this is just as true if the debtor isn’t a business but an individual or a household. In fact, Combest notes, “by far the vast majority of bankruptcy cases that are filed in this country are individual human beings filing Chapter 7 cases” — most of them are no-asset cases in which there’s nothing for unsecured creditors at all. 

But some businesses, even those filing to liquidate under Chapter 7, might have enough assets to pay unsecured creditors something after everyone ahead in line has gotten paid.

Forms and Deadlines

When companies file for bankruptcy, they complete a list of every person or business to whom they owe money. If you’re one of those creditors, you should get notices in the case. And if there are funds available to pay their claims, unsecured creditors will be asked to file a “proof-of-claim” form with documentation — invoices and other relevant paperwork — of what you are owed and why. 

The court, or the bankruptcy code itself, sets a deadline to submit claims, and those deadlines are usually drop-dead dates. It’s critically important that you don’t let any mail or notices from the court stack up on your desk unread.

“If you miss a deadline, you may be out of luck in getting your claim paid,” Combest says.

Chapter 11

Chapter 11 is known as “the reorganization chapter.” Companies opt for that route when they plan to stay in business, perhaps by selling their assets or by reworking their balance sheet and dumping some debt. Unless there’s evidence of fraud or other egregious mismanagement, the existing management typically manages the bankruptcy process instead of an outside trustee. 

In that situation, you’ll have to decide whether you want to keep doing business with the debtor. It might be tempting to simply drop a customer in Chapter 11 bankruptcy — and if there isn’t a long-term binding contract, you can do that. But consider this: If you’re providing goods or services to a company while it’s in Chapter 11, the bills for that work will actually take higher priority than the ones that were outstanding before the debtor went to court. 

To be sure, Combest says, “There’s always some risk in extending credit to a Chapter 11 debtor.” So if you do decide to keep doing business with your customer in Chapter 11, you may want to tighten up procedures — demanding payment upfront, for example, setting a shorter payment deadline, or at least collecting your out-of-pocket expenses (for supplies, say) upfront.

Watch Your Step

One thing you can’t do once a business is in Chapter 11 is sue for an old, unpaid bill. 

Suppose you provide your customer with a service, send the bill, never get paid and then the customer winds up in Chapter 11 bankruptcy.

“The instant the petition is filed with the court, automatically a stay goes into place that is a bar against all creditors,” Combest says. “It prevents virtually all actions that may be taken against a debtor on account of a prebankruptcy obligation.” 

That means you can’t sue. You can’t send threatening letters. You can’t sic a collection agency on the customer. Even if you have already sued before the bankruptcy petition was filed, your suit is frozen — you can’t pursue it any further, unless you get specific permission from the court to do so. In fact, if you tried to take any court action against the debtor, you could wind up in court instead. 

There’s a reason for that strict rule, Combest says. The whole point of a Chapter 11 bankruptcy “is to give the debtor breathing space to reorganize and restructure their business.” Having to fight off old or new litigation defeats that purpose. 

That doesn’t mean you just have to suffer in silence. You’re within your rights to contact the customer and ask how you can work things out mutually by joint consent. But take those words — mutual and consent — very literally.

Preventive Medicine

Follow the procedures, don’t violate the bar on collection actions, and never ignore notices from the bankruptcy court or from the debtor, Combest advises. 

But how can you avoid the whole mess to begin with? The best remedy is the most basic: Stay on top of your accounts receivable, pay attention when any customer gets too far behind and keep your ear to the ground. 

“Monitor the account before it goes into bankruptcy,” Combest says. “If you know it’s in financial difficulty, enforce your remedies as quickly as possible.” 

That way, you’ll never have to see them in court.


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