Dealing with a Customer Bankruptcy Filing

How to react and recover money that's owed to your business

By Matt Alderton, Writer, Editor and Media Consultant Logolepsy Custom Content and Communications

In a perfect world, every customer would pay you – in full – all of the time. The world, however, isn't perfect, and some customers – whether a business or consumer – are bound to default on their debts. A few might even go bankrupt, leaving you, the creditor, empty-handed. That's because bankruptcy affords debtors "automatic stay," which effectively suspends all their debts pending a decision by a bankruptcy court.

You have options, though; in deciding if you want to pursue them, consider:

How much money you are owed
Whether you will have to hire a lawyer to represent you
How much time you will have to invest in the matter
The type of customer bankruptcy — Chapter 7, 11 or 13 — involved

Make some quick moves, now

You may be able to recall goods in transit and even some goods already at the customer's location. You may be able to collect from co-debtors, such as spouses or business partners, or anyone who might have guaranteed your account.
Try: Explore these options and more with the American Institute of Certified Public Accountants' "When Your Customer Goes Belly-Up," a guide to protecting your interests in the event of customer bankruptcy.

Line up your accountant and a lawyer

Upon receiving notice that a customer who owes you money has filed bankruptcy, contact your accountant. He or she will be able to counsel you on potential courses of action, including whether to petition the bankruptcy court for relief from automatic stay.
Try: If you need a bankruptcy attorney, find one at Lawyers.com.

File a proof of claim

By filing a proof of claim, usually attached to a bankruptcy notice, you'll end up on the list of creditors who are eligible to receive a portion of the customer's remaining assets.
Try: Download a standard proof of claim, along with a slew of other bankruptcy forms, courtesy of the federal judiciary.

If the amount owed is large, attend a creditors' meeting

Debtors are required to meet with their creditors in what is known as a 341 meeting, in which you can ask questions and identify courses of action. You aren't required to attend, but doing so will give you a better understanding of your options.
Try: Prepare for the meeting with this checklist from the Moran Law Group.

Collect on credit insurance

Credit insurance protects your business against unpaid debts. If you have credit insurance, file a claim in order to collect on it.
Try: Learn about credit insurance from the Federal Trade Commission, or purchase it from any number of providers, including Atradius and Coface.

Use preventive measures

Prevent future debts from going sour by instituting measures to protect your business. Consider using credit applications and issuing credit limits, for instance, or requiring co-signers on large purchases.
Try: Guard against debt-ridden consumers by verifying customers' credit history with one of the three major credit-reporting bureaus: Equifax, Experian or TransUnion.

Delayed payments or unsigned checks are early warning signs that a customer is headed into debt and should prompt you to take action before bankruptcy prevents you from doing so.
Secured creditors — those with an interest in the debtor's assets — are more likely to be paid in bankruptcy settlements than unsecured creditors, who lack a claim on the debtor's collateral.
Unless you have a Retention of Title (ROT) clause in your terms of sale stating you retain ownership of goods until they are paid for, you will not be able to reclaim the products you sold to a bankrupt customer.