Create a free Manufacturing.net account to continue

Going Under

By Amy Radishofski, Features Editor, Manufacturing.net What can you do to protect yourself or to recoup some lost money when one of your biggest customers files for bankruptcy?

Bankruptcy can be a scary thing. However, with the unsettled economy, it is becoming more and more frequent.

Many small businesses have gone under in the past year. Even some big companies like technology giant Nortel have filed for bankruptcy.

Maybe one of your biggest customers just went bankrupt. What can you do?

The first thing you need to do is stop your collection activities, according to Mike Zaverton, Of Counsel, Walter & Haverfield.

“When a company files for bankruptcy, it creates an estate for the debtor,” Zaverton explains. “There is an automatic stay which stays actions from creditors to file liens, collect debts, file lawsuits, etc. It protects the current condition of the estate. If you violate it, you may be subject to sanctions.”

You might be assessed damages and attorney fees, so it is best to stop your collection activities immediately. However, by halting collection activities, you aren’t necessarily giving up all chances of getting paid.

“Check your contract to make sure you didn’t waive your right to stop shipments that are in transit,” Zaverton advises. “You can stop the goods from getting to the debtor and protect yourself by demanding that shipments be paid in cash or COD.”

If a shipment of your goods has been received by the debtor, you can file a reclamation claim. Reclamation claims do not violate the automatic stay.

You must be able to demonstrate following in order to file a reclamation claim:

  • the debtor received the goods
  • the goods were sold in the ordinary course of business
  • the debtor has possession of the goods
  • the debtor was insolvent at the time it received the goods
  • and you must make the claim in writing, preferably with invoices proving your claims

“You have 45 days from the date of delivery to file a reclamation claim,” Zaverton notes. “If your goods were delivered 44 days ago, you need to have the claim to the debtor by the next day.”

Unfortunately, some common practices in manufacturing mean reclamation claims may not be as valuable to you as they may have been in the past.

“Just in time inventory means that the debtor has possession of your goods for only a very narrow period of time,” Zaverton says. “Moreover, if the debtor takes your widget and puts it into something like a car, then you can no longer reclaim it.”

Zaverton adds that reclamation claims can also be trumped by a secure creditor’s lien on inventory.

“It may turn out to be an exercise in futility, but it is still worth doing,” he suggests. “When you make your demand for reclamation, be sure you demonstrate that the debtor has your goods in their possession. Claims may not be resolved for lengthy periods of time, and having some representation to prove they have your materials at that specific time is a good idea.”

Even if your reclamation claim is found to have no value, you may still have other options.

Under part of the Bankruptcy Abuse Prevention and Consumer Protection Act, you can file an administrative expense claim for the value of goods received by a debtor 20 days before the bankruptcy case began.

“Administrative expense claims are still below claims of secure creditors, but they have a higher priority than claims such as wage claims, which means they have a higher chance of being paid,” Zaverton adds. “However, the debtor is under no obligation to pay your claim until the case is closed.”

Also, if your goods are on consignment, then they are considered your property and you can take them back.

You should examine your contracts and your relationship with the debtor to determine which types of claims you are able to file.

Of course, not extending credit is the best way you can protect yourself. You can outline in your contract that you want cash in advance, or you want COD.

If you find yourself in the situation where a customer goes bankrupt, Zaverton suggests you turn to an attorney for assistance. The attorney can receive notices from the court regarding the status of the bankruptcy case, which can help you.

“You should also retain all notices you receive after the bankruptcy case is filed,” he advises. “Bankruptcy is a complex area of law. You should consult with a creditors’ rights attorney to make sure you are fully protected and not doing anything wrong, such as violating the automatic stay.”

More