Deciding Whether to Pursue Payment by a Bankrupt Customer
Weigh the time and effort required against your odds of collecting the money.
As a business owner, you've had to learn when to let go of a bad deal. Dealing with customers who don't pay is a classic example. Sometimes it's not worth your time trying to get a customer to pay up, but sometimes it is. You have to decide: Will your valuable time be wasted going after them -- especially after they've filed for bankruptcy? In some cases, the answer might surprise you.
An awful lot of money gets left on the table during bankruptcy because creditors neglect to pursue their claims against a customer who's gone bankrupt. Some customers who file for bankruptcy are actually hiding assets; others come into money while their case winds its way through the court system. In addition, the bankruptcy system protects creditors better than you might have thought it would, so that the likelihood of getting your money is probably higher than you think.
Of course, you'll still need to balance the amount that you're owed against the time you'd spend to potentially retrieve it. Read on to help you estimate your probable time expenditure and chances of success.
The Time and Effort to Pursue a Bankrupt Customer
Below is a summary of the tasks that will be required of you in trying to retrieve money from a bankrupt debtor, and a rough estimate of how long they'll take.
First, stop all collection activities. Whether or not you get involved with the bankruptcy case, as soon as you find out that a debtor has filed for bankruptcy, you should mark the account as being in bankruptcy and advise your collection personnel to stop their activities (in compliance with the "automatic stay"). Then decide whether it's worth going to court to request lifting of the automatic stay (sometimes appropriate if you're a secured creditor who wants to foreclose on your collateral).
Examine the debtor's bankruptcy papers. If you spend an hour or two looking over the paperwork that the debtor filed with the court, you'll gain information that will help you decide whether to proceed, and investigate whether there's more money to be had than the creditor is confessing to. The papers will tell you what property the debtor claims to own, which items the debtor thinks are safe from being sold in bankruptcy, and the identity of other creditors (both secured creditors, who were given collateral, and unsecured creditors). With a little detective work, you may be the one to uncover mistakes or omissions. For example, you may know about property that the debtor didn't mention. Or, you may figure out that certain property must exist; for example, if the debtor lists a debt to a tire company but fails to mention owning a car, the debtor may be concealing ownership of an automobile.
Attend a meeting of creditors. All debtors must submit to a public examination by their creditors. It's a great opportunity for you to question the debtor about details relevant to your claim, such as what the debtor plans to do with your collateral (if any), or your suspicions that the debtor hid assets, underreported income, or overreported expenses. You'll probably wait 30 minutes to attend a meeting that lasts only a few minutes -- especially because so few creditors ordinarily show up.
File a proof of claim. The proof of claim is a one-page form that essentially says "I want in on the bankruptcy proceedings." You'll need to attach any documents proving your claim, such as contracts, notes, mortgages, and security agreements. The proof of claim should take you about fifteen minutes to fill out, assemble, and mail to the court. If the debtor objects to any portion of your claim, you'll need to attend a court hearing, unless you and the debtor reach an agreement resolving the debtor's objection.
If you don't file a proof of claim with the court, you normally lose your opportunity to have a voice in the proceedings and to be paid your debt from the bankruptcy proceeds. (Even if you're a secured creditor, you can't necessarily count on collecting on your claim through your lien unless you file a proof of claim form.)
Chapter 11: Attend a hearing regarding the debtor's reorganization/repayment plan. If the debtor filed for a Chapter 11 reorganization, you may choose to propose a reorganization (and repayment) plan and will be given an opportunity to vote on which proposed plan gets adopted. Voting is handled by mail. Consideration of any plan you submit is done at a hearing.
Chapter 13: Attend a hearing regarding the debtor's reorganization/repayment plan. If the debtor filed for a Chapter 13 reorganization, you'll want to attend the hearing at which the court decides whether the debtor's proposed repayment plan should be confirmed. Sometimes these confirmation hearings are held at the same time as the meeting of creditors. At the hearing, you can object to defects in the debtor's plan.
Follow through to the extent necessary. With any luck, your participation in the previous steps will be enough, and the bankruptcy trustee will see to administering a repayment plan (in a Chapter 11 or 13 case) or handling the sale of the debtor's available property and repaying the creditors (in a Chapter 7 case). If, however, disputes or other unusual circumstances arise, more court proceedings may be required. You would want to reassess the amount of money at stake and decide whether it's worth hiring an attorney to continue.
Your Chances of Success
Is it realistic to hope that any money can be wrung from this debtor? You may be in a better position to answer that than anyone. Based on your past knowledge of the debtor or on your alert perusal of the debtor's bankruptcy paperwork, you may have formed an opinion about the debtor's financial prospects and level of honesty. Is the debtor the type likely to have an overseas bank account and a hidden boat, or is the debtor someone who's truly down on his or her luck with nothing left?
If you don't have a good sense of the debtor, consider the following:
- Your active participation in developing a reorganization plan (in a Chapter 11 or 13 case) may lead to a better deal for you and other creditors.
- In most cases, the bankruptcy trustee will be looking for hidden assets and income, and if you've maintained your role in the case, you will be among those who ultimately benefit.
- Reorganization cases take many months to complete, during which time the debtor may get a pay raise, collect an inheritance, or win a lawsuit, all of which will increase the amount of money available to you and other creditors.
To Learn More
For a clear explanation of the practical and legal information you need to run your business, see Legal Guide for Starting & Running a Small Business, by Fred Steingold (Nolo).