At the end of last year, my distributor went into bankruptcy. Since then, I’ve learned a lot about the effects of others’ bankruptcies on small companies.
In last week’s column I discussed ways to protect yourself from others’ potential bankruptcies. This week: steps to take when a key partner — customer, distributor, supplier — enters into bankruptcy.
Not all bankruptcies are alike. Different types of bankruptcies are referred to by their section of the bankruptcy code:
• Chapter 7: liquidation. The company is being closed; the court is distributing the company’s assets.
• Chapter 11: reorganization. The court is trying to keep the company in business. The company must devise a court-approved plan to turn its operations around and pay its creditors.
• Chapter 13: personal bankruptcy. For individuals.
Once another partner has declared bankruptcy, act fast. Get a good bankruptcy attorney immediately. Your regular business lawyer is unlikely to understand the nuances of bankruptcy laws. I was lucky to find an excellent bankruptcy attorney, and he definitely contributed to a positive outcome.
Understand the bankruptcy law basics. The world — and your contract — gets turned upside down in bankruptcy.
In Chapter 11, you must continue to provide goods and services under the normal terms of your contract. Your contract says you can end the relationship upon bankruptcy? You can’t. Chapter 11 protects the bankrupt company, not you.
Some things you may not do once another company is in Chapter 11:
• Unilaterally end contracts.
• Demand payment for goods or services delivered before bankruptcy (yes, even making the demand is an offense).
• Take back property or goods you delivered before bankruptcy.
Even if your contract makes clear that the bankrupt company is merely holding or distributing your goods, those goods could be seized to pay their debts.
Limit your future exposure with the firm. If you’re not required to continue to do business with the company, don’t get yourself into deeper hot water.
“In Chapter 11, companies are required to pay you in full for what you provide them after bankruptcy,” explained Coleman. “It’s possible to demand payment in advance unless you are contractually bound to other payment terms.”
Organize with other small creditors. As part of the bankruptcy process, a formal committee of creditors is formed. Typically, these are the largest creditors. If there’s a way to work together with other smaller creditors, it will cost you much less in legal fees and may give you more of a voice in the process.
Call key customers and/or key suppliers. In many industries, news of a major bankruptcy spreads. You don’t want your customers to panic and cancel orders or key suppliers to demand immediate payment.
In my case, I’m in the publishing industry, so I immediately called key accounts at Barnes & Noble and Borders to tell them my company was financially healthy and would continue to supply books to them.
File a “proof of claim.” A notice will be sent by the court for you to provide details of the money the bankrupt company owes you. Without this, you won’t be paid. It must be filed in a timely fashion.
Assess your other rights. You may be entitled to a reclamation claim for goods delivered recently, a lien against property, or a personal guarantee from the company’s owner. Make sure you talk to an experienced bankruptcy lawyer.
When someone goes into bankruptcy, you’re likely to receive only pennies on the dollars of what you’re owed, and then sometimes a year or two later. So, if you don’t have much at stake, you might take a few minimal steps (such as filing a proof of claim), and get on with your business.
I was unbelievably fortunate. In a few months, we were able to move on. It looks like we’ll get most of our money. But we’re still dealing with the disruption of changing distributors, major cash flow interruption and legal hassles.
It’s never fun when a company goes bankrupt — even when it’s not yours.
Rhonda Abrams is the author of “Six-Week Start-Up” and “What Business Should I Start?”
