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Understanding Your Options When a Customer or Client Files for Bankruptcy Protection

The U.S. Bankruptcy Code provides substantial protections to companies that file under Chapter 7 and Chapter 11. However, these protections are not absolute, and the Bankruptcy Code recognizes that creditors have a legitimate interest in enforcing their right to payment as well.

As a result, when a customer or client files for bankruptcy, its creditors have a variety of potential obligations available. We emphasize “potential” because the options that are available in any particular case will depend heavily on the nature of the debt and other circumstances involved. To find out what options your company can pursue, you will need to consult with an experienced Miami creditors rights attorney.

What Are Creditors’ Options When a Customer or Client Files for Bankruptcy?

If one of your company’s customers or clients has filed for bankruptcy, what might you be able to do? In Chapter 7 and Chapter 11 business bankruptcy cases, creditors’ potential options include:

1. File for Relief from the Automatic Stay

When a business files for bankruptcy under Chapter 7 or Chapter 11, it enjoys immediate relief from collection activities under the automatic stay. The automatic stay prevents creditors from seeking payment, and creditors who violate the automatic stay can face penalties as a result.

But, creditors can seek relief from a bankruptcy debtor’s automatic stay in some cases. For example, creditors with secured debts will often be able to have the automatic stay lifted with respect to their claims. If your company has grounds to seek relief from the automatic stay, then it can initiate (or resume) collection activities as necessary to secure full payment.

2. Stop Delivery of Goods in Transit

As a general rule, creditors can stop the delivery of goods in transit when a customer files for bankruptcy. This can help avoid additional exposure, although creditors must be cognizant of the potential contractual implications of failing to deliver as promised. Absent contractual protections, a creditor may have an obligation to deliver goods to a customer even after the customer has initiated Chapter 7 or Chapter 11 bankruptcy proceedings. With that said, the Uniform Commercial Code’s (UCC) right to demand adequate assurance and/or other protections may apply as well. This can get complicated quickly, and it is best to consult with an experienced Miami creditors’ rights attorney promptly.

3. Assert Your Company’s Reclamation Rights

The Bankruptcy Code and the UCC both provide creditors with reclamation rights in certain circumstances. If your company has delivered goods to a customer that has filed for bankruptcy under Chapter 7 or Chapter 11, your company may be able to use reclamation to demand the return of the goods delivered. However, strict deadlines apply—so, here too, it is important to consult with an experienced Miami creditors rights attorney before taking action.

4. Seek Designation as a “Critical Vendor”

The Bankruptcy Code provides special protections to debtors’ “critical vendors.” A creditor may be classified as a critical vendor if the goods or services it supplies to the debtor are essential for the debtor’s continued business operations. While debtors are generally responsible for designating their critical vendors, creditors can play a role in the process, and securing critical vendor status can allow debtors to make payments that would otherwise be prohibited during the business bankruptcy process.

5. Seek Assumption of an Executory Contract

If your company has an executory contract (a contract under which both parties have continuing obligations to perform) with a bankruptcy debtor, the debtor will have the option to either assume or reject the contract. If the debtor rejects the contract, your company will be left to pursue payment through the bankruptcy process. However, if the debtor assumes the contract, then it will have the obligation to either (i) cure outstanding payment defaults and provide adequate assurance of its ability to perform; or (ii) assign the contract to a third party (subject to cure and adequate assurance). Convincing a customer or client to assume an executory contract will be in both parties’ best interests in many cases.

6. File a Proof of Claim

If the debtor is disputing your company’s claim or has failed to list your company’s claim in its schedule of debts, you may need to file a proof of claim in order to protect your company’s right to payment. These filings are also subject to strict deadlines, and while filing a proof of claim can be essential in some cases, doing so also comes with certain ramifications. Once again, experienced legal representation is vital, and this is an option that you will want to discuss thoroughly with your company’s Miami creditors rights attorney as well.

7. Initiate an Adversary Proceeding

Another option—and potentially your company’s only option—if a customer or client is seeking to avoid payment through the bankruptcy process is to initiate an adversary proceeding. An adversary proceeding is a lawsuit challenging a bankruptcy debtor’s claim for discharge. There are several grounds for initiating adversary proceedings in Chapter 7 and Chapter 11 business bankruptcy cases, including (but not limited to):

  • Assertion of lien rights
  • Debt reclassification
  • Equitable subordination
  • Fraudulent and preferential transfers
  • Post-petition transfers and turnovers

In addition to (if not in lieu of) taking one or more of the steps discussed above, creditors may also need to actively engage in the business bankruptcy process to protect their right to payment. By being actively involved in the meeting of creditors and participating in the formulation of the debtor’s reorganization plan (if applicable), creditors can maximize their chances of collection. An informed and strategic approach is key, and the first step is engaging an experienced Miami creditors rights attorney to guide you forward.

Speak with a Miami Creditors Rights Attorney at Edelboim Lieberman

Are you dealing with a customer or client that has filed for bankruptcy? If so, we encourage you to contact us to discuss your company’s options in confidence. To schedule an appointment with a Miami creditors rights attorney at Edelboim Liberman, please call 305-768-9909 or inquire online today.

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