Caught In The Middle: When Partners Go Bankrupt

Times are tight, but your company’s cash flow seems to be adequate. You can pay bills on time, and even have some put away as a buffer against a slowdown. There’s even a new office complex going up nearby, and you just might be able to land that account. All in all, you’re keeping your head well above water.

But what about your suppliers, customers and other business partners? Do you know how they’re doing — and what affect their financial status might have on your business? As business bankruptcies continue to increase, building service contractors should stay abreast of the health of their suppliers and clients.

The media recently have focused on bankruptcies of large corporations, but smaller companies are showing strain as well. And the fallout of any company’s bankruptcy can have a devastating effect on other companies that do business with it. Unfortunately, many of these surrounding companies are small businesses, vulnerable to financial problems or even bankruptcy themselves.

What can you do to prevent your business from being caught in the middle of another company’s bankruptcy? BSCs always should consult with a lawyer or financial expert before working with a bankrupt partner, or attempting to recover losses, but there are some general guidelines. Your options depend on the type of bankruptcy and your relationship with the bankrupt business.

Types of bankruptcy
The main types of bankruptcy available to businesses are Chapter 7 and Chapter 11. (Another form, Chapter 13, applies to individuals; if an individual declaring bankruptcy has a sole proprietorship, that business is involved in the bankruptcy.)

Bankruptcy can be voluntary or involuntary. A voluntary bankruptcy is filed by the debtor. In an involuntary bankruptcy, creditors can file a petition to force a debtor into bankruptcy.

In Chapter 7, the business liquidates and ceases operation. (This is sometimes referred to as “straight bankruptcy.”) Assets are sold for cash. The money is used to pay administrative and legal expenses, and other obligations, according to a set list of priorities. General creditors are paid if any money remains. They get only a small proportion, perhaps a few cents on the dollar, if anything.

A Chapter 11, or reorganization, bankruptcy is designed to give a business some breathing space to overcome its financial problems. The business continues operations, and management continues the day-to-day aspects of the business, but the bankruptcy court must approve significant business decisions.

The debtor business develops a plan with the committee of creditors — a group designated to represent the interests of parties who are owed money. The plan is then filed with the court, and creditors vote on the plan. The court must approve the plan (if the creditors reject the plan, the court can still approve it.).

The core of the plan is the restructuring of payments to creditors. This usually involves lower payments spread out over a longer period of time than the original debt called for. Creditors in a Chapter 11 bankruptcy have a better chance of receiving at least partial payment.

In either type of bankruptcy, creditors file a “proof of claim” showing the debtor’s obligation so they can collect from the debtor. Complying with the filing deadline is essential.

When you’re owed money
If a customer goes bankrupt and still owes you money, whether you can collect depends on the circumstances. It’s probably too late for you to realize any money from the debt if it’s a Chapter 7 bankruptcy. All you can do is get in line and hope. That company also has gone out of business, so proceed as you would if you lost the account under different circumstances.

A Chapter 11 bankruptcy offers some possibility for realizing money from the debt, but this can take a considerable amount of time. Again, you have to get in line. In both cases there may be numerous claims that have priority ahead of you.

If you’re in the fortunate position of being a secured creditor, which means you have some collateral for the debt, you have a higher priority than other creditors who are unsecured. That scenario is unlikely for BSCs.

When a vendor goes bankrupt
Distributors, manufacturers and other suppliers also can go bankrupt, leaving you wondering where to turn the next time you need to order those proprietary chemicals or custom paper goods. But whether a supplier bankruptcy becomes more than an inconvenience depends on whether you have any outstanding orders or bills.

If you have received all orders, and paid all invoices, it’s relatively simple. In a Chapter 7 bankruptcy, the business — and your connection —simply ceases, and you’ll need to find another supplier. If the bankruptcy is a reorganization, you may continue to do business with that vendor, and possibly with little disruption.

A bankruptcy when there’s “unfinished business” can get murky. Have you paid any money? Has part of an order been shipped? Variables such as these can affect your position. You need legal advice to protect your rights and to determine your position with respect to the unfinished business. Also, bankruptcy doesn’t automatically cancel contracts; you still may be obliged to fulfill your part of the agreement.