6 Things That Happen to Vendors, Customers, and Shareholders When Companies File Chapter 11 Bankruptcy

When a company enters Chapter 11, they have told the court that they need to reorganize their finances and that they intend to pay their creditors, but for now they need to halt payments temporarily. Usually, but not always, a Chapter 11 company intends to keep operating their business, while in Chapter 7 they intend to wind down the business completely.

During bankruptcy, collection efforts must stop. Some creditors have to file their claims, and they’re no longer paid under their original schedules. Anyone who’s been paid recently may have their payments clawed back. A contract can’t be cancelled just because of the filing. Creditors vote on the bankruptcy plan. Customers who’ve deposited money get partial priority in being paid back. And shareholders come in behind creditors.

An automatic stay is an injunction that goes into effect when the bankruptcy petition is filed. Creditors must stop trying to collect during the bankruptcy case. Bankruptcy stops any court case that a creditor may be prosecuting against the debtor. The automatic stay gives the debtor some breathing room. The stay covers only pre-filing debts. New debts have to be paid when due. If there’s no equity in the property, and the debtor doesn’t need it to reorganize, the secured lender may get relief from the automatic stay.

While bankruptcy proceedings run their course, the debtor usually gets to stay in possession and keep operating the business. Ordinary business expenses still get paid, to keep the company afloat. And with court approval, the business may be able to borrow new money during the bankruptcy proceedings.

Proof of Claim

If the debtor lists the claim correctly in the bankruptcy filing, the creditor doesn’t need to file a claim at all. If the claim is left off the schedules or is wrongly scheduled as contingent or disputed, the creditor must file a proof of claim. It’s the creditor’s job to check the schedules to see if their claim has been properly scheduled. If you don’t file, you may lose your right to vote on the bankruptcy plan and to receive part of any payments to creditors.

You get special priority for goods that you deliver in the 20 days before the company filed its bankruptcy, as long as they were sold in the ordinary course of business. These goods are treated as administrative expense, meaning that they get paid ahead of ordinary unsecured claims. If you’re not paid, you can pull back some goods you delivered in the 45 days before the filing. You have to give written demand for reclamation, and on time.

A payment made by the debtor within 90 days before the bankruptcy, to a creditor to repay an old debt, is a preference, which may be recoverable by the debtor or trustee, but there are several defenses. In general, a payment is preferential only if it was made while the debtor was insolvent and gives the creditor more than they would have gotten in a Chapter 7 liquidation. It’s supposed to stop the debtor from paying off friendly creditors before filing. As for the defenses, first, if the payment was made in the ordinary course of business, then it’s not a preference. Second, payments of less than $8,575 in total are exempted.

You can’t cancel your contract just because a company has filed for bankruptcy. But it can be assumed or rejected during the bankruptcy case. If the debtor “assumes” your contract, then they’re telling the court that they intend to fulfill their obligations. But they have to cure any past defaults, including paying off your actual damages, and giving good assurance of future performance. When a debtor has a commercial lease, the lease is automatically considered rejected if the debtor hasn’t formally assumed it within 120 days after the bankruptcy is filed or when the plan is confirmed, whichever is sooner. The court can let the debtor extend the assumption period, so landlords should track those cases to make sure the leases don’t just slip away.

An unsecured creditors committee gets appointed by the U.S. trustee, usually including the seven largest unsecured claims. It investigates the debtor and may hire its own attorneys. It’s involved in developing the plan of reorganization.

The plan of reorganization sorts the claims into categories or classes and states how each class will be treated. Priority unsecured claims get paid ahead of general unsecured claims. At the back of the line are the shareholders. Creditors in each class vote for themselves, and a class accepts a plan if at least two-thirds of the dollar amount and more than half of the voters in the class accept it. Once the plan is confirmed, it generally discharges the debtor’s old debts, and creates new contract rights between the creditors and the debtor.

Customers who’ve deposited money for household goods never delivered get priority up to $3,800 each. This partial priority applies only to goods or services for personal, family or household use. These claims are paid ahead of general unsecured claims.

In Chapter 11, shareholders don’t have to file a proof of claim. They file a proof of interest instead, which simply says that they own stock in the company. They can vote on the plan. Shareholders in a corporation can only be at risk of losing the money they put in -- in other words, the value of their stock. When there’s a corporation, the business is separate from its owners, and its creditors aren’t paid out of their personal property. But if you’re a sole proprietor, your personal assets are included in the bankruptcy. And if there’s a partnership, the partners’ personal assets can sometimes be used to pay partnership creditors. In the plan, shareholders cannot get paid if any class of unsecured claims has voted to reject the plan because its claims will not be paid in full. This is called the absolute priority rule.

Your checklist as a vendor:

• Make sure the debtor has listed your claim correctly. Otherwise you have to file a proof of claim.
• If the debtor paid you shortly before filing, you may have to give that money back.
• If you want to demand goods back, make sure you do it on time.
• You may be able to vote for the plan.