Best Practices in an Economic Downturn (Part II): Your Customer Filed Bankruptcy, What Now?

Best Practices in an Economic Downturn (Part II): Your Customer Filed Bankruptcy, What Now?

By Saalfeld Griggs PC

In today’s troubled economy, many business owners either have or will receive notice that a customer has filed bankruptcy. The question that invariably comes to mind is, “What now?” In the last issue of Business Briefs, we discussed proactive steps business owners can take to minimize the impact of bankruptcy filing. This article focuses on potential pitfalls facing a creditor when a client or customer files bankruptcy, as well as some necessary steps that creditors can take to recover some or all of the amounts owing.


For a creditor, the most important impact of a bankruptcy filing is the “automatic stay.” Immediately upon filing a bankruptcy petition, all actions to collect against the customer’s property are “stayed,” meaning they are prohibited by law. This includes filing a lawsuit, attempting to reclaim property of a customer, enforcing or perfecting liens against the property, and any other act to collect or recover from the customer. The automatic stay even prevents landlords from taking steps to evict or terminate a bankrupt tenant’s lease. Any act in violation of the stay is void, and could create civil liability and a claim for punitive damages.

The automatic stay will continue until the bankruptcy case is closed, dismissed or the property a creditor is seeking to collect against is released from the bankruptcy estate. A typical Chapter 7 bankruptcy takes months to conclude, resulting in a significant amount of time until the creditor sees any payments from the debtor.


The next important question for any creditor owed money by a customer who has filed bankruptcy is whether the creditor’s claims are secured or unsecured. In general terms, a creditor has a secured claim if that creditor has a lien on some of the customer’s property, and that lien is perfected under the law. An unsecured creditor is owed a debt that is not secured by a lien on the customer’s property. Why does this matter? The answer has to do with the way creditors are treated in a bankruptcy proceeding.

Under the bankruptcy code, a secured claim is treated more favorably than an unsecured claim. For example, suppose a customer files a Chapter 7 bankruptcy petition to liquidate and sell all their assets, which includes some farming equipment. Creditor A has a lien on the equipment being sold. When the equipment is sold, the proceeds of the sale will be first distributed to Creditor A. In addition, because Creditor A’s claim is secured, Creditor A may be entitled to “adequate protection.” Adequate protection is a way of protecting a secured creditor’s interest in the debtor’s property. Adequate protection is present when the obligation owed by the customer is less than the value of the property. However, if the obligation exceeds the value of the property, the creditor may be entitled to additional protection such as periodic cash payments or relief from the automatic stay to sell the collateral. However, if Creditor A does not have a secured claim, Creditor A will not receive any proceeds from the sale of the equipment until after creditors with secured claims are paid. In many situations, this means that Creditor A will receive nothing.


If a creditor does not file a “proof of claim,” the creditor could potentially receive nothing, regardless of whether the claim is secured or unsecured. Typically, when a creditor receives notice of a debtor’s bankruptcy filing, that notice will specify the deadline to file a proof of claim. In a Chapter 7 proceeding, a creditor with an unsecured claim must file a proof of claim within the time allowed. Failure to do so will result in that creditor receiving no payments upon the sale of the debtor’s assets, regardless of whether the sale results in sums for the unsecured creditors. A secured creditor should file a proof of claim, though failure to do so will not extinguish that creditor’s lien on the debtor’s property. However, a debtor could provide that the value of the property subject to a creditor’s lien is more or less than the actual value, affecting what, if any, adequate protection that creditor would be entitled to.

In a Chapter 11 proceeding, a creditor is not required to file a proof of claim if that creditor is listed in the bankruptcy petition as being owed an obligation by the customer. However, a debtor may undervalue the obligation owing to the creditor, or simply omit the creditor altogether. Therefore it is important to file a proof of claim regardless of how the customer describes the obligation owing to the creditor in order to preserve the creditor’s rights during the bankruptcy proceeding. This way, a creditor can be sure that the claim against the debtor is for the actual amounts owing.

Please remember that bankruptcy is a complex area of the law, with many exceptions and nuances. This article is intended to raise awareness as to some of the more important issues.

If you receive notice that a customer has filed bankruptcy, the attorneys at Saalfeld Griggs PC are well qualified to assist you through the bankruptcy process.