What to Do If a Bankrupt Company Owes You Money

There are certain legal steps you should take

Suppose you've delivered an expensive piece of equipment to another business or provided it with a service that took hours of your valuable time. Then you find out that the organization on the other side of those transactions is filing for bankruptcy. It's natural to feel uneasy in this circumstance.

Even in this unfortunate scenario, there's a sliver of hope: Creditors like you often get back some of what they're owed during a bankruptcy, even if it's not the full amount due. Still, if and how much you get paid depends on which type of creditor you are and whether you take the appropriate legal steps to obtain that money. The more proactive and knowledgeable you are about the process, the better your chances of coming out relatively unscathed.  

Key Takeaways

  • When a company files for bankruptcy, the court will typically send you a notice and a proof of claim form that allows you to petition for payment.
  • If you don’t receive the bankruptcy notice from the court, it’s essential to contact the clerk promptly to receive your proof of claim document.
  • The bankrupt company’s outstanding debt is prioritized, with preferred creditors and secured debts paid first.

Learn the Type of Bankruptcy

The first thing to realize is that not all bankruptcy filings are the same. Indeed, how the company decides to file can significantly affect how creditors get paid. 

In a Chapter 7 bankruptcy, the owners have determined there’s no viable way to keep the business afloat. The goal is to shut the company down and liquefy any tangible assets, so they can pay off their creditors. A trustee who’s appointed by the bankruptcy court—all bankruptcies are handled through the federal system—assumes the responsibility for selling off those assets and repaying creditors in the order laid out in the Bankruptcy Code.  

Some entities file for bankruptcy with the goal of reorganizing and staying in business, a process known as a Chapter 11 bankruptcy. Unlike with a Chapter 7 bankruptcy, the creditors get to vote on the company’s plan, which includes a strategy for repaying any outstanding debts. Ultimately, the plan has to be approved by the bankruptcy court as well.

Whether a business is filing Chapter 7 or Chapter 11 bankruptcy will affect your ability to get paid.

Learn How the Debt to You Is Prioritized

Regardless of the type of filing, courts require creditors to be paid in a certain order, depending on the type of debt. Creditors with the highest priority—sometimes called preferred creditors—are paid first. These include employees of the company as well as local, state, and federal taxing authorities.

Next in line are secured debts, for which the creditor has a lien on a particular asset. Common examples include mortgage providers or lenders requiring collateral before fronting the company money. 

Unsecured debts are the lowest in the pecking order, meaning those creditors always assume a higher level of risk when providing products or services to a business. It’s important to note that not all unsecured debts have equal standing. For example, a supplier who delivers goods or services after the bankruptcy filing can request that administrative expenses be paid in full or threaten to refuse the reorganization plan. Likewise, individuals and businesses that provide goods to the company within a 20-day window before the filing may also have a right to a full claim.  

Most other claimants fall under the umbrella of general unsecured creditors, who, given the troubled business’s limited assets, often receive a tiny fraction of what they’re owed.

File a Proof of Claim

When the company files for bankruptcy, the court sends a notice to the listed creditors. At this point, it’s critical that you file what is called a proof of claim. Essentially, it’s a formal written statement that tells the court why the debtor business owes you money. Typically, you will also want to provide any documents—including invoices, contracts, and account statements—that support your claim. The official claim form and directions will be included in the bankruptcy notice.

After filing your claim, you’re entitled to attend a creditor’s meeting—sometimes called a 341 meeting—in reference to the applicable section of the Bankruptcy Code. Here the creditors and the trustee can ask the debtor questions in order to obtain insight into its financial state.

When a business files for bankruptcy protection, an automatic stay goes into effect, which means creditors like yourself can no longer attempt to recover their receivable amount outside of the bankruptcy court. That means you’ll have to halt any lawsuits, garnishments, or foreclosures from the moment the business files.

Creditors can petition the court to lift the automatic stay, which allows them to resume collection activities. Whether the motion is accepted depends on meeting specific criteria. For example, the presiding judge may grant relief from the stay if the value of a property is likely to decrease while the bankruptcy plays out, thus reducing the amount that a creditor will be repaid.

Make Sure You're Listed in the Filing

Sometimes, a business may leave you off the court filing even when it owes you money. Because you’re not listed in the bankruptcy, the court isn’t going to send you notice of the filing. 

If you learn of the bankruptcy through an unofficial channel, you’ll want to contact the company and request the bankruptcy case number. You can then get in touch with the court clerk and have them verify that the filing has, in fact, occurred. Then, assuming you’re still within the allowable time frame for accepting proof of claim, the clerk should be able to send you the necessary form. 

Of course, sending in a proof of claim does not guarantee that your debtor will pay you. However, it lets you get in line (so to speak) when the business formulates a repayment plan, or the court-appointed trustee distributes the available assets.

Two important tools for protecting yourself against a business’s bankruptcy are trade credit insurance (TCI) and having a retention of title clause in your contract.

Use Insurance to Protect Your Financial Interests

Unfortunately, creditors often receive pennies on each dollar they’re owed, especially if their receivable amount is lumped in with the business’s general unsecured debt. Nevertheless, there are a couple of ways that individuals and companies can protect against bankruptcy losses, aside from weeding out business partners who are known to be in financial distress. 

One such backstop is inserting something called a retention of title clause in your sales contract. Such clauses give sellers like yourself the right to retain ownership of the goods you sell until you’re paid in full. Otherwise, you could be listed as an unsecured creditor who’s at the mercy of the trustee and whatever tangible assets the company has remaining to pay its debts.  

Suppliers who conduct extensive business with a particular customer may also consider taking out trade credit insurance (TCI), which safeguards the creditor in case the buyer fails to pay because of bankruptcy or other reasons.

Typically, TCI covers a certain portion of the unpaid debt, depending on the policy you take out. In addition to recouping unpaid receivables, some TCI policies provide protection against preference liability, wherein the trustee can recover payments that a creditor has received from the distressed debtor within 90 days of filing for bankruptcy.

How Many Type of Bankruptcy Are There?

The U.S. Bankruptcy Code has six type of bankruptcy: Chapters 7, 9, 11, 12, 13, and 15.

What Type of Bankruptcy Is for Companies?

Businesses can file for Chapter 7, 11, or 13 bankruptcy, depending on the size of the company and goals for filing.

What Type of Bankruptcy Is Best for an LLC?

Chapter 7 bankruptcy is used to liquidate and close a company, while Chapters 11 and 13 are used to reorganize it. Which is best depends on what you want to do with your company.

The Bottom Line

Though the bankruptcy of a company to which you’ve sold goods or provided services is never great news, it’s often possible to get at least some of that money back. Doing so requires you to file a proof of claim promptly, so the trustee overseeing the payment to creditors can put your receivables in the queue. Then, make sure to involve yourself as much as possible in the rest of the process.

Article Sources
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  1. U.S. Courts. "Chapter 7 - Bankruptcy Basics."

  2. U.S. Courts. "Chapter 11 - Bankruptcy Basics."

  3. CompanyDebt.com. "What Is a Preferential and Non-Preferential Creditor?"

  4. Allianz. "What to Do If a Company Goes Bankrupt and Owes Your Business Money."

  5. Foley & Lardner LLP. "Not All Creditors Are Created Equal: Critical Vendors and Bankruptcy."

  6. Robins Kaplan LLP. "Filing a Proof of Claim: Pitfalls and Precautions," Page 3.

  7. GRF CPAs & Advisors. "Are You Owed Money From a Business that Filed for Bankruptcy?"

  8. Lowenstein Sandler LLP. "Trade Credit Insurance as Protection from Bankruptcy Preference Risk: Negotiating for the Broadest Coverage," Page 1.

  9. Allianz. "What is Trade Credit Insurance?"

  10. United States Courts. "Bankruptcy Basics."

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The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.