Steps unsecured creditors can take when customers face bankruptcy

Historically, Chapter 11 of the Bankruptcy Code was more attractive for large businesses, but recent changes may make it a good option for small businesses. The Small Business Reorganization Act of 2019 added the Subchapter V provision to Chapter 11. To be eligible for relief under Subchapter V, a business could have no more than USD 2,725,625 in non-contingent, liquidated, secured and unsecured debt.

On 27 March 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act expanded Subchapter V’s application by raising the debt ceiling of qualifying businesses to USD 7.5 million. While the CARES Act bankruptcy provisions were originally due to sunset on 27 March 2021, the COVID-19 Bankruptcy Relief Extension Act extends those bankruptcy provisions through March 2022.

There are steps that an unsecured creditor can take prior to a customer’s filing for bankruptcy that may significantly reduce the creditor’s ultimate exposure.

Avoid the Preference Claim

Unsecured creditors may be liable to a debtor’s bankruptcy estate when they have received payments within the 90 days before the debtor filed bankruptcy. The creditor is not, however, without defenses to these actions. You should keep accounts current and follow ordinary billing practices. If an invoice is due within 30 days, do not allow the account to slip beyond contractual terms. If you know a filing is imminent, discuss with legal counsel how payments should be applied and against which invoices.

Monitor Customer Solvency

If you extend trade credit to a customer who represents a significant source of your revenue, intermittently request credit opinions from a financial service firm relative to the customer’s ability to meet obligations as they come due.

Establish Protective Payment Requirements

For customers facing imminent potential credit risk, institute payment requirements such as advance payments or cash on delivery of shipments. Such payments will provide insulation from a preference claim. Alternatively, establish an evergreen retainer or cash deposit system or consider conditioning the provision of further goods and services upon the guarantees of the customer’s principals.

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