If a customer files for bankruptcy and you are left with a large bad debt amount, do you continue to do business with them? How can you determine the creditworthiness of a customer?
— Kelly Gunn, Human Resources Manager, Garrison Service Company (Nashville, TN)
Jerry Weidmann: In a Chapter 11 reorganization, a company is able to reduce its debt and get out of costly or unfair agreements. The financials of a company generally improve significantly as a result of the bankruptcy. They are under the supervision of the bankruptcy court and have to pay their suppliers on a current basis after their filing. As such, we continue to do business with companies after they file bankruptcy. Our general experience doing so has been favorable.
Duncan Murphy: There are two stages of bankruptcy: Chapter 11 reorganization to continue in business and Chapter 7 to liquidate. If Chapter 7 is the choice and the people start a new enterprise, you must evaluate them as you would any new customer—knowing that they are a baby financially. Until they establish a track record, your only choice is to accept cash or credit card only.
For Chapter 11, we evaluate how strong they will be when they come out. You must forget that they created a loss for you. We almost always continue doing business, as it is the only way to recoup the loss. It is dependent on their ongoing health. We usually tighten their terms and watch their promised performance much more closely. If they deviate, talk with them immediately. Use the attitude that you want to help but in a fiscally responsible way. We have found that, many times, the emerging customer will recognize that you are trying to help and possibly increase the level of business. Of course, there are repeat offenders out there who you cut off as soon as you see the direction they are heading. In general, though, the only way you make up bad debt losses is by transacting future business.
Brad Baker: We typically have continued to do business with larger customers who have filed for Chapter 11 bankruptcy protection. If the court approves the reorganization, then chances are good you will get paid if you are cautious. Regardless of a company’s financial status, it is always a good idea to get down payments and progress payments to minimize or eliminate the risk of bad debt. A strong internal collection program is a must and will also reduce risk in both pre- and post-petition bankruptcies.
John Faulkner: We always do business with them after they file, but we limit the receivable the second time around to only 60 days. If they go beyond 60 days after the bankruptcy, then we are done. The next step after the Chapter 11 is Chapter 7, and you will get nothing if they file Chapter 7. Write off the account as soon as you receive the Chapter 11 notice. Charge back the commission and get your sales tax dollars back. You also reduce your income tax if you write it off when you get the notice. We get less than 10 percent of the total payments on Chapter 11 filings.
Steve Fawcett: All members should beware of “preference laws” that allow the court to try to recover money from suppliers paid within a short number of days before the bankruptcy filing. The idea behind preference laws is that in the last few days, a troubled company might give preferred payment to undeserving vendors. We were asked to give money back after we were paid by a bankrupt company. We were sued and had to hire an attorney to protect us against this preference claim. On another occasion, our company worked with one bankrupt company after they filed for bankruptcy protection. We lost and never recovered the small amount of money that was owed to us before the bankruptcy filing. However, under reorganization the court oversees all bankrupt companies’ financial matters. Your company is probably safer financially dealing with this company going through bankruptcy reorganization than before or after the court steps away. We were paid promptly for the new work, retained the customer who emerged from bankruptcy and made a good profit. Several of our competitors refused to do business with them, but we continue to enjoy a profitable relationship with them even considering the previous money we lost.
Kevin Katona: We will continue to do business with them. New orders would almost always be cash or credit card only. For creditworthiness, we request a signed credit application. Then, we use a regional credit reporting agency to check on most new customers. As a regional distributor, we’ve found our local credit reporting agency to have more complete credit information on our customer base than national agencies do. We get updated reports when existing customers place larger orders.
Scott Lee: In my book, a bad debt customer is a higher financial risk to your company than no customer at all. We put them on a “do not sell” list and make sure everyone in the organization understands why they no longer add value to our business. However, make sure you stay in communication and keep the relationship alive. You may end up working out a cash-only business transaction until their financial condition improves. The best resource to evaluate the financial position of another organization is Dun & Bradstreet.
Mark Milovich: First thing is to complete the necessary paperwork as quickly as possible and return it to the bankruptcy trustee to get in line for what little money you can get from the settlement. Second, doing business with a customer that is in protection is safe because the courts decree that the business must pay its invoices for the products and services it consumes while under protection if they wish to keep the doors open, restructure and eventually come out of bankruptcy. In some instances, the purchases must be pre-approved by the trustee in advance. By continuing to do business with a customer that is under protection, you can gain back some of your lost revenue and the customer may remember your company as one that did not turn its back on them. It may even win you more business in the future once they emerge from bankruptcy. Tighten your terms with them, and ask for payments via credit card to reduce your exposure.