Your Customer Filed Chapter 7 Bankruptcy. Now What?

Getting a Chapter 7 bankruptcy notice usually means you aren't going to collect what you're owed. But “usually” isn't “always,” and there are a few things creditors should do—and a few things they absolutely should not do—once a bankruptcy is filed. 

Here’s a practical checklist. 

1. Stop collecting 

First things first: stop collection efforts. 

A bankruptcy filing creates an automatic stay, which generally stops calls, collection letters, lawsuits, repossessions, and garnishments. If you already have a lawsuit or garnishment underway, put it on hold. 

And be careful about less obvious collection activity. Don’t file a new lien, repossess collateral, shut off access to property you are holding, apply money you owe the debtor against the debt, or threaten to take any of those steps. If you have a check from the debtor that has not yet cleared, or you are holding the debtor’s property or funds, get advice before doing anything with them. 

Once you know about the bankruptcy, continuing to collect can create problems of your own, including liability for damages and attorney fees. 

2. Decide whether you want to keep doing business with the customer 

For most private businesses, bankruptcy doesn't require you to keep doing business with someone who hasn't paid you, although you can choose to. Be careful about making future business conditional on payment of a discharged debt. The safer route is a reaffirmation agreement, negotiated through the debtor's attorney before the discharge. A reaffirmation makes the debt enforceable after bankruptcy, but strict rules apply, the debtor can change their mind for a period after signing, and many bankruptcy attorneys won't recommend reaffirming unsecured debt. If your debt is secured, a reaffirmation is more likely, especially if the debtor wants to keep the collateral. 

3. Ask whether your debt might survive bankruptcy 

Bankruptcy wipes out most debts, but not all of them. Debts that came from dishonest or harmful conduct can survive. For a business, the most common examples are when the customer: 

• lied to get credit from you, such as by giving you false financial information on a credit application 

• stole money or property from you 

• deliberately damaged your property or business 

• ran up large luxury purchases on credit right before filing 

But these debts don't survive automatically. You have to file a lawsuit in the bankruptcy court within 60 days after the date first set for the meeting of creditors, which is listed on the bankruptcy notice you received. The deadline doesn't move even if the meeting is rescheduled. Miss it, and the debt is wiped out even if the customer committed fraud. If any of this sounds familiar, call a lawyer right away. 

If the customer is a corporation or LLC, it doesn't get a discharge at all, so technically the debt survives. In practice, though, there's usually nothing left to collect once the trustee sells off the business's assets.  

4. Be ready to file a proof of claim 

Most Chapter 7 cases start as "no asset" cases, and the first notice will tell creditors not to file claims yet. If the trustee later finds money to distribute, you'll get a second notice with a deadline. Don't miss it. Late claims are paid only after timely ones, which usually means they get nothing. 

A proof of claim is filed on a standard court form (Official Form 410), and most courts let you file it online. You don't need a lawyer to file one. Have these ready: 

• The amount owed on the date the bankruptcy was filed. Don't add interest or fees that accrued after that date. 

• A copy of the contract, credit application, invoices, or other documents the debt is based on. 

• If the amount includes interest, late fees, or other charges, an itemized breakdown showing the principal and each charge. 

• If the debt is secured, proof that your lien was perfected, such as the recorded deed of trust, the filed UCC financing statement, or the vehicle title. 

Before filing, black out sensitive information. Show only the last four digits of account and Social Security numbers, only the year of any birth date, and only the initials of any minor. The form is signed under penalty of perjury, so make sure the numbers are right. 

5. If you have collateral, check your lien 

If the debt is secured, confirm that your lien was properly perfected—a recorded deed of trust, filed UCC financing statement, lien noted on a vehicle title, or whatever applies to the property involved. An unperfected lien may be vulnerable to the bankruptcy trustee, and you generally can't fix the problem now: recording or filing after the bankruptcy usually violates the automatic stay. A lien perfected late, but shortly before the bankruptcy, can also be at risk. 

If you want to repossess or foreclose while the bankruptcy is still pending, you will generally need bankruptcy court permission through a motion for relief from the automatic stay. 

6. Review payments you received shortly before bankruptcy 

Unfortunately, bankruptcy can sometimes turn a creditor who got paid into a creditor who gets asked to give the money back. 

The trustee may try to recover certain payments made during the 90 days before bankruptcy as preferences. There are important defenses, including ordinary-course payments, contemporaneous exchanges, and new value provided after payment. 

So if you receive a preference demand, don't automatically write a check. Have an attorney review it first. 

7. Don't forget the other options 

A few other things are easy to overlook: 

• Guarantors and co-signers: Chapter 7 usually protects the debtor—not other people who guaranteed the debt. 

• The meeting of creditors: Creditors can attend and ask questions. If you know about hidden assets or suspicious transfers, tell the trustee. 

• Credit reporting: Once the debt is discharged, it should be reported as discharged rather than simply delinquent or unpaid. 

Bankruptcy moves quickly, and some creditor deadlines are unforgiving. If a significant amount of money is involved—or you suspect fraud, hidden assets, or problems with collateral—it is worth getting legal advice early rather than discovering later that a deadline has already passed.