The Bankruptcy Myth of Guaranteed Payments – Michael Dennis, CBF

Seal of the United States bankruptcy court. Ch...
Bankruptcy Court Seal

Years ago, one of my customers filed for Chapter 11 bankruptcy.  Almost immediately after we received notice of the bankruptcy filing, I received a call from the debtor company asking for open account terms.  The debtor told me their bankruptcy attorney assured them they would have no trouble getting product on open account terms following a bankruptcy filing.

Being young and a lot less mature than I am today, I told them that since I was not about to extend credit to a bankrupt customer, perhaps they should try to purchase our products on open account terms from their attorney since she or he promised them open terms.  I know that this comment was neither witty nor funny, but back then I thought of bankruptcies as a personal failure rather than as a cost of doing business.

Flash forward a decade or so.  Another customer files for bankruptcy protection. They call to request open account terms. This time, the reason I was told I should extend credit is that payments to post petition creditors are “guaranteed.”   At this point, I have two options.  The first is that I can tell the debtor they are wrong.  The second is to ask them to explain about guaranteed payments.   I selected the second option.

I said I was not familiar with the “guaranteed payment process” they referred to, and asked for them to explain how this works.   I got the answer I expected.  The customer told me that the bankruptcy code guarantees payment to creditors that extend credit to customers in Chapter 11 bankruptcy.

This is a common myth or misconception.  Put bluntly, it is not true.  A guarantee is made by a guarantor.  For example, a bank can be a guarantor.  Another company could be a guarantor.  Even an individual might be a guarantor… but the United States Bankruptcy Code is not, does not and cannot guarantee payment to creditors that decide to extend credit to a bankrupt customer.

Incorrect interpretation of the bankruptcy code can lead customers to make requests for open account credit terms following the bankruptcy filing. Lawyers representing bankrupt clients sometimes compound the problem by not clearly explaining the challenges that these companies may face in rebuilding open account relationships with suppliers.

Michael Dennis, CBF

How should you deal with the next request to sell on open account terms to a customer in bankruptcy?  I suggest that whatever decision you make, it cannot be made based on any representation that payment is guaranteed.  Remember that only about 50% of companies that enter Chapter 11 bankruptcy emerge successfully from bankruptcy protection.  The rest fail and the assets are liquidated.  This liquidation is done for the benefit of creditors, but this process does not guarantee payment in full to any post petition creditor.  Whatever your decision is, make sure it is done after considering all the facts and with full understanding of the risk inherent in selling on open account terms to a customer in bankruptcy.

Michael Dennis’ Covering Credit Commentary. Michael’s website is  www.coveringcredit.com

The opinions presented are those of the author.  The opinions and recommendations do not necessarily reflect the views of CMA, or their Officers and Directors.  Readers are encouraged to evaluate any suggestions or recommendations made, and accept and adopt only those concepts that make sense to them.

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5 Replies to “The Bankruptcy Myth of Guaranteed Payments – Michael Dennis, CBF”

  1. Your blog will be very helpful to those new to the credit decision making process. Thank you.
    I have been a credit professional for 17 years, I can vouch that only one of my accounts which have filed for Chapter 11 stayed there and were successful (so far) at reorganizing. All other accounts which filed BK no longer exist and filed Chapter 7 soon after with no assets. Be careful and choose your decision wisely post BK.
    We have only moved forward as cash in advance on all Chapter 11 when we have chose to continue our relationship.

  2. At least 1 vendor found out the hard way that even post-petition payments must be approval by the court & lender first (funds were dispersed too early and had to be given back).

    I would be delighted to settle for a 50% successful reorganization rate again. In the last 15 yrs, we’ve only had 1 account that went Chapter 11 who successfully reorganized, majority liquidate within 12 months. There are limited circumstance where we would try open terms again. I wouldn’t rely on “guarantees” but I understand the attorney tries to give their client hope/encouragment in difficult times and some vendors will take a chance or comply.

  3. Thank you for your comments.

    I will check to see if my 50% success rate on Chapter 11 Bankruptcies is still accurate.

    Michael Dennis

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