Cash flow – the money coming in via accounts receivable and going out via accounts payable – is the lifeblood of your business. Whenever you consider extending credit to a client, you take a risk that the client will not pay and your cash flow will be interrupted. Key customers that struggle financially or who declare bankruptcy put your business at risk of being unable to manage financial obligations. A good business risk management plan should include ways to limit your business’s exposure to a company that has gone into administration or bankruptcy and owes you money.
Different Types of Bankruptcy
Bankruptcy is a formal process that gives a business the opportunity to reorganize and pause payments on debts while doing so or before going out of business. There are several different types of business bankruptcy:
- Administration – A company can try to preserve its business venture by choosing administration rather than liquidation bankruptcy. During administration, an appointed administrator decides how to turn the business around in order to pay its debts and avoid insolvency. The administrator may determine to sell the company or explore funding options that can keep the company operating.
- Chapter 7 bankruptcy – Under Chapter 7 bankruptcy, a business determines that its debts are so overwhelming that there is no option other than to close the business. A court-appointed trustee becomes responsible for selling company assets, the proceeds of which are used to pay off the company’s debts.
- Chapter 11 bankruptcy – Under Chapter 11 bankruptcy, a company can reorganize and create a plan to repay creditors over time. Creditors get an opportunity to vote on that plan. The company can continue to operate, but financial decisions (like paying off creditors) must be approved by a bankruptcy court.
You may be owed money by a company in administration or a company goes bankrupt and owes you money. In both types of bankruptcy, claims are paid in a specific order. Secured claims, like those made by mortgage holders, are paid before unsecured claims, like those made by businesses that provided products or services. If you get any money at all, it will likely be much less than the actual debt owed to you.
What Type of Creditor Are You?
If a business goes bankrupt and owes you money, your debt is listed with all other debts according to a specific scale. That scale determines the order in which debts are to be paid. Typically, bankruptcy debt is determined to be preferential, secured or unsecured, in that priority order.
- Preferential or preferred creditors can include employees of the company who are owed wages as well as tax authorities.
- Secured creditors are those that have liens on the debtor’s property (such as a financial institution that has loaned money for the company to purchase a building or vehicles).
- Unsecured creditors are those that provided the company goods or services, such as suppliers and contractors.