Know The Law: Customer Filing for Bankruptcy in the Near Future

May 1, 2012

Published in Union Leader

Q. My company sells products to a customer, which may file for bankruptcy in the near future. Despite this risk, I would like to continue to do business with the customer. What can I do to protect my company’s interest and claims before this customer files for bankruptcy?

A. Several measures may be available, and depending on the nature of your company’s business or dealings with the customer, some may be preferable over others.

Purchase Money Security Interest. To start, your company may obtain a purchase money security interest in the goods sold to the customer on credit. This security interest — if protected by executing a security agreement, filing the appropriate UCC-1 financing statement, and giving proper notice — would give your company a priority position over other secured creditors with respect to the goods as well as added protections in the bankruptcy case.

Where obtaining a security interest is not practicable, other actions may be taken to reduce the risks a bankruptcy presents.

Preference Defenses. A preference action is a lawsuit that the customer or bankruptcy trustee may bring against your company to recover payments the customer made during the 90 days prior to the bankruptcy filing. The best defense is to insist on COD (cash on delivery) terms, which provides the obvious benefit of receiving immediate payment and an absolute defense against preference actions. If dealing with the customer on credit terms, making proper arrangements to ensure that the amount, manner, and timing of the customer’s payment during this 90-day period is consistent with the customer’s prior practice, could also provide a defense. Additionally, your company may demand third party payment and/or guaranty, which would not be subject to preference actions so long as the third party is not in bankruptcy.

Reclamation. In limited circumstances, your company may reclaim delivered goods by making proper written demand within 10 days after the customer’s receipt. Similar rights are also available after the customer files for bankruptcy under specific conditions. These reclamation rights are, however, subordinate to subsequent buyers and senior liens.

Proof of Claim. Finally, your company should consider filing a claim in the bankruptcy case and maintain relevant records. In particular, if your company did not reclaim any goods, it may be entitled to a priority claim for goods the customer received within 20 days before the bankruptcy filing.

Although not bankruptcy-proof, these measures may help minimize your company’s losses in dealing with a troubled but worthwhile customer.

Jinjue Pak can be reached at

Know the Law is a bi-weekly column sponsored by The McLane Law Firm.
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