Customer Bankruptcies: Ten Tips to Minimize Losses

Strategies to avoid letting a customer’s bankruptcy devastate your finances.

1. Diversify Your Customer Base. You know the old saying: Don’t put all your eggs in one basket. If you’re supplying goods and services to larger businesses, this can be all too easy to forget. By diversifying your customer base, you can help ensure that you won’t be forced to file for bankruptcy because one of your customers does.
2. Get Credit Applications from New Customers. Lending money or extending credit to customers without checking their creditworthiness is asking for trouble, as you run the risk of not getting paid if the customer files for bankruptcy. You can protect yourself from the risk of nonpayment and preserve your ability to challenge fraudulently incurred charges by having a customer give you a detailed, written, and signed credit application. For a sample credit application form, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo).
3. Verify the Customer’s Credit History. After the customer has completed the credit application, verify the information -- or find out the truth -- by obtaining a credit report from one of the three major credit-reporting agencies. You'll need to subscribe to one of their services. The big three are:
   • Equifax, at 888-202-4025 or www.equifax.com
   • Experian, at 888-217-6064 or www.experian.com, and
   • TransUnion, at 312-466-7363 or www.transunion.com.
4. If your customer is a business, credit reports can be obtained from Dun & Bradstreet (888-814-1435). By reviewing the credit reports you receive, you'll be better able to predict how likely the customer is to default on a loan. If the customer ultimately does go bankrupt, you'll be better protected by showing you reasonably relied on a positive credit report.

1. Require a Cosigner or Guarantor. You need not rely on just one person to pay a debt. If the credit application is from an individual, you can ask that someone else cosign for the debt. If the credit application is from a business, see if one of the principals will guarantee the debt. By requiring a cosigner or guarantor, you will be more likely to receive the money you are owed if the person you provided credit to files for bankruptcy.
2. Obtain Collateral. You can look to the debtor’s property for payment by asking the customer to give you a security interest. A security interest allows you to sell the property that is collateral for the loan in order to collect your claim if the debtor doesn’t fully repay you. Although the customer's bankruptcy will hamper your ability to sell the collateral, you'll be in a much better position than the "unsecured" creditors (who have no collateral).
3. Cash All Checks Promptly. Don’t let checks sit around your office. You may think you’ve been paid as soon as the check arrives, but the law says the money isn’t yours until the debtor’s bank honors the check. If the debtor is sliding toward bankruptcy -- a fact you may not know until it’s too late -- you’re better off getting that check through the system as soon as possible.
4. Ask Customers to Pay by Cashier’s Check or Money Order. If you’ve got reason to worry about a particular customer's financial situation, don't accept a personal check. Cashier's checks and money orders are legally considered equal to cash, so the transfer occurs as soon as they're given to you.
5. Periodically Review Long-Term Customers' Creditworthiness. A customer who three years ago passed your credit application with flying colors may be in very different straits today. Depending on how well you know your customers, ask for updated credit information before extending new credit.
6. Look for the Telltale Signs. A business customer who is at risk of filing for bankruptcy may exhibit warning signs, which you can catch if your radar is up. Start asking questions if you notice your customer’s:
   • pattern of late payments
   • selling off of assets
   • changes in company personnel
   • changes in payment practices
   • changes in buying patterns, or
   • doing business in an industry or region that’s undergoing economic decline.
7. Know When to Sue. If a customer has a delinquent account, don’t let a mere threat of bankruptcy stop you from suing. The worst that’s going to happen is that the customer will file for bankruptcy before you receive a judgment, in which case the automatic stay will simply stop matters in their tracks. The best that could happen is that you’ll get a judgment and get paid by enforcing it against the debtor’s income or property. The upside clearly outweighs the downside.

by Attorney Stephen R. Elias