How to Deal with Bankruptcies

A supplier's bankruptcy can have significant impacts on your job. Here's why.

Editor's note: Bankruptcy. Leveraged buyout. Due diligence. ROI. These terms aren't usually part of a technical education, but they can have a major effect on your IT operation … and your career. That's why we're introducing James E. Powell's Business Basics column. In the coming months James will define common business concepts to help you understand how they may affect your department, division or company.

We're all familiar with the "Going out of Business" signs plastered on storefront windows or missing Web pages reflecting the dot-bomb fallout. No matter what the reason—from dwindling sales to mismanagement—bankruptcy is often declared when a company experiences continued operating losses or can't pay its bills.

A bankruptcy doesn't occur in a vacuum, and there are distinct and important impacts a supplier's or service provider's misfortune can have on your business, whether you buy or sell IT products or services. This month I'll focus on the two types of business bankruptcies and explain the differences.

Bankruptcy types are named for the chapter within U.S. Code Title 11 that applies to them. Chapter 7 bankruptcies are a common method companies use to completely close up shop—cease operations, liquidate assets and pay off creditors. Another type of bankruptcy, called Chapter 11 bankruptcy, allows a firm to continue operations while it figures out how to meet its obligations and get back on its financial feet. A company using this type of bankruptcy is commonly known as having filed for reorganization protection.

Understanding the difference between these two bankruptcy types is critical for the operation of your business. Chapter 7 leaves you in the lurch, while Chapter 11 gives you some wiggle room.

Chapter 7: End of the Line
If you buy from a supplier filing for Chapter 7, the impact to your budget, service level agreements, and implementation schedules can be sudden and painful. Services you contract for may stop without warning, a potential disaster if, for example, you're buying telecommunication services. Outstanding equipment orders won't be filled. Down payments may be lost. That multi-year contract you had? It's history. And, in a best-case scenario, money owed to you might be paid back, but only pennies on the dollar.

The bottom line: You'll have to act fast to find alternative suppliers and sign new contracts. You may also need time to reassure your users that your department or company is doing everything possible to minimize the impact of a supplier's demise.

Bankruptcy By The Numbers

Chapter 7: For company liquidations, or personal bankruptcies for individuals unable to repay all debts.

Chapter 9: Filed by municipalities.

Chapter 11: Used by businesses wishing to maintain operations while a repayment plan is developed and executed.

Chapter 12: For family farmers.

Chapter 13: For individuals who need additional time to repay debts, plus sole proprietors (such as single, self-employed consultants).


Chapter 11: The Buyer's Perspective
When declaring a Chapter 11 bankruptcy, a company files a petition with the U.S. Bankruptcy Court and, according to code, has 120 days to pull together a plan to pay its debts. This buys the company, and you, time for contingency planning.

If you're buying from a company that has declared Chapter 11, business may be conducted with few, if any, noticeable changes. However, Chapter 11 casts a shadow over the company and its employees, often affecting your relationship with the supplier. A company developing a reorganization plan may be distracted from everyday business operations. One thing's for sure: expect delays. Ordered parts may take longer to arrive because your supplier cuts inventory to conserve cash. Increased employee turnover or cuts in customer service may impact the quality of support you receive (your wait in a telephone queue may grow) or the continuity of your buying process (because the sales rep you always deal with has taken a job elsewhere).

Information may be hard to come by: Customer service representatives may have no more knowledge about the company's continued operations than "the company line"—the company is continuing normal operations. It will be anything but normal.

If you have arranged financing from a company in Chapter 11, expect changes to the terms in future purchases. Deposits or down payments may be higher, and lease or pay-off periods shorter—assuming your supplier can still provide financing.

Chapter 11: The Seller's Perspective
If you've sold services to a company in Chapter 11, expect your cash flow to be seriously affected. Once filed, all claims (both legal and financial) against the company declaring Chapter 11 are put on hold (one reason Chapter 11 is aptly called bankruptcy "protection"). Pacific Gas and Electric, the Northern and Central California utility, filed for Chapter 11 bankruptcy in late September, 2001.

While it expects to pay all claimants the full amount owed, plus interest, the payment schedule may cause problems with your cash flow (see "PG&E: A Case in Point"). Furthermore, you may not receive all you're due. First to be paid: Federal, state, and local taxes, including all penalties and interest. Those with "secured" interests (companies holding a mortgage on a company's building, for example), come next, and so on down the line.

Complicating full payment are the additional fees companies incur during Chapter 11—most notably legal costs—adding yet another claim on the company's assets.

That's not the only impact to your bottom line. Your buyer may expect you to continue to ship products or provide services during their bankruptcy period, putting additional strain on your cash flow.

PG&E: A Case in Point

According to PG&E's Chapter 11 reorganization plan:

  • Claimants will be paid the full amount owed, plus interest.
  • Payments won't begin until the end of this year, a full 15 months after many invoices were originally submitted.
  • The repayment plan will allow it to pay in cash any creditor owed up to $100,000.
  • Companies owed more than $100,000 can expect 60 percent in cash and 40 percent in notes (corporate I.O.U.s).


Protecting Yourself
Chapter 7 is the end of the line for a company. But Chapter 11 is no guarantee the reorganization will be successful. Late last year Egghead Discount Software said its Chapter 11 reorganization had failed and it suspended all remaining operations.

It's always wise to have a backup plan. Up-front contingency planning, especially in tough and uncertain economic times as these, will help protect your operations.

For some added protection, be on the lookout for slipped shipping dates and unfavorable changes to purchase or lease terms. Your accountant can be your best friend in spotting signs of financial difficulties, such as spotting bills that remain unpaid for longer periods (called aging), a sign your supplier may possibly be in trouble.

Monitor business publications for rumblings of financial distress, online sites devoted to bankruptcy filings (e.g., Should a company file Chapter 11, they must file monthly updates to their plan. Be sure you stay abreast of this information.