Quick primer on Chapter 11

• By David Snead on November 11, 2008

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A couple of my client’s customers have recently declared Chapter 11 bankruptcy.  This unfortunate turn of events affects not only the party filing for bankruptcy, but also their suppliers.  While bankruptcy law is outside the scope of a blog entry, there are a couple of pointers and lessons for hosting companies whose clients may file for bankruptcy.

The first major lesson is to understand the “automatic stay.”  The automatic stay essentially stops collection of debts that predate the filing of bankruptcy.  This means is that if your customer files for bankruptcy and they have a past due debt that is prior to the date of the filing, you can’t try to collect that debt.  The definition of “trying to collect” is generally quite broad.  So, you cannot turn off their account based on the pre-bankruptcy debt.  This often means that you are required to provide services without getting paid.

This obligation continues as long as the contract is in force.  For example, if you have a year contract and you are in month 6 of the contract when your customer files for bankruptcy, and you received payment in advance for the year, you must continue to provide services to the customer for the final 6 months.  Even if you don’t get paid.  Your obligation continues only as long as the contract is in force.  Once the contract expires, you can generally terminate the contract.

Hosts who feel that their customers are teetering on the edge of bankruptcy, might consider altering the terms of their contract.  For example if a customer begins to fall past due, and you negotiate with the customer about their account, you may want to offer to shorten the term of the contract.  That way, if the customer files Chapter 11 bankruptcy, and owes you money, you are not obligated to provide them with services for such a long period of time.

It is important that you pay attention to notices of bankruptcy you receive.  While it’s unlikely that a bankruptcy court will actually fine you for violation of the automatic stay for a $9.95 hosting account, you will save your company some legal fees if you don’t try to collect a pre-bankruptcy debt from a bankrupt client.  Taking notice also includes ceasing all debt collection efforts, from having your accounts receivable department call the customer, to sending the debt out for collection.

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