Legal

What happens to you if you're owed money? What if they file for bankruptcy? What legal protections do you have and what action must you take? Find out what steps to take and how to avoid problems.

Some companies are closing their doors, some consumers are filing for bankruptcy protection, and many small businesses that sell on credit are concerned about receiving payment---for good reason.

Understanding bankruptcy
If a company or person files for bankruptcy protection, most unsecured creditors stand at the back of the line; they're lucky to receive pennies on the dollar. Some creditors may gain special status in a bankruptcy proceeding and will ultimately recover more than other unsecured creditors. For example, if you can qualify as a "critical vendor" who continues to supply goods to a company that has filed for a reorganization under bankruptcy protection, you gain a better spot in line for collection. You can't do this simply by having the company dub you a "critical vendor;" you need to have an attorney file a motion with the bankruptcy court.

Returning payments. A bankruptcy court may send vendors of a company that has filed for bankruptcy a letter asking that the company return payments received within 90 days of the bankruptcy filing. This is referred to as a "preference" and a "claw back." The trustee in bankruptcy has the right to undo certain transactions or payments and then use this money to make equitable payments to all creditors, not just you. If you don't respond to the trustee's demand letter, you can be sued and you could lose if the trustee can show that the company was insolvent at the time it made the payment to you (there are certain defenses to be raised in this situation that can save you).

Filing claims for unpaid invoices. If a customer has not yet paid you for goods or services you've delivered, you can file a claim with the bankruptcy court. Whether and how much you collect remains to be seen.

Work with an attorney. The bankruptcy rules are complex and you should work with a knowledgeable attorney to protect your interests. In the very least, discuss the matter with an attorney so you can make an informed business decision on how to proceed.

Workouts
If you're approached by a company or consumer who asks that you reduce the outstanding balance owed or wait longer for payment, what should you do? It depends. If you know your customer well, you stand a better chance of making the right decision. It may make sense to accept less than what you're owed; this may be more than you'd receive if you (and the customer's other creditors) force the customer into bankruptcy.

Writing off uncollected receivables
If you are on the accrual method for tax accounting purposes, you can deduct any uncollected receivable when you can establish that it is in fact uncollectible. The write-off serves as an offset to the income you've already accrued.

If you are on the cash method of accounting, no deduction is allowed. If you furnished services, you are simply out your time and effort. For materials you may have used in the job, the deduction for them has already been taken as material or supplies.

Avoiding problems in the future
Don't sell on credit but instead get paid up front. Require payment upfront or COD (cash on delivery). If, for example, you sell B2C, use credit cards, debit cards, and/or PayPal to collect payment when goods and services are sold.

If you must extend credit (for example, it is customary in your industry or for the nature of your work), be sure to collect payment in stages as work is completed. For example, if you do a web design, obtain a down payment (a retainer) and then break the job into targets that you can bill for once you've met the targets.