Businesses fail on a daily basis, and our economy is set up, at least in principle, to enable new businesses to take their place. This is little comfort, however, to consumers who relied on a failed business for one reason or another. A business “fails” when it can no longer meet its obligations to its customers, creditors, and owners with its available income. This is also known as “insolvency.” The bankruptcy system gives insolvent businesses some options beyond outright failure. In a Chapter 7 bankruptcy, a business liquidates its assets in order to pay as much debt as possible. At the end of the bankruptcy case, the business usually ceases to exist. A Chapter 11 bankruptcy allows a business to reorganize in order to continue operations. The rights of the consumer in these processes depend on numerous circumstances.
When a company files for bankruptcy, its business affairs come under the jurisdiction of a bankruptcy court. The court will usually appoint a trustee to oversee the case. The trustee has authority to manage many of the affairs of the business and, in a Chapter 7 case, dispose of business property.
An important feature of any bankruptcy case is the automatic stay, which takes effect as soon as the case is filed. The automatic stay prevents legal proceedings against the debtor from moving forward without the court’s permission. This includes any action by a consumer under state or federal consumer statutes.
A consumer with a claim against the debtor becomes a creditor in bankruptcy. The debtor business must identify its debts and creditors in schedules attached to its petition. All identified creditors will receive a notice of a creditor meeting from the trustee. This notice may also indicate if assets are expected to be available to pay creditors, and whether creditors should file a “proof of claim.” Even if a business does not identify a consumer in its petition, it is possible to file a notice of claim with the court.
Most bankruptcy cases result in a discharge of any remaining unpaid debts. Unfortunately, consumer claims are usually given low priority for repayment.
A bankrupt business may present other problems for consumers besides unpaid claims or judgments for damages. Businesses often take possession of consumers’ property or enter into agreements with consumers to provide services. How a consumer deals with a bankrupt business depends on the nature of their relationship.
If a Bankrupt Business Has a Consumer’s Property
A consumer may leave his or her property with a business, such as clothes at a dry cleaner, a car at a mechanic shop, or a computer at a repair shop. While large companies often continue business operations during a bankruptcy, smaller companies may shut their doors without advance warning. The bankruptcy system has no specific procedure for retrieving consumers’ property from a closed business. A consumer may have to start making phone calls or sending emails.
The business owner or manager may be able to return the consumer’s property directly. If the business is a franchise of a larger company, the franchisor may be able to obtain the property. The bankruptcy trustee also may have arranged for storage and retrieval of customer property. Local or state law enforcement or consumer protection officials may be able to assist with retrieving property, or in extreme cases, a consumer may be able to file an adversary proceeding in the bankruptcy case to regain possession of his or her property.
If a Bankrupt Business Has a Consumer’s Deposit
Consumers often put down deposits with businesses to reserve a popular product or a rental property. The ability of a consumer to retrieve a deposit from a bankrupt business depends on multiple factors, such as the type of property reserved by the deposit, whether any local or state law applies, and whether the business keeps deposits separate or commingles them with their general funds.
Payment of a deposit creates a contractual obligation on the part of the business, but once a bankruptcy case commences, the consumer may have to join the ranks of creditors. It may be possible for the business to follow through on its obligation, or to refund the deposit. It is also possible, however, that the deposit will become a discharged debt.
Tenants are often required to submit a refundable security deposit during the term of a residential lease. Most states have laws specifically regulating security deposits. Landlords might be required to keep security deposits separate from other funds, to account for any deductions, and to refund them to a tenant within a certain time frame. Security deposits are less likely to be affected by bankruptcy because they remain the property of the tenant at all times, although the automatic stay may affect a tenant’s ability to enforce state law.
If a Bankrupt Business Owes Services to a Consumer
Some businesses offer services to consumers on monthly or other periodic plans. If a business enters bankruptcy during the term of a service contract with a consumer, the automatic stay prevents enforcement of the contract in court, and the obligation becomes subject to the bankruptcy proceeding. The same generally applies to warranty coverage offered by a business.
If a Consumer Has a Gift Card from a Bankrupt Business
Regulations regarding gift cards and gift certificates vary widely among the states. Some businesses have decided to honor their gift cards after filing for bankruptcy, so it is worthwhile for consumers to ask. A gift card represents an obligation of the business, so a consumer can also submit a claim to the bankruptcy court.