The Disadvantages of Selling to a Debtor in Possession

It has become relatively common for companies that file voluntarily for Chapter 11 bankruptcy to ask creditors to sell the debtor company (the Debtor in Possession) on open account terms. There are advantages as well as risks of doing so. The advantages include the ability to recoup some of the losses incurred when the debtor filed for bankruptcy by generating additional sales and additional profits from the bankrupt account.

A serious risk associated with selling to any bankrupt company involves the possibility that the customer's business will fail while the customer is still in bankruptcy. If the creditor company extends open account credit to a customer in bankruptcy, and assuming that customer cannot navigate its way through and out of bankruptcy, that creditor may incur a bad debt loss involving (a) its pre-petition balance and (b) the post petition balance owed. One sobering statistic is that less than 50% of companies that enter Chapter 11 bankruptcy successfully emerge with a confirmed Plan of Reorganization.

One final thought: A significant problem associated with selling on open account terms to a debtor in possession is the possibility that the company may fail and the credit manager will have to explain how it is that the company has an another bad debt loss to the same customer.

Edited by Michael C. Dennis, author of "Credit and Collection Handbook" and "The Credit and Collection Manager's Manual."