Vulture Capital You can't beat the big creditors to the bones of a bankrupt client, so what do you do?

Before September 11, Le Gourmet Gift Basket Inc. was growing at a healthyclip. But in the months that followed the attacks, with steep dropsin the stock market and mounting layoffs, many of its would-becustomers began welshing on their contracts and bouncing checks.Five of them went bankrupt in a 10-month period. "I'venever seen anything like it," says Cynthia McKay, 47,president and CEO of the Denver-based franchise.

McKay stood in line with the other creditors but was mostlyunsuccessful in her efforts to recoup her investments. Althoughthere might be some indication of a problem beforehand, she says,often "you don't know 'til you get that littlepostcard [from bankruptcy court]."

Thanks to the continuing dismal economic climate, bankruptcyannouncements have been darkening the mailboxes of more and moreentrepreneurs. So what do you do if you find one in yours? Afterreading the carefully underlined dates and deadlines for claimsfilings, consult a bankruptcy attorney. One of the many ways alawyer can help is advising whether you should continue supplyingthe customer. If losing the account could bankrupt you, it mightnot be a bad idea to continue, at least temporarily, says HowardEhrenberg, a bankruptcy specialist and partner with Sulmeyer,Kupetz, Baumann & Rothman, based in Los Angeles. "Thebankruptcy code protects vendors who continue to provide goods andservices after the bankruptcy is filed by giving them the highestpriority," says Ehrenberg.

Ehrenberg also advises participating in the unsecuredcreditors' committee, which is usually formed after a companyfiles for bankruptcy. It won't put you ahead of other unsecuredcreditors, but the committee has the inside track on thecompany's financial status and is empowered to appoint atrustee if current management is deemed wrong for the job."The committee helps ensure that the unsecured creditors aretreated fairly," says Ehrenberg. "Without a voice, thedebtor will not likely be able to negotiate a betterresult."

Business owners like McKay have found that smaller shops getshort shrift when looking to recoup debt. When she learned recentlythat one of her customers, a large investment company, was not onlybankrupt but also facing criminal charges, she realized shewasn't getting paid. "If it's a few thousand comparedto $20 million, I'm irrelevant," she says. "But thatfew thousand dollars is a weekly payroll for an employee, orseveral."

An ounce of prevention is still the best cure. Experts agreethat the most important precaution is making sure that you'readequately diversified. If you place all or even most of your eggsin one customer's basket, your business is at a tremendousrisk, particularly if you've made decisions based on thatcustomer being there. "If you added a second shift or boughtadditional equipment to meet their needs, you could really be in avery difficult position," says Bruce Kemelgor, professor ofentrepreneurship and management and director of the Small BusinessInstitute at the University of Louisville in Kentucky.

Be sure to heed the warning signs. Obvious clues are customerstaking longer to pay or not returning phone calls, says EvaRosenberg, CPA and publisher of Taxmama.com, a Web site providingfree tax information to individuals and small-business owners."And their order pattern will change. They're eitherordering a lot more because they know you're not going to givethem credit shortly or a lot less because they're going out ofbusiness."

Of course, the easiest way to eliminate risk is to stopextending credit. Although McKay hasn't stopped extendingcredit on the retail side for fear of alienating customers andlosing them to bigger players, she has changed policies on thefranchising side, cutting out freebies, encouraging payment upfrontand imposing a finance charge if franchisees finance. Surprisingly,she says, business is up about 17 percent since the changes startedlast December. "I'm not sure why," she says."Maybe psychologically, if people feel they're beingevaluated in more distinctive terms, maybe they feel it's moreof a value for them."

C.J. Prince is executive editor of CEO Magazine. Shecan be reached at cjprince@chiefexecutive.net.