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Work Advice: When a business you've been doing contract work for files for bankruptcy

Q: I am a contractor for a company. After completing my last project, instead of a paycheck, I received an email informing me that the company was closed and filing for bankruptcy and that "someone" would be contacting those of us who still need to be paid.

A week later, I emailed the head of the company, my only contact there. I said I planned to file a claim in small claims court but would rather go through mediation to save us both time and money. He said he would do whatever he could, even if it meant paying me out of his own pocket, but a month has passed, and I still do not have a paycheck.

I have excellent records to cover the burden of proof, but my understanding is that if the company has filed for bankruptcy, it may not have to pay up even if I sue and win.

Is there any other recourse, or do I simply have to take the loss? (Lesson learned: If you sense the ship is faltering, abandon it while you can!)

A: I don't know what foresight could have helped you avoid this. If there's one thing we've learned in the last decade, it's that any ship can founder.

I turned to Nora Raum -- who in addition to having practiced bankruptcy law since 1986 is a part-time newscaster at National Public Radio_ for a rundown on the process. Spoiler alert: Your outlook isn't great.

When a company files for bankruptcy protection, all other claims and collection actions stop. If the company hasn't filed yet, you can go ahead and sue in small claims court, but be prepared to withdraw the suit if you receive "an official notice" -- not an email -- "prepared by the bankruptcy court," Raum says.

If the company closes and then files for bankruptcy protection, all its assets will be sold in a Chapter 7 liquidation. Any proceeds from the sale of the assets will be used to pay off creditors according to priority. Unpaid employees are among the first in line; independent contractors, however, have to meet specific criteria to be considered priority creditors.

I'm sure the owner had the best of intentions when he promised to pay you -- but I wouldn't camp out by the mailbox. If he pays you within 90 days before closing and filing for bankruptcy, you could be asked to return the money to be split with the other creditors. Once bankruptcy proceedings begin, he has less incentive to pay you himself, and you're prohibited from pressuring him to do so.

To recap: If the company has filed for bankruptcy, and if it has assets to sell, and if any assets remain when your number is called . . . well, while you're waiting, you might as well ask your accountant about the possibility of deducting your loss on next year's tax return.

Raum's entire response is below:

I'm going to assume the company is incorporated, so the owners aren't personally liable.

If the company really did file bankruptcy, you wouldn't be notified by email. You'd receive an official notice prepared by the U.S. Bankruptcy Court and delivered by the U.S. Postal Service. If that hasn't happened yet, you can go ahead and sue in state court. But if the company does file a bankruptcy, then all lawsuits stop and the matter is under the jurisdiction of the bankruptcy court.

If the company is now closed, it would file a Chapter 7 bankruptcy, which is the liquidation kind. The trustee sells all the assets of the company and pays off the creditors as long as the money holds out. Creditors would be instructed to file a proof of claim, showing what is owed.

Some creditors get priority, including employees who are owed wages from the six months before the company shut down, up to $12,475 per person. But it sounds as if you were an independent contractor so this probably wouldn't help you. And of course, all this depends on whether the company has assets that can be sold.

And I have one more discouraging thought: If the owner does pay you out of his own pocket and then files bankruptcy for the company, the trustee could ask you to give it back to be shared with the rest of the creditors. In business cases such as this one, this applies to payments of $6,225 in the 90 days before the company shut down. (I'm assuming your claim is less than that, since you're considering small claims court.)

So you are free to sue now, but be prepared to withdraw the suit if you receive an official notice from the bankruptcy court. Then wait to see if you get another notice from the court, telling you to file a proof of claim. If you don't get one, that means the company has no assets, and you are out of luck. If you do receive that notice, file a proof of claim and hope there are enough assets that you end up with something.

• Miller has written for and edited tax publications for 16 years, most recently for the accounting firm KPMG's Washington National Tax office. You can find her on Twitter, @KarlaAtWork.

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