Trade Creditors’ Behavior in Bankruptcy

In bankruptcy, there is an active market within the claims against distressed firms. In this study, we use information on complete capital structure as well as claims transfers filed under the Rule 3001(e) of the Federal Rules of Bankruptcy Procedure for 132 U.S. Chapter 11 bankruptcy cases filed between 1998 and 2009. Contrary to the existing evidence on use of trade credit, we show that suppliers that extend significant amounts of trade credit (measured with respect to their own capacity) hold private information about borrowers. Specifically, we show that private and smaller firms are more likely to rely on trade credit as a source of financing. For these informed suppliers, the decision to sell receivables of a distressed company in bankruptcy is predictive of lower recovery rates; moreover, they sell ahead of less informed suppliers and other creditors. This result is especially pronounced for cases where the distressed firm relied most heavily on trade credit as their source of financing as compared to bank debt, or other forms of debt more broadly.