Client Advisory from the Creditors' Rights and Bankruptcy Group
December 2008
YOUR CUSTOMER HAS FILED FOR BANKRUPTCY:
WHAT SHOULD YOU DO?
Nearly 29,000 companies filed for bankruptcy relief in the first half of 2008, a 45 percent increase over the number of filings during the first half of 2007. This means it is increasingly likely that some morning you will wake up to learn that an important customer has just filed a petition for relief under chapter 11 of the Bankruptcy Code. Maybe the customer owes you a substantial amount of money or has just placed a substantial order or perhaps you recently sent the customer a large shipment. What should you do to protect your business? STOP ALL EFFORTS TO COLLECT MONEY THE DEBTOR OWES YOU. Under the Bankruptcy Code, the commencement of a bankruptcy case triggers an automatic stay of all pending or potential actions to collect pre-petition claims against the debtor. This means that you cannot initiate or continue any collection efforts against the debtor or the debtor's property to collect monies owed before the date on which the debtor filed a petition for relief. If you continue to pursue collection efforts after the automatic stay has become effective, the BANKRUPTCY COURT may impose sanctions against you. If the court determines that you "willfully" violated the automatic stay, you may have to pay damages, attorney's fees and punitive damages. HOW TO PROTECT YOUR BUSINESS Notwithstanding the automatic stay, you can take certain steps to protect your business if a customer files for bankruptcy. You can: Stop the Shipment of Goods in Transit Under applicable non-bankruptcy law, a supplier has the right to stop the shipment of goods if, before the goods are delivered, it discovers that its customer is insolvent (Uniform Commercial Code § 2-702(1)). Accordingly, if you are a supplier, you should determine the status of any shipments of goods to the debtor and, if possible, stop delivery of such shipments. Make Your Demand To Reclaim Goods in a Timely Manner Generally, applicable non-bankruptcy law gives a supplier the right to reclaim goods that an insolvent buyer has received where: (1) the buyer has received the goods; (2) the goods were sold to the buyer in the ordinary course of business; (3) the buyer had possession of the goods at the time of the demand; and (4) the buyer was insolvent when it received the goods. (Uniform Commercial Code § 2-702(2)). You will not be violating the automatic stay on debt collection if you make a reclamation demand. Section 546(c) of the Bankruptcy Code expressly allows a seller of goods to reclaim goods under certain limitations. Outside of bankruptcy, a reclamation demand applies only to goods the buyer receives within ten days of the date the reclamation demand is made. Under section 546(c) of the Bankruptcy Code, however, a seller may seek the return of goods received by the debtor within 45 days before the debtor's bankruptcy case begins. To do so, the seller must assert a written reclamation demand no later than 45 days from the time the debtor receives the goods or no later than 20 days after the bankruptcy case begins if the 45-day period expires after the bankruptcy case begins. This written demand must specifically state that it is asserting the "right of reclamation" under 11 U.S.C. § 546(c) and applicable state law and be sufficiently detailed to permit the debtor to identify the goods being reclaimed, i.e., delivery dates, invoice dates and invoice numbers should be specified and copies of the invoices attached. Additionally, in order for your reclamation demand to be valid, you will have to demonstrate that the debtor was in possession of the goods at the time you made the reclamation demand. Because the validity of a supplier's reclamation demand is typically addressed long after the demand is made, you should try to confirm the amount of the goods in a debtor's possession as of the date of the bankruptcy either by a prompt, on-site inspection of the debtor's facilities or a written acknowledgment by the debtor. As long as you make the reclamation demand in a commercially reasonable manner, it is effective when you dispatch it. To avoid any disputes over the date of the demand, send the reclamation notice to the debtor by facsimile and also by overnight delivery or certified mail. If you are a supplier who asserts your right to reclamation in a timely fashion, you generally are entitled to recover possession of the goods. Unfortunately for you, when the buyer of the goods is in bankruptcy, this rarely happens. Because the goods at issue are frequently critical to the post-petition business operations of a debtor, the bankruptcy court will usually award you an administrative priority claim or a replacement lien on other assets of the debtor instead of ordering a return of the goods. Your reclamation rights are, however, subject to the rights and interests of third parties. Thus, if there is a secured creditor with a security interest in the buyer's inventory, your reclamation claim may be denied in whole or in part. Finally, even if you fail to make a reclamation demand, section 503(b)(9) of the Bankruptcy Code gives you administrative expense priority to the extent of the value of any goods the debtor receives within 20 days before the debtor's bankruptcy case begins, assuming you sold the goods to the debtor in the ordinary course of business. Such priority is not granted automatically, but requires the filing of an administrative expense claim with the BANKRUPTCY COURT. Carefully monitor notices from the BANKRUPTCY COURT so that you do not miss any deadline that may be established for the filing of section 503(b)(9) administrative expense claims. Ship on COD or Cash in Advance Terms If you are a supplier selling to a customer on open account, you do not have to continue providing credit to the customer after the customer's bankruptcy case has begun. Assuming you have no ongoing supply contract with the debtor, you can refuse to do any further business with the debtor or you can change the terms of your business dealings with the debtor. Thus, if you are selling on open account, you can demand that the debtor-in-possession pay for goods in advance or on a COD basis. Moreover, even if your business is a party to a supply agreement with the debtor, you have the right to demand adequate protection from the debtor to ensure that your business will not be prejudiced by continued, post-petition compliance with the supply agreement. Recover Consigned Goods Under revised Article 9 of the Uniform Commercial Code, a consignor's title and right to consigned goods are no longer subject to the claims of other creditors. Instead a consignor's title and right to the goods are identical to those that the consignor has or had prior to the transfer. In other words, if you are a consignor, your interest in the consigned goods is equivalent to a purchase money security interest in inventory. Consequently, you are free to enforce your title interest under applicable non-bankruptcy law governing consignments without worrying about the duties relating to repossession and sales normally imposed on a secured party under UCC Article 9. Consult with Experienced Creditors' Rights Counsel Get experienced counsel to assist you. Your customer's bankruptcy raises many complex legal issues with respect to matters of commercial law, the impact of the automatic stay, and the assertion of state law rights in the bankruptcy arena. Many of these issues are unique to bankruptcy and unfamiliar to most attorneys. Creditors' rights counsel with experience in such matters can most effectively help you in protecting your interests. If you do not properly exercise your rights, you could face costly litigation with the debtor, or worse, loss of your rights. Other Actions You Can Take:
ADDITIONAL INFORMATION For more information on this or other creditors' rights issues, please contact one of the attorneys in Walter & Haverfield's Creditors' Rights and Bankruptcy Practice Group. WALTER & HAVERFIELD LLP The information in this Client Advisory is a summary of often complex legal issues and may not cover all of the "fine points" of a specific situation or court jurisdiction. Accordingly, it is not intended to be legal advice, which should always be obtained in consultation with an attorney. |
