Bankruptcy Rights of Suppliers

What suppliers can do when a customer cannot pay


Suppliers may welcome the elevated priority for their 20-day claims under § 503(b)(9). However, suppliers need to temper the expectations for prompt payment. Court decisions since the enactment of § 503(b)(9) have resulted in delays and other roadblocks to the receipt of timely payment by suppliers with 20-day claims. For example, the priority for payment matters only if the customer is successful in reorganizing or is liquidating in Chapter 11. If the customer does not exit from bankruptcy, or is sold and the case converted to a Chapter 7 liquidation, this benefit may be difficult to realize.

• Setoff and Recoupment

Generally speaking, if at the time of the filing of bankruptcy there are mutual debts due by both supplier and customer to the other, the supplier can offset the amount it owes to the customer against what the customer owes to the supplier, thereby relieving the supplier’s obligation to the customer to that extent. The operative provision of the Bankruptcy Code is § 543(a). Before the supplier can take this step, it must give the customer notice and get the court’s permission to act. Failure to get permission from the court is a violation of the automatic stay.

If the debt of the supplier to the customer does not arise until after the bankruptcy filing, the right of setoff under § 543 does not help the supplier, because it applies only to mutual debts where both arose prior to bankruptcy. However, the supplier whose mutual debt arises post-bankruptcy may be able to set off that debt against the money due by the customer using a remedy called “recoupment.” Recoupment is not found in the Bankruptcy Code but is one of those “otherwise applicable non-bankruptcy law” concepts that apply in the bankruptcy setting because it is not prohibited by the Bankruptcy Code. To enforce a right to recoup a mutual debt, the law requires that both debts arise out of the same transaction. Recoupment is a useful remedy for a franchisor or other supplier seeking to avoid payment of rebates and other incentive obligations when continuing to do business with a franchisee-buyer while in bankruptcy.

• Post-petition Shipments

Contrary to popular belief, there is no guaranty for payment of post-bankruptcy extensions of credit. Suppliers who ship on credit during Chapter 11 do get paid on a priority basis over the suppliers with pre-bankruptcy claims, but there still has to be money to pay, and the banks, which are likely providing revolving credit to fund operations in bankruptcy, generally have a super-priority claim so that, in the event of a post-bankruptcy insolvency, the suppliers could still get stuck. Suppliers are advised to limit the credit balance and watch the payment cycle closely to make sure they do not get extended beyond normal terms during the course of the bankruptcy.

Conclusion

Suppliers of goods are cautioned to exercise diligence in these difficult economic times for franchisees and other buyers of their goods on credit. If a customer becomes insolvent, prompt action is required to take advantage of a few basic remedies available to the supplier. By diligently paying attention to trends and patterns of payment, a supplier can stay in position to take advantage of rights to (1) recall goods in transit not yet received by an insolvent buyer, (2) reclaim goods received by an insolvent buyer within 10 days of delivery outside of bankruptcy and 45 days of delivery to a buyer who has filed bankruptcy, (3) assert an unsecured claim with administrative priority and enhanced prospects for payment on account of goods received by an insolvent buyer within 20 days prior to the filing of bankruptcy, (4) set off or recoup mutual debts owed to the buyer who has received goods or services without payment, and (5) stop deliveries altogether or demand C.O.D. or other payment term modifications when a buyer is found to be insolvent or as a condition for provision of goods or services after a bankruptcy is filed.

There are issues with all of these remedies and a thorough review of all options with competent bankruptcy counsel is recommended before action is taken. Nonetheless, the price of inaction can be dramatic so the watch word for suppliers is to remain ever diligent in dealings with customers in an economically distressed economy.

About the Author: Michael J. Viscount, Jr. is a partner in the Atlantic City office of Fox Rothschild LLP. He is a commercial lawyer with 27 years of experience representing public and private businesses and creditors’ groups on corporate debt restructuring, workouts, bankruptcies and other complex commercial matters. Michael can be reached at 609-572-2227 or mviscount@foxrothschild.com.

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