With the threat of a bankruptcy filing by one or more of the domestic automotive manufacturers looming, automotive suppliers face their own economic challenges. Indeed, many automotive suppliers have significant receivables owed to them by one or more of the domestic automotive manufacturers (hereinafter "Customer" or "Customers") that may not be paid in full. Should such bankruptcy filings occur, suppliers who have developed both pre and post-bankruptcy strategies will be better positioned to weather the storm. This article addresses certain of these strategies.
Assess and Use Your Contract Leverage
By using your contract leverage, you are in a better position to maximize payment of your receivables even if a bankruptcy of your Customer ensues. To understand the extent of your leverage, you must review your contract terms with your Customers. Relevant terms include: (1) the parties to the contract; (2) the extent to which the contract is long-term or order by order; and (3) the duration of the contract.
First, understanding the identity of the parties to your contract is important because you are only precluded from collecting outstanding receivables from an entity in bankruptcy. If your Customer is a subsidiary or affiliate of the bankrupt entity and is not seeking bankruptcy protection, the bankruptcy of your Customer's parent will not prevent you from collecting your outstanding receivable.
Second, if your contract is not long-term, but order by order, even if a bankruptcy ensues, you may not be compelled to perform in the future, because the contract is not executory as defined below.
Third, if a review of your long term contract reveals that it will expire shortly, you may have leverage to condition an extension of the contract on payment of outstanding receivables or on the Customer's agreement to improved contract terms. Improved contract terms may include changing your payment terms to cash in advance or cash on delivery which terms would continue even if a subsequent bankruptcy is filed. Further, as discussed in detail below, you may also be in the position to negotiate early assumption of that contract under Section 365 of the Bankruptcy Code if the Customer files a Chapter 11 bankruptcy proceeding.
Consider Demands Under the Uniform Commercial Code
You have tools under the Uniform Commercial Code ("UCC") that may force a negotiation with your Customer before an actual breach of contract occurs to shore up your contractual position prior to a bankruptcy filing. For example, under Section 2-702 of the UCC, when a Customer is insolvent, you may (a) refuse to deliver goods unless the Customer agrees to pay for them in cash or (b) stop delivery of goods, even if they are in transit, under Section 2-705 of the UCC. A Customer is insolvent under the UCC when it (a) has generally ceased to pay its debts in the ordinary course of business other than as a result of a bona fide dispute; (b) is unable to pay its debts as they come due; or (c) is insolvent within the meaning of federal bankruptcy law. Such a demand cannot be made post-bankruptcy without relief from the automatic stay.
Further, under Section 2-609 of the UCC, if reasonable insecurity exists concerning a Customer's willingness or ability to perform a future obligation, you can issue a demand for adequate assurance of performance. Reasonable grounds for insecurity include, late payments, credit insecurity and stated liquidity problems. In response to a demand for adequate assurance, a Customer must provide written assurances to you demonstrating its ability to perform future obligations, including, financial information. If a Customer fails to provide adequate assurance, you may, among other things, modify or suspend your performance.
Obtain Critical Supplier Status
Depending upon the jurisdiction of your Customer's bankruptcy proceeding, you may be in the position to be deemed a "critical" supplier. While a cardinal principle of bankruptcy law is that similarly situated creditors receive equal treatment, courts have created an exception to this principle known as the critical supplier doctrine. A Customer may argue that a supplier is critical if the supplier would either (a) stop doing business with the Customer because of the bankruptcy or (b) be forced into insolvency by the Customer's unpaid claim. Case law respecting critical supplier status varies by jurisdiction but the doctrine has been adopted in Delaware, New York and Michigan.
The advantages of being deemed a critical supplier include: (a) being paid in advance of and at a higher percentages than other general unsecured creditors; and (b) conversion of a pre-bankruptcy claims into administrative claims that must be paid in full prior to confirmation of a plan of reorganization.
Position Yourself for Early Contract Assumption
Pursuant to Section 365 of the Bankruptcy Code, your Customer must assume or reject "executory contracts" for the sale of goods no later than confirmation of its plan of reorganization. A contract is executory if obligations are owing by both parties to the contract. Your Customer is obligated to perform under the contract during the period between the bankruptcy filing and assumption or rejection of the contract. The Customer may be compelled to assume or reject your contract before plan confirmation for cause, including failure to perform.
The advantage of contract assumption for suppliers is that the Customer must cure all monetary defaults, including outstanding receivables arising prior to bankruptcy, and must give adequate assurance of future performance under the contract. In addition, claims under assumed contracts are entitled to administrative priority meaning that they must be paid in full upon plan confirmation. Your ability to obtain early contract assumption depends upon your contract leverage. For example, if the term of your contract expires post bankruptcy and your product is not easily resourced, you may be in the position to negotiate early assumption that would result in payment of your pre bankruptcy receivable in addition to an extension of your contract on more favorable terms.
Setoff and Recoupment
Setoff enables identical parties with mutual claims to offset such claims. In bankruptcy, to exercise rights of setoff of pre-bankruptcy debts, you must first obtain relief from the automatic stay. In addition, the claims must be of similar character (i.e. both claims are pre-bankruptcy or post-bankruptcy). Prior to a bankruptcy filing, you could negotiate an expansion of your rights of setoff to involve debts of third parties such as subsidiaries and affiliates. Such an expansion is advantageous if you do business with a non-debtor subsidiary who would not be protected by the automatic stay. This is an example of the advantage of shoring up your contract terms prior to a bankruptcy.
Recoupment is an equitable doctrine that enables you to avoid paying your Customer if your Customer owes you money. Your claim and the Customer's debt must arise from the same contract. Absent a court order to the contrary, relief from the automatic stay is not necessary for recoupment. In addition, unlike setoff, pre and post bankruptcy claims can be recouped.
Reclamation and 503(b)(9) Claims
Under Section 546 of the Bankruptcy Code, you can reclaim goods by written demand delivered to your Customer within 45 days after delivery or, if the 45 day period expires post-bankruptcy, within 20 days after the bankruptcy filing. This right is subject to the rights of a secured creditor in the goods or their proceeds.
Even if a written reclamation demand is not made, you are entitled to an administrative priority expense claim for the value of goods received by the Customer within 20 days prior to the bankruptcy filing pursuant to Section 503(b)(9) of the Bankruptcy Code.
Each of the strategies described above should be evaluated in the context of your individual needs and circumstances. Such strategies should only be employed if they satisfy your specific business goals. Consider hiring legal counsel to aid you in evaluating these and other supplier survival strategies.
Nicole Y. Lamb-Hale is managing partner of Foley & Lardner's Detroit office. She is also a member of the firm's Bankruptcy & Business Reorganizations and Public Finance Services Practices and its Automotive Industry Team. Foley & Lardner LLP continually evolves to meet the changing legal needs of our clients. www.foley.com http://www.foley.com/services/practice_detail.aspx?practiceid=43)
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