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April 23, 2024

Cross-Border Update

Q2, 2024—"Strategies for Managing Distressed US Commercial Customers, Part 3: Your US Customer Has Filed for Bankruptcy: Here's How to Protect Yourself"

A customer’s impending bankruptcy is one of the most stressful experiences a supplier can face in the course of running their business. You are confronted not only with the potential loss of a major customer but also the possibility of a significant financial loss due to unpaid accounts receivable. Following a US customer’s bankruptcy, Canadian-based manufacturers will invariably ask themselves if they could have seen this coming. They will wonder what signs they missed and the obvious red flags that should have alerted them to their customer’s financial distress. Often, there are early warning signs that can signal a US customer is experiencing problems or is in financial distress—and there are steps you can take as a creditor to proactively prevent or minimize your risk of loss. To help guide you, this three-part series of articles outlines some of the more common signs of financial trouble as well as protective measures creditors can take to prevent financial loss both prior to and after a customer’s US bankruptcy filing.

After hiring US counsel to protect your creditor rights, Canadian suppliers can undertake the following steps in the event their US customer has filed for bankruptcy.

  • Protect your position by respecting the automatic stay, which under the US Bankruptcy Code, strictly prohibits post-petition collection efforts for pre-bankruptcy amounts owed once a US customer files its bankruptcy petition.
  • If your purchase order has not been delivered by the time of the bankruptcy filing, you may indeed stop delivery and get confirmation that the customer (i.e., the debtor) will treat the order as post-bankruptcy for payment purposes.
  • Bankruptcy law in the United States recognizes certain reclamation rights; most importantly, creditors receive an administrative claim for goods received by the debtor within 20 days of the bankruptcy filing.
  • Depending upon the particular facts and circumstances of each bankruptcy case, creditors may receive “critical vendor” status, which permits creditors to receive payment in full on all pre-petition amounts owed as well as current payments while doing any business with the debtor post-petition.
  • Consider serving as a member of the Official Unsecured Creditors’ Committee (Creditors’ Committee), which the Office of the United States Trustee, a component of the US Department of Justice, appoints whenever possible to help steer the course of bankruptcy cases, thereby leveling the playing field with the debtor at no cost to individual creditors. Being “inside the room” during all Creditors’ Committee deliberations provides you with invaluable insight into the direction of a bankruptcy case—especially if you want to know whether you will still be able to do business with your US customer once their bankruptcy case concludes and they are no longer a debtor in possession.

Creditors’ Rights

Even if goods are delivered to a retail customer who subsequently declares bankruptcy, a creditor may have the following rights:

  1. Reclaim the goods under US Bankruptcy Code Section 546(c).
  2. Assert an administrative expense claim for goods the retailer received within 20 days of the retailer’s bankruptcy filing under US Bankruptcy Code Section 503(b)(9), assert a claim for mutual prepetition setoff, or both.
  3. US Bankruptcy Code Section 546(c)(1) provides that, with some limitations, “a seller of goods that has sold goods to the debtor, in the ordinary course of such seller’s business, [may] reclaim such goods if the debtor has received such goods while insolvent” within 45 days of the petition date. A demand for reclamation must be made “not later than 45 days after the receipt of such goods by the debtor, or not later than 20 days after the commencement of the [bankruptcy case], if the 45-day period expires after the commencement of the bankruptcy proceeding.”

Even though the US Bankruptcy Code appears to afford broad relief to creditors, in practice its application is sometimes limited. Certain US bankruptcy jurisdictions require that the retailer still possess any goods the supplier seeks to reclaim. And Section 546(c) specifically provides that reclamation rights are “subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof,” to the extent that if a retailer’s secured lenders have a floating lien on inventory, the lenders’ security interest will be senior to any reclamation rights a supplier may have. Thus, while Section 546(c) provides sellers with some protections, it does not eliminate altogether the risk associated with providing goods to distressed US entities.


Other Remedies

In addition to the reclamation rights afforded under Section 546(c), you may also have other available remedies under the code. Section 503(b)(9) provides creditors with an administrative expense claim for goods (not services) that a debtor receives in the 20 days before the debtor files for bankruptcy. Section 503(b)(9), which is not dependent on a retailer’s continued possession of goods and that often results in a dollar-for-dollar recovery, is generally recognized as an alternative (and more desirable) remedy to reclamation rights. Section 553(a) also preserves a creditor’s rights to offset mutual pre-bankruptcy debts under non-bankruptcy law. Offset claims are essentially secured claims and—like Section 503(b)(9) claims—often result in a dollar-for-dollar recovery.

Consult Counsel Before Taking Action Against a Bankrupt Retailer

In summary, when a Canadian supplier learns that a US customer is contemplating bankruptcy, it is strongly advised they explore all options to mitigate losses. The rights afforded under both the UCC and the US Bankruptcy Code may provide creditors meaningful mechanisms by which to do so. Because the mechanics for invoking these provisions can be complex, any Canadian supplier to a US retailer should always consult with US counsel before taking any action. Doing so ensures that your rights are exercised correctly, maximizes your ability to get paid, and limits any potential losses.
 

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