Friday, January 6, 2012

Bankruptcy - What happens when a supplier files for bankruptcy protection?

The first thing that occurs is a trustee in bankruptcy is appointed by the Bankruptcy Court. The trustee in bankruptcy does not have to honor your agreement with the supplier. This means that any contract rights or options no longer exist unless the trustee agrees to honor them. For example if you had materials held in escrow and a license grant that triggered with a certain event, If you failed to exercise those rights prior the Supplier bankruptcy the trustee does not have to honor them.The supplier’s bankruptcy does not excuse you of any obligations that you have if the trustee elects to continue to honor the agreement.For example if you made a firm commitment to purchase a set quantity and the trustee continues to ship them at the agreed price, you would still be obligated to purchase them.

If the supplier has existing inventory that can be sold, the trustee must do what is best for the creditors. This means they don’t have to sell the inventory to you at your contracted price they need to sell it for the best price they can get. So while they could force you to honor a firm quantity commitment, they may not if they can get a better price elsewhere.

If you have buyer owned inventory at the supplier or a location controlled by the supplier, unless that inventory is identified as being owned by the buyer, it becomes part of the assets of the supplier.If you have buyer loaned product or equipment at the supplier, unless those products or equipment are identified as being owned by the buyer, they become part of the assets of the supplier.If you have consigned material to them, unless that consigned material is identified as being owned by the buyer, it becomes part of the assets of the supplier. In these three situations you would have a claim in bankruptcy as an unsecured creditor.

Bankruptcy has a hierarchy that determines who gets paid first. At the top of the list is the Trustee who may also serve as a liquidator of the bankrupt company. that is appointed by the bankruptcy court. Next is any government claims such as claims for taxes. Third is secured creditors. This could be a company that sold a piece of capital equipment to the supplier under credit terms and holds a security interest in the equipment. Secured creditors are similar to a bank having a lien against the title to a car you purchased because they loaned you money for the purchase.Bond holders are frequently considered to be secured creditors. Next comes unsecured creditors. If there are any assets remaining after unsecured creditors are paid, those remaining assets would be disbursed first to any preferred stockholders and last to any common shareholders.

In any agreement where there will be buyer owned product held under the supplier’s control,
Buyer owned products or equipment or any consignment of buyer owned materials, you want those items to be held in a separate area and be specifically and when possible labeled as being owned by the buyer.The reason for that is if you can prove ownership you will be protected by the law. You are not a creditor, you are the owner of that property. As an owner you can pursue the right of replevin where with court order and accompanied by police, you could legally enter the supplier’s premises where your items are being held and remove them.

Saying that you may terminate an agreement for cause in the event the supplier files for bankruptcy doesn’t buy you much. If they filed for bankruptcy, the trustee does not have to honor that right. Further any damages that you may be awarded would fall under the category of unsecured creditors.

If you are dealing with a financially troubled supplier and need things like license and escrow materials delivered you need to have the trigger for that to occur prior to a company filing bankruptcy. One trigger could be a further deterioration in their financial statement. That way its already in place and not subject to the trustee’s decisions.

Trustees in bankruptcy don’t care about you or your companies needs. They are hired to get the most for the creditors of the bankrupt company. To do anything else would put them in breach of their fiduciary responsibilities to the court that appointed them.

Bankruptcy laws and responsibilities will vary by jurisdiction.

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