Publications

---

Current economic conditions present an extremely difficult environment for retailers. Consumer sales are down. Credit terms have tightened. Bankruptcy filings and liquidations are increasing, often leaving trade vendors with large unsecured claims that may yield pennies on the dollar in a retailer’s bankruptcy.

However, trade vendors do have a number of powerful tools at their disposal that, if employed effectively, can reduce their exposure both before and after the retailer files for bankruptcy.

Pre-Bankruptcy Strategies

Trade vendors’ pre-bankruptcy rights vis-à-vis a distressed retailer customer generally will be governed by the terms of the parties’ contract and by Article 2 of the Uniform Commercial Code (the UCC). If the retailer breaches the parties’ contract – including by failing to make a payment when due – UCC section 2-703(2) allows the trade vendor to take a number of steps, including:

Withhold delivery of goods. Under UCC section 2-703(2)(a), the trade vendor may withhold delivery of goods until the retailer provides adequate assurance of performance.

Stop delivery of goods. Even if the goods already are in transit, under UCC section 2-703(2)(b), the trade vendor may stop delivery of goods until the retailer provides adequate assurance of performance.

Resell goods. Under UCC section 2-703(2)(c) and (g), the trade vendor may identify both finished and unfinished goods to the contract, use its reasonable judgment to resell the goods in a commercially reasonable manner, and recover damages from the retailer.

Reclaim goods. Under UCC section 2-703(2)(d), the trade vendor may reclaim goods by demand made within a reasonable time after the trade vendor discovers that payment was not made.

Cancel the contract. Under UCC section 2-703(2)(f), the trade vendor may cancel the contract by giving the retailer reasonable notice of cancellation. Upon cancellation, the trade vendor may pursue its other remedies.

Recover damages and lost profits. The trade vendor has a number of damage remedies available to it under UCC sections 2-703(2)(g), (h), (i), (j) and (l), including the right to recover (i) the difference between the contract price and the resale price of any identified goods sold to third parties; (ii) the difference between the contract price and the market price, when a trade vendor has reclaimed goods; (iii) lost profits as a result of the breach, when other measures of damages are inadequate; (iv) the contract price, when resale of the goods is impracticable; or (v) liquidated damages, if specified in the contract and if reasonable in light of the anticipated or actual harm caused by the breach. Because only provable damages will be awarded, the trade vendor should take great care to document all actual, incidental and consequential damages it has incurred.

In addition, if the retailer becomes insolvent – meaning that the retailer has generally stopped paying its debts in the ordinary course of business, is unable to pay its debts as they become due, or is insolvent on a balance sheet basis – then UCC section 2-703(3) allows the trade vendor to take a number of other steps, including:

Withhold delivery of goods. Under UCC section 2-703(3)(a), the trade vendor may withhold delivery of goods except for cash, including payment for all goods previously delivered.

Stop delivery of goods. Under UCC section 2-703(3)(b), the trade vendor may stop delivery of goods in the possession of a carrier or other bailee.

Reclaim goods. Under UCC section 2-703(3)(c), the trade vendor may reclaim goods upon demand made within a reasonable time after the retailer receives the goods.

Finally, even though the Bankruptcy Code does not apply until a bankruptcy case is filed, the trade vendor should consider its potential impact when dealing with a distressed retailer customer.

Among other things, the trade vendor should:

Limit exposure to preferences. Section 547 of the Bankruptcy Code generally permits a debtor to avoid and recover certain payments – known as “preferences” – made to its creditors within 90 days before its bankruptcy filing. The most common defense to a preference action involves showing that the alleged preference was received by the trade vendor in the ordinary course of business or according to ordinary business terms. Thus, the trade vendor should attempt to maintain payment terms with the retailer – particularly when it becomes clear that the retailer could be headed for a bankruptcy filing – or move the retailer to C.O.D. terms and avoid the problem entirely as to future payments.

Reduce potential for fraudulent transfers. Section 548 of the Bankruptcy Code generally permits a debtor to avoid and recover certain transfers of property or interests – known as “fraudulent transfers” – made for less than “reasonably equivalent value” during the two-year period before its bankruptcy filing and while the debtor was insolvent. Accordingly, when dealing with a distressed retailer customer, the trade vendor should take steps to justify and document the value of the consideration given or received in any extra-ordinary transactions with the retailer.

Maximize future setoff rights. Because setoff rights are treated as secured claims in bankruptcy, the trade vendor can preserve such rights and maximize the portion of its claim that will be treated as a secured claim by delaying payments to the retailer. This strategy has its limits, however, as the trade vendor cannot acquire claims against the debtor for the purpose of enhancing its setoff rights.

Post-Bankruptcy Strategies: Act Early

A common misconception is that once a customer files for bankruptcy, there is little the trade vendor can do to protect its interests.

In fact, by taking certain steps early in the customer’s bankruptcy, it is possible for the trade vendor to elevate some or all of its claim above the level of general unsecured claims. For example, the trade vendor may:

Make a reclamation demand. Under section 546(c) of the Bankruptcy Code, the trade vendor may demand reclamation of goods that were received by the debtor, in the ordinary course of the trade vendor’s business, within 45 days before the bankruptcy. To preserve its reclamation claim, the trade vendor must make a written demand not later than 20 days after the bankruptcy filing. Because reclamation claims remain subject to prior perfected liens on a debtor’s assets, the trade vendor also should consider whether it is likely to be paid anything on account of its reclamation claim.

Assert a section 503(b)(9) administrative expense claim. Under section 503(b)(9) of the Bankruptcy Code, added to the Bankruptcy Code in 2005, the trade vendor may assert an administrative expense priority claim for the value of goods that were received by the debtor in the ordinary course of business within 20 days before the bankruptcy. Absent court-ordered procedures to the contrary, the trade vendor must assert such a claim by motion or application for payment – not by filing a proof of claim. Because the retailer may attempt to delay payment of section 503(b)(9) administrative expenses until the end of the case, the trade vendor should file its motion or application as soon as possible after the bankruptcy and ask the bankruptcy court to order immediate payment.

File a proof of claim. Finally, because the right to assert a general unsecured claim in the retailer’s case will be waived if not asserted by the claims bar date, the trade vendor should file a proof of claim as soon as possible after the bankruptcy – even if a bar date has not yet been established.

These are just some of the tools that can be employed by a trade vendor dealing with a distressed retailer customer. Depending on the nature and complexity of the parties’ relationships, other issues may arise (e.g., use of cash collateral, adequate protection, post-petition financing, assumption and rejection of executory contracts). No matter the circumstances, the prudent trade vendor should consult with bankruptcy counsel as soon as a customer begins to show signs of financial distress.