May 14, 2020
Safety concerns arising out of the Covid-19 crisis have caused numerous well-known retailers to file bankruptcy and more will likely follow. If you supply products to these retailers, or are worried if and how these filings can affect your business, what can you be doing now so to best position your company if one of your customer-retailers files?
These refrains and questions are becoming more common in light of the recent (and anticipated) retail bankruptcy filings. Retailers have been feeling the strain of competition and change for some time. The impact of shifting market dynamics, however, has accelerated due to the coronavirus (COVID-19) outbreak and the resulting state-imposed closures, lay-offs, and the growing economic crisis. Many well-known retailers have recently been, or will soon be, pushed into bankruptcy. If you supply products to these retailers, how should you prepare yourself now for the possibility of bankruptcy by one of your customer-retailers?
Sorry to start out by stating the obvious, but your instincts are right—your customer filing bankruptcy is not terrific news and the likelihood of being repaid in full is not high. For the most part, the claims of retail suppliers are treated as “general unsecured claims.” This means these claims generally get paid only after secured lenders, the professionals running the bankruptcy case, and specially protected suppliers are paid in full. As a result, there is often little or no money left for general unsecured creditors. Based on recent cases, a recovery of 5–10% is fairly typical in retailer bankruptcies. But, all hope is not lost. There are some steps retail suppliers can take to improve their chances of getting promptly paid.
In many instances, Bankruptcy law protects those who continued to do business with the retailor in the period immediately leading up to the bankruptcy. In light of this fact, one way that you can improve your position in a retail bankruptcy is to file a 503(b)(9) claim for goods delivered in the twenty days before the bankruptcy filing. This rule allows a supplier to jump ahead of regular unsecured creditors and have their claim treated as an “administrative expense” for “any goods received by the debtor within 20 days before the commencement of a case” if the goods were delivered in the ordinary course. Since all administrative expenses, including 503(b)(9) claims, must be paid before any Chapter 11 plan can be approved, filing and defending an administrative claim is often a path of payment. When evaluating the filing of your claim, keep in mind that the key date for calculating what you are entitled to is the date the goods were actually received. To that end, some Court have held that in cases where goods are shipped F.O.B. this is the date they are delivered to the loading dock and not necessarily delivered to the debtor’s premises. In addition, another court has questioned whether shipments made directly to retail customers, as opposed to delivered to the retailor, are protected.
Long before the Bankruptcy Code was modified to protect suppliers who delivered to retailors in the twenty days before the bankruptcy, various state laws allowed suppliers to “reclaim” goods that were unpaid for and in possession of the retailor under the Uniform Commercial Code. The Bankruptcy Code recognizes and protects these rights under section 546(c) which permits suppliers to exercise their state law reclamation rights. In short, Bankruptcy Code allows for a vendor to seek the return of any goods that are identifiable received by an insolvent retailer 45 days prior to the bankruptcy filing, however, creditors must assert such demands within 20 days after the bankruptcy filing. It should be noted that, recent rulings have indicated due to the priority of liens on the inventory by post-petition lenders, vendors should file a reclamation claim as soon as possible following a bankruptcy filing.
On a practical note, suppliers should also consider what they will do with the reclaimed merchandise if they are successful in obtaining their return. It is unlikely that they can sell the goods as “first-quality” to other resellers or through their online channels. Also, in many sectors, goods that are over 45 days old could be an entire season and, therefore, the goods will be être démodé when received.
In many instances retailors do not actually purchase, and thus do not own, the goods that they are selling. Rather, they hold them on consignment. The typical retail customer, walking into a store, can’t tell what is owned by the retailor and what is held for sale on consignment. Consignment arrangements can occur in a wide variety of product lines and include both hard and soft goods. A high-end designer may supply the merchandise for a shop within a department or specialty store or a sporting goods manufacturer may supply equipment. Under the typical consignment arrangement, the merchandise belongs to the supplier and the goods are paid for when an item is sold. As we noted, the typical consumer can’t tell that this arrangement is in place and unfortunately, nor can many courts.
Things get complicated for a supplier and their consigned inventory when the retailer files for bankruptcy. Unless, the supplier has properly filed a financing statement prior to the bankruptcy filing stating the relationship between the supplier, the retailer, and the goods, the goods will likely be considered part of the bankrupt entity’s estate and the supplier’s claims go to the bottom of the pile with the other unsecured creditors. The financing statement is critical and you should work with counsel to make sure the filings are completed properly and to confirm any already filed documents adequately protect your interests prior to a bankruptcy filing by any of your customers, especially in the case of a troubled retailer.
If you are hearing rumors about a retailer’s struggles and you are looking at their A/R balance with alarm, you may be inclined to lean on the retailer and ask them to “do you a favor” and pay it down. If the retailer does go bankrupt, however, this could be a problem. Any such payments made within 90 days of the filing, could be challenged as preferences under the Bankruptcy Code and you may be required to return the payments even if you are still owed money by the retailer. The rationale behind these rules is to provide a level playing field when it comes to creditors as a whole.
Suppliers can protect themselves from claw-back demands if they can prove the payments made were done in the “ordinary course of business.” An example of this exception would be a situation where the retailer pays you on a set schedule—even if that schedule is not always bringing the retailer current. If you are still doing business with a retailer, another way to receive payment for goods AND to protect yourself from preference claims is to ship goods on a C.O.D. (cash-on-delivery) basis. In all events, it is likely better to take the payment now, and deal with the potential suits later, as preference actions are often waived as part of a Chapter 11 plan and or settled at a discount—however, it is also imperative to understand the real risk of an eventual claw back even if you also have outstanding claims against the customer.
These are just some of the issues that suppliers will face as more retailers consider bankruptcy protection. While the bankruptcy process can be challenging, thoughtful planning and appropriate responsive actions can help put you in a better position to maximize your recovery in a bankruptcy case. Our Retail and Financial Restructuring and Bankruptcy teams are ready to assist clients grapple with these issues.
The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.
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