of terms, or no collection activities’the odds are that the dealings were in the ordinary course of business.
3. Official Unsecured Creditors’ Committees have new obligations to provide information to the creditors they represent. These are groups of creditors that work collectively to protect creditors’ interests. They are formed under the law and advised by counsel (and sometimes business and financial advisors). Cred-itors have no obligation to join a com-mittee, but those who do are bound by a fiduciary duty. Creditors have to decide based on their own specific circumstances whether or not to join a committee. Most do, but it’s not unusual to find those who do not.
A controversial provision of the new law appears to require open information sharing between the committee and non-committee creditors. The controversy exists because committee members are fiduciaries who must treat the often highly confidential information with great care and may not engage in self-dealing. Non-members apparently have no such restrictions.
4. Preferential transfer lawsuits. The changes to the preferential transfers section improve an aspect of bankruptcy law that has probably stuck in more distributors’ craws than almost any other.
Preferences arise when transfers are made by a company within 90 days of its bankruptcy. A transfer can include the payment of a bona fide debt, including a completely legitimate trade payable that is not paid exactly on time. So, in practice, if a now-bankrupt customer bought materials on net 30 terms and paid in 45 days, the supplier can expect the bankruptcy trustee to file suit to return the money’which seems even more unpleasant than just not being paid in the first place.
However, the new law has strengthened suppliers’ defenses. In the past, lots of preference actions for small amounts were settled just because they were not worth the cost of defense, especially as the lawsuits were often out of town or out of state. Distributors often felt like victims of a shakedown. Now, amounts aggregating less than $5,000 cannot be the subject of preference actions, and suits for amounts less than $10,000 must be filed in the federal district court where a business resides. In practice, this should greatly reduce the nuisance suit preference shakedown.
Distributors often have more than $10,000 in credit extended, so what happens to large amounts under the new law? According to Coleman, a supplier still has a defense. If the debt was legitimately incurred in the ordinary course of business, one of the following must be proved: a) the payment was also made in the ordinary course of business between the company and the debtor or b) the payment was made according to ordinary business terms in the industry generally. (Note that the new law has made the ordinary course of business defense easier’the above “or” used to be an “and.”)
Ordinary course of business is the key phrase here. Unusual transactions, special deals, collection activities, tightening of credit terms, or even late payments can drop a distributor right into the soup’making a well-trained and watchful credit department the first and best line of defense.
This article appeared in the February 2006 issue of The Electrical Distributor magazine. Sullivan is president of JSA. Reach him at 972-463-1125 or at email@example.com.
Congress made changes to the bankruptcy code that took effect in October 2005. Here’s a brief review of the key changes with their potential consequences for wholesaler-distributors.
Bankruptcy has been big news over the past year or so. In addition to some high-profile bankruptcies’including Delta Airlines, Northwest Airlines, and auto components giant Delphi’a couple of good-sized electrical contractors have filed as well, proving a source of pain for more than a few electrical distributors. Also in the news was the Congressional battle over bankruptcy revision, and in October 2005 the changes from that revision took effect.
With the new rules in place, bankruptcies certainly aren’t going to go away, making this a good time to take a hard look at the changes to see just how they will impact those in the distribution business.
Four areas of impact
Bankruptcy lawyer Joseph Coleman of the Dallas firm Kane, Russell, Coleman & Logan provided the following overview of the changes and their consequences for suppliers.
According to Coleman, the new law is 195 pages long’half of it deals with commercial bankruptcy; the rest covers consumers. In all of that, he noted, there are four main areas of impact on distributors:
1. Increased reclamation rights. Reclamation is a potentially powerful tool: It is a legal way to get back the goods shipped to a customer right before bankruptcy was filed. This keeps customers from skinning suppliers by loading up on materials at the last minute before filing. A supplier can’t just drive over and snatch the stuff back, however. A proscribed legal procedure must be followed (remember, this is only general information, and by no means legal advice):
- First, the goods must have been sold in the ordinary course of business (itself a legal term), within 45 days of the filing.
- Second, within 45 days of delivery, but no more than 20 days after the date of the bankruptcy filing, the supplier must provide written notice to the debtor of the intent to reclaim.
- Third, the bankrupt customer must have been legally insolvent at the time the goods were received. Generally speaking, legal insolvency means that liabilities were greater than the assets. Simple as that seems, it can be the subject of vigorous arguments about accounting methods, or the actual value of assets.
A possible fly in the ointment is this: If the customer’s banker has a blanket lien that covers inventories, that lien may trump the supplier’s rights. Unless the bank’s collateral is valued at significantly more than its debt, the bank may be able to claim the materials as collateral. It is tricky. For this reason, a credit department needs to stay on top of the financial condition of any significant customer and be aware of any liens filed.
2. A new administrative claim for goods delivered on credit within 20 days of filing. This right to get paid on a priority basis is independent of a supplier’s reclamation rights. The hoops through which one must jump are a bit more difficult, and there will probably be quite a wait for the money. Nevertheless, those with a priority claim will probably get a much better ultimate payout than will the ordinary trade creditors.
To secure a claim, a supplier must prove that goods were sold in the ordinary course of business within 20 days of the bankruptcy filing, and must file an application or motion with the court by the court-determined deadline.
Ordinary course of business” is a phrase that keeps coming up and is often the subject of case law. However, a common-sense rule of thumb can help a supplier stay out of trouble: If during the three months right before the creditor filed the supplier did business with the now bankrupt customer in the same way it always had previously’no special deals, tightening