December 2, 2024
In 2010, the Eleventh Circuit Court of Appeals upheld a judgment in favor of the chapter 7 trustee against a vendor that sold petroleum to a debtor post-petition in exchange for payments from the debtor totaling about $1.9 million. Under the Bankruptcy Code, the vendor would normally have an “administrative expense claim,” which is a protected, priority status over pre-bankruptcy claims. Unfortunately for the vendor, the debtor did not have the bankruptcy court’s approval or the secured lender’s permission to use the cash collateral in the debtor’s possession, and the court held that the payment was avoidable under § 549 of the Bankruptcy Code.
The Delco decision is still good law, which means that vendors must continue to protect themselves from the same fate as Marathon Petroleum Company, the vendor that was forced to return the payment to Delco. Vendors that are parties to executory contracts with a debtor may not simply cease doing business with a debtor after it files for bankruptcy, but they can take the following steps to protect themselves.
- First, vendors should monitor the credit of all companies with which they are doing business to determine if they have recently filed for bankruptcy protection. You may think that if you have no knowledge of the bankruptcy case that you are protected, but the Delco decision makes it explicitly clear that lack of knowledge of the bankruptcy is not a defense.
- Second, once a vendor is aware that it is receiving payment for goods and services from a chapter 11 debtor, the vendor must confirm if the payments constitute cash collateral. Assuming the payment is cash collateral, the next step is to determine if the use of cash collateral has been authorized by the court or by the debtor’s secured creditor.
- Third, if the payments are from cash collateral that the debtor has been authorized to use, vendors should verify that the payments to it are specifically provided for in the cash collateral budget that has been approved by the court or the secured creditor.
Vendors may need time to make these determinations and may consider employing state law remedies under § 2-609 of the Uniform Commercial Code (UCC) if they have reasonable grounds for insecurity about the debtor’s ability to perform its obligations under a sales contract. Before seeking to employ state law remedies under the UCC, vendors may want to seek a comfort order or request expedited clarification from the court about the applicability of the automatic stay and relief from stay, if necessary, in connection with exercising rights under § 2-609 of the UCC.
Bankruptcy practitioners can assist vendors in finding the answers to these questions. When in doubt, I am available to help.
