April 15, 2020 - Barack Ferrazzano Client Alert

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Client Alert: Considerations for Supplier Bankruptcies

Pace Industries (Pace) recently filed for Chapter 11 bankruptcy in Delaware. It makes die-cast parts for the automotive industry, among others. Pace cited supply-chain problems caused by COVID-19 (coronavirus) and mandatory stay-at-home orders as one of the precipitating reasons for the bankruptcy, as it temporarily shut down a majority of its U.S. die-casting facilities.

This case was pre-negotiated with Pace’s lenders and bondholders. Having filed as a “prepack” case, Pace may exit bankruptcy early this summer with those creditors as new equity owners. Nonetheless, most cases are not that tidy. Additional OEM suppliers are sure to be forced into bankruptcy throughout 2020.

Bankruptcy Basics

Chapter 11 Or Chapter 7

• If a supplier is going out of business and winding down its operations, it may file a Chapter 7 bankruptcy. In a Chapter 7 business operations cease, and an independent trustee is appointed to liquidate all assets and make distributions to creditors.
• In contrast, to reorganize its financial affairs and emerge from bankruptcy, a supplier will file a Chapter 11 case where it stays in charge of its operations and is given the exclusive right to file a plan of reorganization for a limited time.
• Most cases filed as a Chapter 11 result in a sale of the business as a going concern or being converted to a Chapter 7 liquidation.

Automatic Stay

• Immediately upon filing a bankruptcy a stay automatically applies to prevent any creditor attempts to collect pre-bankruptcy claims, both formal (e.g. lawsuits) and informal (e.g. collection letters). The stay also applies to a common remedy of “setoff” where parties apply mutual claims and debts against each other to settle an account.
• Approval of the bankruptcy court is required before taking actions prohibited by the stay, and willful violations of the stay can result in damages and court sanctions being assessed against the offending party.

Executory Contracts

• One of the most powerful remedies a debtor has is over contracts that are “executory” as of the bankruptcy filing. While not defined by the Bankruptcy Code, courts generally find a contract to be executory where both parties have remaining material obligations to each other. A sales or supply agreement with a debtor will most likely be deemed an executory contract.
• A debtor may reject most obligations under a contract and relegate a party’s claim for breach to be paid in fractional bankruptcy dollars, or it may assume all the obligations by curing any existing defaults. This decision is required to be completed as part of the plan of reorganization process. Importantly, until the debtor makes that decision the counterparty is generally obligated to continue performing under the contract.
• If assumed, the debtor may also assign the contract to a third party notwithstanding general contract language prohibiting assignment. This is typically done as part of a sale process.

Key Considerations

• Application of an OEM’s setoff rights and treatment of its contract with the debtor are critical issues in a supplier bankruptcy and can be intertwined.
• Careful review of the supply contract and your claims against the supplier should be done at the outset of a case. The size of your claim against the debtor, and whether court authority is needed for you to apply that claim against your open invoice debt to the debtor should be determined immediately. There are nuances involved with each, and the debtor has the continued right to demand payment for orders shipped before and after filing bankruptcy. If not protected and applied appropriately, a valid setoff claim could become nothing more than a general claim entitled to little to no distribution in the bankruptcy case.
• A debtor’s decision to reject your contract or assume and assign it is similarly important, especially if the contract has a lengthy remaining term. An “anti-assignment” contract provision that requires consent as a condition of an assignment is generally not enforceable in Chapter 11. An OEM can nonetheless protect itself against assumption by the debtor and an assignment to a third party.

We Can Help You

Barack Ferrazzano's Bankruptcy & Creditor Rights Group has 80 years of combined experience representing parties in bankruptcies, business reorganizations, and non-judicial workouts of debtors throughout the U.S. We represent large national companies in all of their significant bankruptcy disputes, including negotiation of pre- and post-bankruptcy claims, counseling on extending credit to bankruptcy entities, adversary proceedings related to preference and fraudulent transfer actions, assumption of contracts, and critical vendor status. We have represented supply agreement contract parties in some of the largest auto parts maker bankruptcies, and regularly represent OEM clients in dealer bankruptcies.

COVID-19 Resources

We recommend reviewing the following pandemic-related business and legal considerations we have been discussing with our clients:

• Barack Ferrazzano's COVID-19 Resource Center