Magazine article Business Credit

DIP Trade Credit Claims vs. the Preference Monster: DIP Trade Credit Claim Wins

Magazine article Business Credit

DIP Trade Credit Claims vs. the Preference Monster: DIP Trade Credit Claim Wins

Article excerpt

A supplier considering extending credit to a customer in chapter 11 is faced with a dilemma. The supplier can either sell on cash in advance or cash on delivery terms and risk the loss of sales to other suppliers willing to ship on credit terms. Alternatively, the supplier could sell to the debtor on credit terms and risk nonpayment or delayed payment of the supplier's claim if the debtor's business fails.

A recent bankruptcy court decision in Delaware addressed an additional risk facing a supplier that extends credit to a chapter 11 debtor. The debtor had resisted payment of a creditor's chapter 11 administrative expense claim because of a preference claim asserted against the creditor. Fortunately for the creditor, the bankruptcy court directed the debtor to pay the creditor's unpaid administrative claim and held that the debtor could not raise the existence of a preference claim as a defense to payment of the administrative claim. Score this one for the creditor!

Chapter 11 Credit Grantor's Administrative Priority Claim

A trade creditor that extends post-petition credit to a chapter 11 debtor is granted an administrative expense priority claim under the Bankruptcy Code. As a result, the creditor with an unpaid post-petition claim for goods sold on credit to the debtor during the chapter 11 is entitled to priority in payment ahead of most pre-petition claims.

A trade creditor that sells on credit to a chapter 11 debtor faces risk despite being granted an administrative priority claim against the debtor. Most chapter 11 debtors' businesses fail. What follows is the liquidation of the debtor's assets, either in the chapter 11 case--usually under the control of management, or in a chapter 7 case, under the control of a trustee.

In a liquidation, the debtor's secured creditors have a prior right to payment from their collateral ahead of all other creditors, including unpaid chapter 11 trade creditors with administrative claims. If there are insufficient collateral proceeds after payment of secured claims and the debtor does not have any unencumbered assets, there will be no assets available to pay a chapter 11 trade creditor's administrative claim.

Where the debtor has available unencumbered assets to pay claims, administrative creditors usually must make application to the bankruptcy court for allowance and payment of their claims. The debtor's immediate payment of their administrative claims is not assured. Administrative priority creditors face the risk that the debtor does not have sufficient assets to pay in full all chapter 11 administrative expense claims. The debtor must first determine how much is available for payment to creditors and the total amount of administrative priority claims that must be paid. After secured claims are paid in full from collateral proceeds, unpaid chapter 7 administrative expense claims must be paid before any payment can be made to creditors with chapter 11 administrative expense claims. If there are sufficient assets to pay all chapter 11 administrative expense claims in full after the full payment of secured claims and chapter 7 administrative expense claims, the bankruptcy estate is administratively solvent and ch apter 11 administrative expense claims will be paid in full. However, chapter 11 administrative expense claims will, at best, be paid on a pro rata basis and perhaps receive no payment where the debtor is administratively insolvent because it does not have sufficient assets to pay their claims. Unpaid chapter 11 trade creditors of an administratively insolvent debtor may be forced to share the debtor's assets with other unpaid chapter 11 administrative expense claimants, such as landlords, utilities, licensors and professionals retained by the debtor and creditors' committee. In any of these scenarios, an unpaid chapter 11 trade creditor may have to wait several years before receiving payment of its administrative claim, and in the case of an administratively insolvent debtor, they may, at best, receive only a fraction of their claim, and possibly no payment at all. …

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