Magazine article Business Credit

Protection for Trade Creditors from Chapter 11 Debtor's Refusal to Accept Goods under Post-Petition Contract: An Administrative Priority Claim. (Business Law)

Magazine article Business Credit

Protection for Trade Creditors from Chapter 11 Debtor's Refusal to Accept Goods under Post-Petition Contract: An Administrative Priority Claim. (Business Law)

Article excerpt

Introduction

A trade creditor doing business with a chapter 11 debtor may be faced with the following situation. The debtor placed an order for specially made goods to fill an order from one of its customers. After the creditor incurs the expense of manufacturing or purchasing the goods and is ready to deliver the goods, the debtor announces that it is no longer willing to accept delivery of the goods and repudiates its post-petition contract with the creditor. The debtor may be responding to a declining market for the goods, or perhaps the debtor's customer has cancelled its order with the debtor, and the debtor is attempting to pass its loss on the sale to the creditor.

The creditor could have demanded third party support to secure the debtor's obligation to accept delivery of and pay for the goods. For example, the creditor could have insisted that the debtor arrange for the issuance of a letter of credit in favor of the creditor; or the creditor could have required a guaranty of payment from a creditworthy third party; or the creditor could have negotiated for a security interest in some or all of the debtor's or a third party's assets. However, for whatever reason, either the creditor was unable to obtain a security interest or third party support to secure payment of its claim or was unable to recover from the third party or from the collateral securing its claim. What protection is then available to the creditor where the debtor repudiates its post-petition contract to purchase goods from the creditor?

A recent decision of the United States District Court for the Northern District of Mississippi in the River Oaks Furniture Inc. chapter 11 case addressed this issue. The court held that the creditor had an allowed chapter 11 administrative priority claim against River Oaks for the purchase price of certain custom made goods that River Oaks had first ordered and then refused to accept and pay for during its chapter 11 case. The court upheld the creditor's administrative priority claim despite River Oaks not receiving the goods and, therefore, allegedly deriving no benefit from them. River Oaks did not have the goods because it had refused delivery, but still benefited from the potential of filling a profitable order from one of its customers. Another victory for trade creditors!

The River Oaks Furniture Case

On March 3, 1998, River Oaks, a furniture wholesaler in Tupelo Mississippi, filed a chapter 11 petition. Following its chapter 11 filing, River Oaks had placed an order with Lifestyle Enterprises, Inc., a furniture component dealer, to purchase three lots of custom-sized furniture components from Lifestyle for a purchase price of $75,384. River Oaks had intended to use the Lifestyle components to fill an order from the furniture retailer, Heilig Meyers, for the purchase of motion sofa sets.

However, as a condition for its agreement to sell the components to River Oaks, Lifestyle required River Oaks to furnish a letter of credit in the amount of $86,000 in favor of Lifestyle to secure River Oaks' obligation to take delivery of and pay for the goods. On June 18, 1998, the Bank of New York ("BNY") issued a letter of credit in the amount of $86,000 in favor of Lifestyle. The letter of credit required BNY to pay any draft or demand for payment that Lifestyle had presented for payment, provided Lifestyle also presented all of the documents required under the letter of credit.

On July 31, 1998, Lifestyle began delivering the goods ordered by River Oaks. The goods were to be initially shipped from Hong Kong to Los Angeles and then on to their ultimate destinations in New Albany, Mississippi and Compton, California; however, it was not to be!

On August 13, 1998, Lifestyle presented a draft/demand for payment and documents to BNY under the letter of credit. Then, on August 20, 1998, Lifestyle informed River Oaks that the shipments had arrived in the United States, cleared customs and were ready for delivery. …

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