Effective Seller Remedies When Confronting a Financially Distressed Buyer Prior to Bankruptcy
Nathan, Bruce, Business Credit
Well folks, the old movie adage "Fasten your seatbelts, it's going to be a bumpy night!'' (1) from the movie, All About Eve, has lots of meaning to credit executives in these very troubled economic times. Trade creditors are now confronting an economy in recession, featuring tight or no credit; consumer spending in a downward spiral, and the resulting poor holiday shopping season; more and more struggling retailers and other businesses filing, or threatening to file, Chapter 11 bankruptcy and the financial crisis and bankruptcy risks afflicting the automotive sector.
So what are the options for trade creditors who are obligated to sell on credit to a financially distressed company that is on the verge of, but has not yet filed for, bankruptcy? Article 2 of the Uniform Commercial Code ("UCC") contains two remedies (in addition to reclamation) that, a trade creditor can utilize, in the right circumstances, to enhance the likelihood of payment of its claim.
The first remedy is a seller's state law right to stop delivery of goods to a customer that is either insolvent or is in default of its obligations to the seller. However, what if the seller has a financially troubled customer that is current in payment of its obligations and/or the seller has no proof of the customer's insolvency, and, therefore, cannot exercise any stoppage of delivery rights? The trade creditor may still have concerns about the customer's ability to pay for goods sold on credit based upon the customer's perilous financial condition and/or the threat of the customer's imminent bankruptcy filing.
The answer is an alternative, less widely-known, UCC Article 2 remedy where the seller can demand adequate assurance of due performance from a financially shaky customer that the seller has reasonable grounds to believe will not be able to pay for goods sold or otherwise perform under their contract. Pending receipt of such assurance, and if commercially reasonable, the seller can suspend performance under the contract, including selling only on cash terms to the financially distressed customer.
There's a lot to chew on here. Let's flesh out some of these trade creditor remedies.
A Seller's Stoppage of Delivery Rights
According to UCC [section][section] 2-702, 2-703 and 2-705, an unpaid seller can stop delivery of goods not yet received by a buyer that is either insolvent or has failed to timely pay its obligations to the seller. A seller seeking to prove the insolvency of its financially troubled buyer can rely on the UCC definition of insolvency. The UCC defines insolvency on either an equity or balance sheet basis. Under the easier to prove equity definition, a buyer is insolvent when it is unable to pay its debts in the ordinary course of business or as they come due. Under the far more restrictive and harder to prove balance sheet definition, a buyer is insolvent when its liabilities exceed its assets.
According to UCC [section] 2-702(1), a seller can refuse to deliver goods to an insolvent buyer other than on cash terms. This remedy allows a seller to stop delivery of goods in its possession and condition further deliveries on a change from credit to cash terms.
An unpaid seller can also stop goods in transit, goods in the possession of a common carrier, warehouse or other third party bailee, where the buyer is insolvent or in default of its obligations to the seller. A seller that seeks to stop delivery of goods in transit must instruct the carrier, warehouse or other third party not to release any goods they are holding to the buyer. While there is no requirement for a written instruction to stop delivery, the seller would be wise to deliver a written demand to stop delivery to the carrier, warehouse or other bailee, and also send a copy of the demand to the buyer.
A carrier, warehouse or other bailee that receives a seller's notice to stop delivery of goods in transit, must hold and deliver the goods according to the seller's instruction. …