Article

A New Concern for Vendors Doing Business with Companies in Chapter 11

June 29, 2010

The March 16, 2010 decision issued by the Eleventh Circuit in In re Delco Oil Co., 2010 WL 918058 puts vendors at risk for the claw back of payments they receive for goods or services purchased by companies in Chapter 11 bankruptcy.

In Delco, a vendor supplied $2 million worth of goods to Delco, a Florida-based motor fuel distributor and gas station operator that was in Chapter 11 bankruptcy. Delco paid the vendor for the goods in the ordinary course of doing business. It turned out, however, that the bankrupt Delco needed, but did not get, permission from the bankruptcy court to use its cash. The court ordered the vendor to return to the bankruptcy estate the money it received as payment from Delco. The vendor appealed twice, but both the district court and the Eleventh Circuit af-firmed the bankruptcy court decision.With the Delco decision in place, vendors that accept payments from a debtor that does not have the authority to use its cash are at risk for the bankruptcy trustee to try and claw back those payments, even if the vendor provided goods or services to the debtor. Particularly if you are a vendor dealing with a company that has filed bankruptcy in Alabama, Florida or Georgia, you will need to make sure that the debtor either has authority or needs no authority to use its cash. And, unless or until other courts reject Delco, it would be prudent for vendors to make sure that all debtors they are dealing with have or do not need authority to use their cash, regardless of where the debtor filed for bankruptcy.

Behind The Delco Decision
The Bankruptcy Code provides that when a debtor files for Chapter 11 and there is a creditor that has a lien on the debtor’s assets, the debtor must either have approval from its secured creditor or seek permission from the bankruptcy court in order to continue using cash that might serve as collateral for the secured creditor.

Before Delco, no court had ruled that unauthorized payments made by a Chapter 11 deb-tor could be clawed back from a vendor that provided goods and received payment. It was pretty safe to assume that if the debtor ordered goods or services, it could pay for them with money that it was making from the sale of its own goods or services. In most Chapter 11 cases, this approval and a court order allowing the use of cash happens in the first few days after the debtor files. If approval is not granted, typically the debtor shuts down and the case is converted to Chapter 7 liquidation. Receiving payment from a debtor in Chapter 11 rarely required investigation into whether such payment was authorized.

Critique of Delco Decision

Delco seems to be a bad decision due to the burden it puts on the vendor, and due to the delay it may cause a debtor in procuring necessary goods and services.

The unusual thing about Delco is that the facts were quite favorable to the vendor. It was uncontested that the debtor received goods of a value that were at least equal to the amount paid to the vendor. It also was uncontested that the vendor acted in good faith and did not know that the debtor lacked authority to use cash collateral. The vendor argued that no one was harmed by the payment.

On the other hand, a secured creditor may oppose the debtor’s use of cash when it has determined that its collateral position is deteriorating with no way to shore it up. The secured creditor also may object to the use of cash because the lender has determined that there is no way the debtor could propose a feasible Chapter 11 plan for repayment. In other instances, there may be extreme mismanagement. Regardless, when a secured lender is able to make a case that the debtor should not use its cash collateral – as was the case in Delco – then the secured creditor whose position is deteriorating daily may be harmed if its cash collateral is paid to third parties.

Conclusion
Right or wrong, Delco can’t be ignored. Even though most debtors are permitted to use cash collateral, at least in some limited way, at the beginning of a Chapter 11 case, we recommend that vendors check to see if the debtor is authorized to use cash prior to selling the debtor any goods or services.

For a more detailed examination of the Delco case, click on the link below to see an article by Jonathan Friedland and Bill Schwartz published in the ABI Journal.

Punishing the Innocent_Lessons From Delco Oil.pdf

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