Trade creditors take note: even though Chapter 11 debtors may
continue purchasing goods and services and may continue operating
in the ordinary course of their business, an earned cash payment in
the creditor's hands may not be safe from recovery. Moreover if
you are a party to a supply contract and under an obligation to
continue to furnish goods or services, the payments you receive may
be recoverable by a subsequently appointed trustee. The 11th
Circuit recently upheld a bankruptcy court ruling that a
post-petition trade vendor was required to return $1.9 million in
post-petition payments that the vendor had received from the
bankruptcy debtor in the ordinary course of business.
In Marathon Petroleum Co. v. Cohen [In re Delco Oil,
Inc.], Case No. 09-11759, 2010 U.S. App. LEXIS 5452 (March 16,
2010), the bankruptcy debtor filed for Chapter 11 bankruptcy
protection and sought a bankruptcy court order that would allow the
debtor to use cash collateral for operations. The debtor's
secured lender strongly opposed debtor's motion and
debtor's use of cash collateral. Approximately three weeks
after the bankruptcy filing, the Court denied the debtor's
motion to use cash collateral. In the meantime, however, the debtor
had paid Marathon approximately $1.9 million for goods that
Marathon supplied to the debtor post-petition.
After the Chapter 11 case was converted to Chapter 7, the Chapter 7
Trustee sued Marathon to recover the $1.9 million as unauthorized
post-petition transfers under Section 549 of the Bankruptcy Code.
The bankruptcy court held (and the 11th Circuit agreed) that the
payments were recoverable as post-petition transfers of estate
property that had not been authorized by the Court or by the
Bankruptcy Code. The transfers were recoverable even though the
debtor had paid the vendor in the ordinary course of the
debtor's business and even though the payments were
compensation for post-petition goods that the vendor had sold to
the estate. The bankruptcy estate kept the goods and the vendor
was, presumably, left with only an administrative claim against the
estate for the value of those goods.
The Marathon Petroleum opinion creates uncertainty for trade
creditors who are selling goods and services to customers in
bankruptcy. Traditionally, a trade creditor who continued selling
post-bankruptcy was protected so long as the creditor received
payment on delivery. Under the 11th Circuit's approach,
however, a vendor who sells goods and services, even COD, in the
first days of a customer's bankruptcy runs the risk that the
Court may later deny the debtor use of Cash Collateral –
in which case, all transfers would be "unauthorized" and
the court could order the creditor to give back the payments.
The 11th Circuit did not consider the importance of what the trade
creditor did or did not know at the time of the sale. The lower
court opinions in Marathon Petroleum note that Marathon knew about
the debtor's bankruptcy and knew about the secured lender's
objections, yet continued to ship and accepted payments without a
court order in place. The 11th Circuit, however, did not rely on
this fact and it is thus unclear whether a vendor who sells without
knowledge of a cash collateral dispute – or for that
matter, without notice of a debtor's recent bankruptcy
– would be equally vulnerable.
The Marathon Petroleum ruling is a warning to trade creditors who
sell to customers in bankruptcy. The case suggests that creditors
should delay any post-petition sales until the customer provides a
cash collateral order that protects trade creditor payments.
Alternatively, trade creditors may require adequate assurance even
if sales are COD. This would require the filing of a motion with
seeking that the debtor be required to provide adequate assurance
that the supplier of goods or services will be paid. The other
option, at least for some creditors, is to forego the sale rather
than accept a payment that may have to be returned. On the other
hand, creditors that are obligated to continue performing under
contracts may have little option but to accept the risk of
disgorgement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
