Editor’s Note: Paul A. Fanning is a member of the Financial Institutions and Creditors’ Rights Practice Groups of Ward and Smith, P.A.

The current economic downturn is unprecedented in modern times. Consumer sales are down and credit is tight. Bankruptcy filings are rising and trade vendors are being left with large unsecured claims in those bankruptcy cases. However, there are many powerful tools vendors such as technology companies can use under state and federal law to reduce their exposure to loss before and after a customer files bankruptcy.

Review Your Contracts

Now is the best time to get your customer contracts in order. That includes making sure you understand what your remedies are if your customer won’t pay and who is responsible for payment. Additionally, it is also important that you understand what collateral is pledged for payment. Now may be a good time to negotiate enhanced protections.

Know/Exercise your Rights and Remedies

The Uniform Commercial Code ("UCC") provides you, as a vendor, with powerful tools. You should know your rights under the UCC, be in a position to exercise them without hesitation, and consult with your attorney if you have questions. Article 2 of the UCC provides the following remedies for vendors whose customers have defaulted:

• Withhold delivery of goods. This device can be very effective. Withholding delivery of goods until you receive adequate assurance of performance is a good business decision.

• Stop delivery of goods. Even if your goods are in transit, you can stop their delivery until the customer provides adequate assurance of performance.

• Resell goods. If you withhold or stop the delivery of goods to the defaulting customer, you can use reasonable judgment to resell them in a commercially reasonable manner and recover the difference between the price paid by the substitute purchaser and the price you were entitled to receive from the defaulting customer, as well as loss in time of transit.

• Reclaim goods. You can reclaim goods already delivered to a customer by demanding their return within a reasonable time after you discover that payment was not made. Insolvency of a customer, even if the customer has not yet defaulted on your contract, also provides grounds for reclamation rights. In certain cases, this tool is available against a bankrupt customer as well, as explained below.

• Cancel the contract. You can cancel a contract by giving the customer reasonable notice of cancellation. Even after cancellation, you can pursue your other remedies.

• Renegotiate the terms of your contract. If your contract allows, you can impose shorter payment terms or require COD or cash in advance payment for shipment. You should consider terminating or modifying supply agreements and evaluating the costs and time delay of re sourcing, as long as such modifications do not breach the terms of your existing contract. In fact, using nonpayment or late payment by a customer as an opportunity to re negotiate unfavorable provisions in the original contract can put you, as vendor, in a better position in the long run. All contract modifications should be documented properly, and you also should consider requesting additional assurances of payment. For example, requiring the customer to henceforth provide you with security deposits, letters of credit, third party guarantees, or additional collateral may be enough to provide adequate assurance of the customer’s future performance.

• Assert statutory lien rights. There are also statutory liens under state and federal law that may provide you protection, even if your contract is silent as to lien rights. For example, North Carolina and federal statutes contain mechanics’ liens, tooling liens, artisans’ liens, landlords’ liens, and shippers’ liens which are intended to give certain vendors additional remedies in order to keep commerce flowing. You should consult counsel to determine whether these types of protections can work for you.

Post-Bankruptcy Strategies: Act Early

Even if you’re too late and your customer already has filed for bankruptcy protection, there are still valuable tools for you to use to maximize your recovery. However, all of these rights and remedies must be exercised early in a customer’s bankruptcy in order to result in a possible elevation in the priority of your claim.

• Reclaim goods. Under Section 546(c) of the Bankruptcy Code, a vendor may demand reclamation of goods received by the debtor customer in the ordinary course of the vendor’s business within 45 days before the bankruptcy. To preserve this claim, you must make a written demand no later than 20 days after the bankruptcy filing. If your reclamation claim is subject to a prior perfected security interest (e.g., a traditional lender), you still may be entitled to be paid as an administrative claimant, as set forth below.

• Assert an administrative expense claim. Under Section 503(b)(9) of the Bankruptcy Code, a trade vendor may assert an administrative expense priority claim for the value of goods that were received by the debtor in the ordinary course of business within 20 days before the bankruptcy filing. This claim must be asserted by motion or application for payment and cannot be made simply by filing a Proof of Claim. In many cases, the Bankruptcy Court can order immediate payment to the vendor.

• File a Proof of Claim. You also should file a Proof of Claim with the Bankruptcy Court to the extent you have any claim against a bankrupt customer. Doing so early is the prudent thing to do to make sure your claim is recognized and you are kept abreast of the status of the bankruptcy proceeding.

• Use caution in taking any action outside of the bankruptcy case. Certain actions by creditors while a debtor is in bankruptcy are prohibited by the "automatic stay" that is imposed immediately after a bankruptcy case is filed. Therefore, once a bankruptcy case is filed, you no longer should request or demand payment of a debt incurred by the bankrupt customer before the bankruptcy filing or threaten to terminate your existing contract unless you follow proper Bankruptcy Court procedures. It is important that you avoid taking a prohibited action that can work against you later.

Conclusion

The economic downturn has hit all sectors of our economy. Now is the time to take action. Be prepared for future challenges, and do not wait until your largest customer has filed bankruptcy before you act to preserve your rights and get paid. Know your rights and remedies and employ them with diligence.

© 2009, Ward and Smith, P.A.

Ward and Smith, P.A. provides a multi-specialty approach to the representation of technology companies and their officers, directors, employees, and investors. Paul A. Fanning practices in the Financial Institutions and Creditors’ Rights Practice Groups. Comments or questions may be sent to paf@wardandsmith.com.

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.