Speed is Power:  Minimize your exposure when your customer files for Bankruptcy.

By: Tyler N. Hayes

Transportation creditors generally have the most leverage during the initial weeks of a bankruptcy proceeding.  That is why it is important to take the necessary steps to protect your interests as soon as possible.  The sooner you move to protect your rights, the more power you will generally have to effectively do so.  More important than taking immediate action, however, is taking the RIGHT action.  Bankruptcy can be a minefield. 

Actions that seem intuitive from a business point of view can squarely violate the bankruptcy code and potentially cause many more problems than you hope to avoid.  It is important to seek the counsel of an attorney with experience in both transportation law and bankruptcy law in order to avoid the potential pitfalls of bankruptcy.

The first step you must take when you learn that a customer has filed for bankruptcy is to stop all collection activities against that customer.  The filing of the bankruptcy petition triggers the “automatic stay” provision of the bankruptcy code.  The “automatic stay” prohibits creditors from starting or continuing any collection efforts against the debtor or its property.  Creditors who violate the stay can be held liable for damages and sanctions.  It’s important to keep in mind, however, that the automatic stay applies only to the debtor.  Other parties who may be jointly liable-other parties on a bill of lading, for example-receive no protection from the automatic stay and may become your best, or only, recourse for payment.  Competent counsel can advise you on which actions, and against which parties, are allowed in a bankruptcy scenario.

Contemporaneous with ceasing collection activities against the debtor, a carrier should quickly determine whether or not it has possession of any goods in transit consigned by the debtor.  Michigan law gives carriers a lien on goods covered by a bill of lading for any charges incurred subsequent to their receipt of the goods for transportation or storage.  The law requires that the carrier have possession of the goods to exercise its lien rights, and the lien can only be exercised against freight charges related to the goods under that bill of lading.  A carrier does not have a statutory lien on goods for charges related to other freight shipped under other bills of lading.  Asserting such a lien can leave a carrier open to liability for conversion.  It is important, however, to review your contract with the debtor (if you have one apart from the bill of lading) to determine whether your lien rights have been modified by contract.

Carriers and other transportation service providers (3PL’s) also need to review their contracts with the Debtor to determine if they have continuing obligations to the debtor.  While companies that provide services on open terms to the debtor are generally not required to continue doing business with the Debtor, companies with ongoing service contracts likely do not have unilateral ability to discontinue doing business with the debtor.  These contracts are considered “executory contracts” by the bankruptcy code and are subject to different treatment.  Transportation attorneys with bankruptcy experience can best advise you on dealing with executory contracts in bankruptcy, whether you are seeking to have your contract assumed or terminated.

Carriers and others that continue to do business with the Debtor during the bankruptcy need to take steps to limit their exposure.  Insisting on shorter terms, or even COD can limit your exposure to further losses.  While services provided to the Debtor during bankruptcy are accorded “administrative expense” status and have a higher priority, a conversion from a Chapter 11 to a Chapter 7 can put your claim back at the end of the line.

Finally, a Chapter 11 Debtor needs to keep freight moving to stay alive during the reorganization process.  Certain carriers and transportation service providers may be in the position to seek “critical vendor” status.  If a provider qualifies for critical vendor status, it can receive payment in full of pre-petition obligations in exchange for continuing service while the bankruptcy is pending, subject to approval by the court.  A carrier or other service provider is often in the best position to negotiate critical vendor status during the initial days or weeks of the bankruptcy. 

Articles are designed to provide general information of interest.  Articles cannot substitute for in-depth legal analysis of your particular problem. Readers are encouraged to seek counsel regarding individual situations.