The global supply chain is an often written topic in the press. Recent public company chapter 11 filings (usually Delaware or the Southern District of New York) highlight the global network of suppliers reflected in debtors’ lists of 20 or 30 largest unsecured creditors. This list often consists of offshore creditors from around the globe, whether Asia, Europe or South America.
Offshore suppliers who ship goods to the U.S. on credit should be wary of insolvent, or potentially insolvent, customers. Although U.S. Bankruptcy Code section §503(b)(9) provides that suppliers of goods are entitled to an administrative expense claim for the invoice value of the goods received by the customer within 20 days prior to their filing, an issue arises as to when the goods are received.
For many offshore suppliers, it is advantageous to ship goods to a U.S. customer “Free on Board port of origin” (“FOB”) as it places risk of loss during transportation on the customer. However, shipping goods FOB would also mean that the goods are technically received by the customer on the date of shipment. For many offshore shipments, this would mean that the shipment may have been received prior to the 20 day period of the customer’s bankruptcy filing, even if the goods were actually in the customer’s possession within the 20 day period.
The recent decision in In re World Imports, Ltd2, however, takes the §503(b)(9) priority claim protection away from the offshore supplier. There, the Bankruptcy Court held that an offshore supplier who provided goods to a U.S. debtor within 20 days of the bankruptcy was not entitled to a priority claim under Bankruptcy Code §503(b)(9) because the goods were “received by the debtor” at the time they were placed on the vessel at the port overseas more than 20 days before the debtor’s bankruptcy filing, even though the debtor took physical possession of the goods within the 20 day period.
The ruling of World Imports is a red flag for offshore suppliers and their global supply chain selling to U.S. customers on credit who are insolvent as they may not have a priority claim, leaving them with a non-priority claim, which translates to no distribution on the invoices. To avoid this harsh result, we consider ways the foreign supplier can reduce this payment risk.
The World Imports Court Ruling
In World Imports, a Chinese supplier had shipped goods to the Debtor within 20 days of the bankruptcy filing, and claimed that such prepetition delivery entitled them to an administrative priority claim pursuant to §503(b)(9). The supplier asserted that because §503(b)(9) does not define “receipt,” the Uniform Commercial Code should apply, which defines “receipt” as occurring when the buyer takes physical possession of the goods, which occurred within the 20 days required by §503(b)(9).
However, the debtor argued that given this was a contract for the international sale of goods the UCC was preempted by the federal CISG treaty. Under this treaty, Free On Board (“FOB”) delivery provides that the customer’s “receipt” occurs not when the customer takes physical possession, but when the vendor delivers the goods to the agreed upon carrier.
The bankruptcy court found that the contract was governed by the CISG. The court noted that the parties did not opt out of the CISG and concluded the delivery occurred outside of the 20 day window and barred the offshore supplier from administrative priority under § 503(b)(9). The World Imports only applies to international contracts between countries that have adopted the CISG treaty. The CISG has been ratified by 80 countries, including: Argentina, Australia, Bahrain, Belgium, Brazil, Canada, China, Columbia, France, Germany, Italy, Japan, Korea, Mexico, Netherlands, Russia, Singapore, Spain, Switzerland, Turkey, the United States, and Venezuela.
The Creditor Waterfall in Chapter 11
Suppliers selling on credit to an insolvent customer know well that when the customer files chapter 11, the value of the prepetition invoices that are very old, say 100 days, will typically bring but a few cents on the dollar, often years after the filing. The reason is the creditor waterfall or priority scheme of creditors. Secured creditors are entitled to be paid first from the collateral in which they have a security interest. After secured creditors, administrative or priority creditors are next in line. Each of these creditor classes are entitled to be paid in full prior to a junior class of creditor. Last in line of the creditor class is suppliers that have provided trade credit. Even though these suppliers may have undisputed invoices entitling them to payment, the problem is that they are at the bottom of the creditor waterfall and they face a shortfall. Thus, the World Imports case is significant as the §503(b)(9) claims are often paid in full.
The Credit Team Reducing the Risk of Being Ensnared in an In re World Imports Setting
So what steps can the offshore supplier take to reduce the payment risk that World Imports creates when that customer is insolvent? One step is for the supplier to opt out of the CISG’s application. Another option is moving the customer to CIA. However, the supplier may lose the business if terms are cut off. A supplier may also require the customer to post a letter of credit at the time it delivers the goods to the carrier, which insures that payment is made to the supplier at the time the “risk of loss” shifts to the customer. With a drawdown of an L/C, the supplier is protected from preference as the payment comes from a third party, the issuing bank of the L/C, and not payment from the debtor.
Key Concepts & Terms
§503(b)(9) of the Bankruptcy Code – provides that suppliers of goods are entitled to an administrative expense claim for the invoice value of the goods received by the customer within 20 days prior to their filing
FOB Origin – The acronym for Free on Board. A shipment for which the seller is responsible for transportation and shipping costs to the point where the goods are delivered to and loaded onto a carrier.
CISG: The Convention on Contracts for the International Sale of Goods. This international treaty has been signed by most industrialized nations and many that are not. Its provisions govern the formation and subsequent rights and obligations of the parties to international contracts, meaning those entered by parties in different countries, both of which countries are signatories to the convention. The list of countries changes almost every year. Current status of accession of a particular country to this convention can be checked, for prospective sales and international law concerns, at the CISG database.
Scott Blakeley, Esq., is a founder of Blakeley & Blakeley LLP, where he advises companies around the United States and Canada regarding creditors’ rights, commercial law, e-commerce and bankruptcy law. He can be reached at email@example.com.