The Chapter 11 bankruptcy filings by Chrysler, LLC and General Motors are likely to create a ripple effect of defaults and lawsuits through all tiers of the automotive supply chain and will impact businesses connected to that supply chain. Although Chrysler has emerged from bankruptcy as Chrysler Group LLC and all signs suggest that General Motors will attempt to emerge from Chapter 11 proceedings very rapidly, the underlying bankruptcy cases may proceed for months, if not years. The ripple effect could cause primary or lower tier suppliers to stretch payables or seek their own bankruptcy protection. Taking steps now may help protect you against the effects of insolvent customers or suppliers and prepare your company for a possible waive of bankruptcy avoidance and preference actions.
The keys are simple: pay attention to Chrysler notices, GM news, and your customers and suppliers; use common sense business judgment when dealing with your customers and suppliers; preserve relevant records, identify knowledgeable personnel; and conduct a preference analysis.
1. Pay Attention.
In the Chrysler and General Motors Chapter 11 cases, certain suppliers were designated “critical vendors” and continued to be paid as if the bankruptcy case had not been filed. It is important to pay attention to those proceedings if your business is closely linked to the automotive supply chain. To begin, stay on top of all notices from the Chrysler and GM Bankruptcy Courts. Similarly, use common sense and closely scrutinize current relationships with your suppliers and customers. If you sell to Tier One suppliers, you may wish to consider exercising rights under the Uniform Commercial Code to obtain additional assurances of future performance from them. Such assurances will verify that the Tier One supplier will have the ability to pay for the product you deliver. Additionally, if your customers are insolvent, you have a right to stop goods in transit, return items yet to be delivered, and reclaim goods already delivered. Additionally, if your customer has become a “slow pay,” consider additional credit limitations, review margins, and adjust payment methods to C.O.D. or cash in advance.
If your supplier appears to be insolvent or is likely to end up in a bankruptcy proceeding, develop alternative sources of supply and, as appropriate, consider termination of existing supply arrangements with the vendor before the bankruptcy proceeding.
2. Protect Yourself From Bankruptcy Preference Actions.
Bankrupt entities in automotive supply chain may pursue avoidance actions against suppliers and other creditors, so it is always helpful to prepare in advance for possible recovery actions when you have received payments from an entity that is now in a bankruptcy proceeding.
Under the bankruptcy code, a debtor generally has two years to file suit to avoid and recover payments made to creditors during the 90-day preference period[1] before it sought bankruptcy protection. In general, a debtor may avoid payments made during the preference period if they were not made in the ordinary course of its business relationship with the creditor or otherwise were not made on terms customary within the industry and result in the creditor receiving more than it would have received had the debtor filed a Chapter 7 liquidation. Because a debtor can initiate a preference action months or years after the underlying transaction, taking the following steps now will help you maximize your potential defenses and minimize your exposure to a preference claim if it is filed:
- A complete set of business records can be the best defense to a preference action so, as soon as you learn that one of your customers is now a debtor in bankruptcy, organize and store your records, electronically or manually, of any transactions that resulted in a payment from the debtor within 90 days before the bankruptcy filing. Retain those records for at least 36 months or until advised otherwise by legal counsel. If the debtor files a preference action against you, you will save time and money by having the records on hand and available to your legal counsel.
- Identify personnel, including staff in the sales and accounts receivable areas, with knowledge of the transactions and record their information. If key personnel leave the debtor, obtain up-to-date contact information. Their assistance and testimony may be important in successfully defending a preference action. In addition, identify what is ordinary cause in your business or industry. Determine if value was given by extending credit after each payment was made during the 90 days.
- After gathering your business records, conduct a preference analysis to determine the company’s potential exposure to a preference action. Legal counsel can help with this analysis. If the preference exposure is significant, budget for the potential repayment and for legal fees.
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