As the automotive industry continues to restructure, whether through self-liquidation or government intervention, suppliers will inevitably be confronted with many of the same issues prevalent 4-5 years ago, including a supplier’s obligation to continue to provide goods post-petition and the supplier’s rights to adequate assurance as a condition to such shipment.
Often, certain factors will lead a seller to believe that a buyer is experiencing financial difficulties which may result in the buyer’s inability to provide payment for goods, or otherwise render it unable to perform its obligations under an agreement. Perhaps the relationship in the auto industry most susceptible to such concerns is that between the supplier and customer, where the supplier believes the customer is in financial crisis and it is industry knowledge that the customer is considering a major restructuring or even filing for bankruptcy. In such a situation, the supplier is likely to experience subjective, although not necessarily objective and reasonable, insecurity with respect to the customer’s ability to perform under the existing purchase orders and requirements contracts that it has with the customer.
Applied frequently in situations prior to any bankruptcy filing, section 2-609 of the Uniform Commercial Code (the “UCC”) authorizes a party, upon reasonable grounds for insecurity, to demand adequate assurances of due performance and until it receives such performance, . . . if commercially reasonable, to suspend any performance for which he has not already received the agreed return. However, the UCC does not require a party to request assurances as a condition precedent to recovery. The purpose of a demand under section 2-609 is to permit a party likely to be injured by the other party’s nonperformance to take steps to protect itself without worrying that its own nonperformance will later be construed as a repudiation.
Whether a supplier has reasonable grounds for insecurity is generally a question of fact. Because the reasonableness of a supplier’s insecurity is determined by commercial standards, an objective factual basis must exist for the supplier’s insecurity, as opposed to a purely subjective fear that the customer will not perform.
A buyer who has recently filed for Chapter 11 bankruptcy is likely to insist that its suppliers continue to ship goods and seek to compel performance by filing a motion to enforce the automatic stay and the underlying contract.1 Debtors are increasingly seeking to enforce prepetition credit terms without any assurances of post-petition payment to suppliers. However, suppliers are not without recourse and legal argument, as illustrated by a recent motion filed by a supplier in In re Visteon Corp., Case No. 09-11786 (Bankr. D. Del.).
In the Visteon bankruptcy cases, Visteon suggested that suppliers were not entitled to cash on delivery or cash in advance, despite the fact that the debtors were insolvent and had no debtor in possession financing. In support of its position, Visteon sent letter to its allegedly recalcitrant suppliers stating:
Under section 362 of the Bankruptcy Code, an automatic stay has been imposed to prevent third parties from taking actions against the assets of the Debtors (including the Debtors’ contracts) without prior approval of the Bankruptcy Court. [Supplier’s] actions to unilaterally modify and interfere with the Debtors rights under the Debtors’ contract[s] with [Supplier] . . . would violate the automatic stay.
Prior to Visteon’s bankruptcy filing, one of Visteon’s suppliers sent a demand for adequate assurance of future performance under section 2-609 of the UCC. The supplier subsequently received acceptable adequate assurance, but nonetheless was owed approximately $2.5 million, of which $179,000 was past due. When Visteon filed for bankruptcy, the supplier informed Visteon that it was prepared to continue to ship post-petition, but only in the event that Visteon provided payment on cash in advance basis. Visteon, however, refused to agree to cash in advance terms and reiterated that such a demand was a violation of the automatic stay. The supplier aggressively disputed the debtors’ position by filing a motion requesting, among other things, adequate assurance under section 2-609 of the UCC on a post-petition basis.
The supplier argued that shipping post-petition on prepetition credit terms would unfairly expose it to significant economic harm, especially in light of the fact that Visteon (i) admitted it was administratively insolvent, (ii) had no debtor in possession financing or other long term source of working capital, and (iii) had a limited right to use cash collateral. The supplier further argued that if forced to adhere to prepetition credit terms, it would in essence be forced to finance Visteon’s bankruptcy and suffer from the risk of an administratively insolvent estate.
The supplier’s motion emphasized that Visteon’s use of cash collateral alone was insufficient to assure the supplier that Visteon would continue to satisfy its obligations to the supplier post-petition by noting, among other things:
- Visteon’s lack of a post-petition working capital facility;
- Visteon’s admitted insolvency;
- cash collateral financing could be terminated as a result of an event of default with no notice to the supplier;
- a cash collateral budget that failed to contain a line item for payment to the supplier and only a generic line item entitled “operating disbursements;”
- no carveout from the secured lenders’ post- petition liens for the payment of goods deliv ered by the supplier to Visteon prior to the occurrence of an event of default but unpaid as of the date of the default; and
- a cash collateral order structured to provide maximum protection for a particular OEM and creditors who supply parts for that OEM, when the supplier’s parts are not used for that OEM.
The supplier also attempted to refute any claim of Visteon that it would be adequately assured of future performance as a result of the supplier’s administrative expense under section 503(b) by stressing that Visteon has not demonstrated that it is not administratively insolvent or is not at risk of administrative insolvency. Finally, the supplier emphasized that its refusal to ship absent cash in advance or other forms of security was supported not only by section 2-609 of the UCC, but also sections 2-702(1), 2-703 and 2-610(c).2
Ultimately, Visteon and the supplier appear to have resolved the dispute before the bankruptcy court considered the supplier’s motion. However, Visteon’s assertion that a supplier cannot demand cash in advance or some other form of adequate assurance for post-petition shipments is likely to occur with a great deal of frequency in the future. In such instances, suppliers should take note of the aggressive posture assumed by Visteon’s supplier in this particular instance and not hesitate to file a similar motion to protect against potential post-petition losses.