14 Sep The Law of Unintended Consequences
Unfortunately, life is full of them . . . and so is the 2005 Bankruptcy Code. Today’s post will discuss just one: The expanded protection afforded trade creditors under Section 503(b)(9).
What does this section do? And just how much protection does it provide? As amended, Section 503(b)(9) was intended by Congress to protect vendors who supplied goods to a debtor within 20 days of a debtor’s bankruptcy filing by extending “administrative” (i.e., 100% payment) status to their claims. Along with amendments to Section 546(c), the idea was to protect vendors who extended credit to a debtor immediately before the debtor filed a case. But in fact, Section 503(b)(9)’s application may now be leaving many such vendors at greater risk.
How so? A recent Daily Deal piece by Natixis’ Christophe Razaire briefly outlines three general problem areas.
– Goods? Or services? Section 503(b)(9) protects suppliers of goods well enough, and understandably so: Along with Section 546(c), it is designed to preserve and augment the protections extended to the same vendors under the Uniform Commercial Code. But what about suppliers of services? Unfortunately, as a number of creative service providers have discovered, the Code offers no such similar protection. Moreover, where a company relies primarily on services for its activity, it appears doubtful that the Code’s amendment does anything to alleviate the risk of a debtor’s default and eventual bankruptcy.
– Payment? Or post-petition payables? Though Section 503(b)(9) provides administrative priority for “20-day” vendor claims and Section 546(c) likewise permits vendors to assert reclamation demands for goods supplied immediately prior to the debtor’s filing, in practice, vendors rarely see any early compensation in the case.
Instead, a bankruptcy court is far more likely to simply afford such claims their entitled administrative status, then require the vendors holding them to wait until the conclusion of the case for payment. Economically, this means that vendors who should be enjoying administrative protection and receiving cash are, in fact, merely exchanging one “IOU” for another – and, in the meantime, suffering as much liquidity distress as any other general unsecured creditor.
Needless to say, this liquidity distress has to be dealt with in some fashion. And it is often addressed through a refusal to further supply the debtor-in-possession except on “COD” or similarly restrictive terms. Alternatively, other customers of a cash-strapped vendor may feel the squeeze through tightened terms as the vendor struggles to compensate for large – but unsatisfied – administrative obligations owed by the debtor.
– Administrative protection? Or administrative insolvency? Perhaps the most unintended consequence of Section 503(b)(9)’s amendment is that business reorganizations involving large numbers of “20-day” claims may, in fact, be threatened by its application.
“20-day vendors” can, if they so choose, accept payments on their administrative claims at a discount – and, in fact, it is not uncommon for debtors to attempt to cut such deals. But where there are numerous “20-day” claimants, the debtor often faces very slow, arduous negotiations. Many vendors are reluctant to negotiate with the debtor for fear of “selling out” too low; others may try their hand at brinksmanship, betting that the debtor’s need to satisfy such claims prior to emerging from bankruptcy will reward their willingness to “hold out.”
Often, the “reward” for such bargaining is something less than creditors may have hoped for. The debtor concludes it cannot negotiate and must instead incur the [additional] administrative expense of contesting such claims directly in an effort to reduce their aggregate amount. If these claims disputes do not go the debtor’s way, or if the debtor is already struggling to emerge with sufficient cash, the debtor may be forced to liquidate – thereby leaving all creditors, from secured debt to general unsecured claims, with far less than might otherwise be the case.
How big can these problems get? A recent “Dealscape” blog post by Ben Fidler illustrates how the section is playing out in the troubled retail and auto parts sectors, where vendors of goods often play a significant role in a company’s operations. Fidler points to larger Chapter 11 filings, such as Empire Beef Co., Blackhawk Automotive Plastics, Inc., and Plastech Engineered Products, Inc., which have been left administratively insolvent or have been threatened with such insolvency, as a result of section 503(b)(9)’s amendments.
Though not every case is as large as the ones cited by Fidler – and not every case results in administrative insolvency – similar dynamics with similar results can just as easily arise in smaller Chapter 11’s.
In sum, this anecdotal data suggests that Congress’ well-intended efforts to afford some creditors with more options in a debtor’s reorganization may, in fact, have left all creditors with far less options.
Surely, this cannot have been Congress’ intended consequence.