Experts Weigh In: What Happens to Customers in the Event of Bankruptcy Filings?May 31st, 2011 by DWM Magazine
In recent months the door and window industry has continued to see changes occur in various companies, including and bankruptcy filings. The recent news that United States Aluminum, along with its sister company, International Window Corp., had filed Chapter 7 bankruptcy may have been a surprise for some in the industry. Additionally, Florida Extruders International was one company who filed for Chapter 11 recently. And as much of the construction industry continues to struggle, it’s not unlikely that another could happen in the future. In such an instance, though, what can customers do to protect themselves?
Mark Lindsay and David Ross are both shareholders in the creditor rights and insolvency group with Pittsburgh-based Babst Calland, Attorneys at Law. Ross says it’s first important to understand the differences in a Chapter 7 compared to a Chapter 11 bankruptcy.
“A Chapter 7 is a liquidation of the debtor’s assets; the company is shut down and it does not continue to do business,” says Ross. “A trustee is appointed by the court who attempts to liquidate the assets and sell them for the benefits of the creditors. In a Chapter 11 a company attempts to reorganize, continues to operate and emerges as a restructured business.”
So in the case of a Chapter 7, such as that of U.S. Aluminum, customers are unlikely to recoup any deposits or receive any ordered materials.
“Unless there was some type of special agreement regarding treatment of the deposit, that money is likely unrecoverable,” says Lindsay. “It’s not something a customer can simply get back.”
Lindsay says there are a couple possible scenarios.
“First, if a customer orders 10,000 units, for example, and provides a deposit to the manufacturer, the question becomes, where does that money go?” Lindsay says, noting that it may have been used to purchase raw materials or may simply have been used to cover expenses (bills, payroll, etc.).
“The purchaser, however, could seek protection of the deposit by requesting it be placed into an escrow account and once he receives his order the money will be delivered,” Lindsay says. “[In a Chapter 7] if a deposit has been placed for materials, without such protection the trustee would not likely deliver those materials unless there is a benefit to be derived from doing so. He’s not responsible [for those] purchase orders. But if specified material had not yet been delivered and it’s still in the warehouse the trustee may still want to have it delivered and the balance of the purchase price paid.”
Ross adds, “A customer can’t force the trustee to make and deliver the materials, though.”
Both Lindsay and Ross agree that when a deposit is required, ideally it should be placed into a separate escrow account where it’s protected. Otherwise the company can use it and it’s gone.
And in the case of materials, Lindsay and Ross say the trustee will likely deal only with whatever is there.
“If there are some materials on the ground, the trustee may deliver them if he/she can obtain a benefit from doing so, but in a Chapter 7 there is probably nothing left,” says Lindsay.
So, with so much uncertainty these days, is there anything a customer can do to best protect his/her business?
“The first lesson for the people placing the order is to know your suppliers,” says Ross. “There are always rumors and gossip circulating and that information is valuable. Google the suppliers, read articles, [find out] how they have sent orders in the past. And the second lesson, if asked for a deposit, then find out and understand what the terms are.”
And what about warranties for materials already ordered, received and installed?
“Generally speaking, warranty claims constitute general unsecured claims in a bankruptcy case and receive no special treatment,” explains Lindsay. “They are, unfortunately, subject to the same fate as other general unsecured claims, which is dependent upon whether or not there are estate assets sufficient to pay such claims in a liquidation scenario.”
He adds that in a Chapter 11, though, where a debtor reorganizes and continues operating, warranty claims are often provided for in the Plan of Reorganization as obligations to be honored by the reorganized debtor. Lindsay says that although a plan is not required to provide this it often makes the most sense for a debtor in order to garner support for its plan and maintain a satisfied customer base going forward.