Protections When Supplying to a Troubled Customer

Automotive sales in North America continue to climb, and many suppliers are prospering. However, there are some companies who are struggling and who may face bankruptcy. We have seen companies such as A123 Systems and certain subsidiaries of Revstone Industries recently file for protection under the Bankruptcy Code. How can a supplier to a troubled company protect itself? Must a supplier continue to supply on credit terms? The Uniform Commercial Code may assist such a supplier in this situation. UCC Section 2-702 permits a supplier, under certain circumstances, to withhold future deliveries and reclaim goods already delivered to an insolvent buyer.

Section 2-702(1) of the UCC provides that “[w]here the seller discovers the buyer to be insolvent he may refuse delivery except for cash including payment for all goods theretofore delivered under the contract.” This right to stop delivery is reinforced by § 2-705, which allows a supplier to “stop delivery of goods in the possession of a carrier or other bailee when he discovers the buyer to be insolvent . . .” These provisions reflect the unfairness of forcing a seller to sell goods on credit when the buyer is manifestly unable to perform its part of the bargain. Thus, when a buyer becomes insolvent, the seller need not deliver the goods. Rather, the seller can withhold or stop in transit the delivery of the goods until the seller is assured of the buyer’s ability to pay cash on delivery, despite the fact that the contract terms may provide for the seller to sell the goods on credit. Withholding delivery in such a manner amounts to a suspension of performance and not a termination of the contract.

If the buyer has filed for bankruptcy by the time the seller determines that it wants to withhold delivery, the application of § 2-702 becomes somewhat more complicated. Some litigants have argued that the seller’s post-petition exercise of its rights under § 2-702 violates the automatic stay imposed by § 362 of the Bankruptcy Code, which prohibits, among other things, “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” However, several bankruptcy courts have rejected this argument and have allowed sellers to withhold performance to bankrupt buyers without seeking relief from the automatic stay in the bankruptcy court. Whether performance can be suspended after a buyer files for bankruptcy requires a thorough examination of the particular facts and circumstances.

Finally, beyond the seller’s rights to withhold delivery of goods, UCC § 2-702(2) allows a buyer to “reclaim” goods shipped to an insolvent buyer “upon demand made within 10 days after the receipt, but if misrepresentation of solvency has been made to the particular seller in writing within 3 months before delivery the 10 day limitation does not apply.” There are, of course, other rules that apply in such circumstances, but the right of reclamation may be useful to a seller and is a right that is preserved, and in some cases expanded, in bankruptcy proceedings.

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