1. Preparing for Your Customer's Chapter 11: the Rise of Supplier Vigilance to Protect A/R (Including 503(b)(9) Claims) and Reduce Preference Risk
Brad Boe
Director of Credit
Scott E. Blakeley, Esq.
Partner
Ronald A. Clifford, Esq.
Partner

2. State of the Retail Industry
Intense competition
Capital intensive
Saturated industry
Fickle consumers
Expansion through incurring debt
Leased real estate

3. Major Bankruptcies American Apparel BCBG Max
Garden Fresh Restaurant Corp
Gordmans
Gymboree
HHGreg
Ignite Restaurant Group
Logan’s Roadhouse
Payless Shoes
Rue21
Sports Authority

4. State of the Retail Industry
MACRO TREND CONSIDERATIONS
Cost of Goods –demand for higher quality will result in significant COGS increases, narrowing already thin margins
Oversupply, competition and labor related concerns
Rising interest rates
Increasing competition from grocery and convenience store offerings
What factors are affecting you industries

5. Supplier Strategy with Insolvent Customer: Alone or Team Approach
Supplier Pact
Benefits
Unique claim
Negotiate repayment plan
Race to the courthouse: first to the assets
Risks
Expense and resources to act alone
Customer silence
Preference risk
Complaining about customer’s silence: defamation and libel
Benefits
Same priorities
Threat of an involuntary petition
Share costs
Risks
Antitrust concerns
Share results with others
Freerider risk

6. Trade Creditor Pre-Petition Concerns
Key Market Share Losses
Multiple agencies track data and are found in industry news publications, analysts’ reports and subscription services
Declining same store sales
Changes in lending agreements
Frequent covenant breaches and forbearance agreements
Poor store presentation
Departure of CEO/CFO and/or insertion of a CRO
Employee rumors and mass departures/layoffs
Changes in communication patterns

7. Trade Creditor Pre-Petition Concerns
Financial metrics
Capital Structure
Declining EBITDA
Declining same store sales
Eliminating or drastically reducing capex spending
Requests from customers for extended terms
Wage increases
Reducing total amount of retail locations
Slowdown of customer payments
Eliminating discounts and impact on bottom line
Technological investment

8. Trade Creditor Post-petition Concerns
Request appointment to the unsecured creditors committee
Obtain critical vendor status
Undergo a preference defense analysis – ordinary course and new value
Assert 503(b)(9) claims – enter into a trade creditor agreement for pre-petition payments of 503(b)(9) claims in the ordinary course in exchange for post-petition terms of sale
Set-off right

9. 503(b)(9) Administrative Priority Claims
Bankruptcy Code section 503(b)(9) grants goods suppliers a priority claim for goods received by debtor within 20 days prior to filing
503(b)(9)’s must be paid before a plan can be confirmed
Debtor may load up on inventory on credit terms and then delay planned bankruptcy filing to limit 503(b)(9) claims
In many Chapter 11’s, 503(b)(9) claims are the only claims paid of the supplier class
Suppliers at risk of losing on 503(b)(9)’s can file an involuntary bankruptcy petition, which allows the 20 day look-back to start the day it is filed
Petitioning creditors preference evaluation before filing

10. The Involuntary Bankruptcy Petition
Petitioner's due diligence
Eligibility to file:
Claims subject to bona fide dispute
Contingent claims
Unsecured claims aggregate $15,325
Three or more petitioning creditors
The Standard: The debtor generally not paying its non-disputed debts as they come due
Bad Faith filings

11. Trade Creditor Post-petition Concerns
Can you protect post-petition trade credit with liens on unencumbered assets or letter of credit carve outs
Evaluate strategic alternatives – pursue a strategy that maximizes value for the unsecured creditors – this may men a lower recovery for the GUC’s while increasing while increasing liquidity for the debtor to give a longer runway toward
Assess whether the restructuring will create a viable business going forward or whether the process is being run solely for the benefit of the secured creditors
Determine whether restructuring is preferable or whether a sale is in the best interest of creditors and will generate greater recoveries

12. Trade Creditor Post-petition Concerns
Review short term liquidity projections – do the short term cash flow projections allow for reasonableness of the size of the DIP and exit facilities
Is the DIP large enough to get the debtor through a confirmed plan of reorganization with post confirmation financing or is the DIP structured only to get through a 363 sale
Assess the terms of the DIP – preserve and pursue the pre-petition unencumbered assets for the benefit of the GUC’s

13. Trade Creditor Post-petition Concerns
Are the DIP carve outs adequate to cover committee professional fees and investigate the validity of the pre-petition liens
Assess the debtor’s go forward business plan and projections-review the long and short term projections and develop an independent point of view of the business plan along with long term liquidity

14. Trade Creditor Post-petition Concerns
Are locations cash flow positive or negative? Is EBITDA positive or negative?
Has a complete four wall analysis been performed on all locations?
Key Employee Retention Plan (KERP) – are they necessary and are they overinflated? Make KERP performance based upon obtaining key financial metrics.

15. Trade Creditor Post-petition Concerns
Is there a Plan Support Agreement (PSA) and has it been reviewed by the committee?
What does acceptance or rejection of your contract mean to your organization?
Are you entitled to contract rejection damage claims?
Proofs of claims – accounts receivable, proprietary inventory and contract rejection damage claims.

16. Trade Creditor Post-petition Concerns
Investigate pre-petition liens – validate properly perfected liens
Minimize dilution of recoveries – understand contract rejection and potential damage claim (employee wages)
Assess possible causes of action – analyze pre-petition transactions, current and former management, insiders, and challenge blanket releases for negotiations to maximize unsecured creditor recoveries

17. Considerations And Options When Faced With A Troubled Account
Tension between credit and sales
Get the money vs. concern for unusual conduct
Additional dunning or financial reporting
Manner of payment
Changes in invoice terms or credit limits
Letting payment times slide
Settling outstanding amounts

18. Hedging Nonpayment Risk
Letter of credit
Credit insurance
Certificate of deposit
Personal guaranty
PMSI
Consignment
Sale through distributor
Drop ship to vendor controlled warehouse

19. Dealing with Chapter 11 Filing
The preference clawback
Purpose of this provision is two-fold
Creditors discouraged from racing to courthouse
Debtors discouraged from preferring certain creditors
Elements of a preference
Statutory defenses
Contemporaneous exchange
Ordinary course of business
Subsequent new value

20. Responding To Preference Demand Letters
Make sure preference defense analysis has been completed
Was there consistency in the amount and manner of payments which were tendered to you prior and during the preference period?
Was there an absence of any unusual collection activity or other action taken by you to gain an unfair advantage as a result of the debtor’s deteriorating financial condition?
Did you continue doing business with and extending credit to the debtor as a financially distressed customer?

21. Responding To Preference Demand Letters
Was there consistency between the alleged preference payments and the debtor and your payment history and other aspects of the relationship?
Did the debtor ever assert that any type of dispute existed concerning the consistency of the alleged preference payments with the debtor’s prior payments to you as to timing, amount and manner of delivery of the payment and the circumstances surrounding the payments?
Was there any difference in the manner, method and circumstances of the debtor’s payments of the alleged preferences compared to the payments made prior to the preference period?

22. Responding To Preference Demand Suits
Push back
Cost of defense analysis – what discount is the trustee offering? Is your potential out of pocket expense greater than your potential liability as stated in the complaint? Are the trustees numbers accurate? How much money does the trustee have to litigate? Is the trustee simply throwing everything against the wall to see what sticks? Is the trustee basically trying to extort a small settlement?
File an answer to the complaint
File a motion to dismiss the complaint prior to trial based on undisputed facts

23. Responding To Preference Demand Suits
Metrics that can be used in a preference defense analysis are as follow:
Payment days – payment days = payment date - invoice date
Days sales outstanding
Percent current
Percent over 90 days
Average days delinquent/average days beyond terms
AR turnover
Average beyond due date
Net bad debt reserves as a percent of total AR
Collection effectiveness index
Business delinquency score/business failure score/business failure risk class/paydex score

24. Asset Sale Through Chapter 11
The stalking horse bid is often set just above the amount of the market chain’s secured debt and estimated administrative claims
The timetable to complete a sale of assets continues to compress
Once the bankruptcy sale is complete and the sale is approved by the court, the market chain may propose a plan of liquidation, structured dismissal of the Chapter 11 or conversion of Chapter 7
If vendor selling to market chain on an invoice-by-invoice basis, vendor’s prepetition claim will be paid pro-rata based on available sale proceeds

25. Chapter 11 Considerations
Keep market chain within 20-day terms
If selling beyond 20-day terms, consider moving from PO-based to supply contract based
If selling commodities to market chain on future date and at fixed price, contract may qualify as forward contract under Bankruptcy Code
Vendor can elect to sell pre-petition claim, at a discount, if customer files for bankruptcy
Vendor has no further obligation to sell to customer