Manufacturers should prioritize, understand, and address troubled supplier situations with greater advance awareness. They should continually analyze their contracts to maximize leverage, and therefore make legal options available, when dealing with troubled suppliers.

The automotive industry has recently enjoyed a strong period of sales growth and productivity. But even during this period, some manufacturers and raw materials suppliers continue to face pressures presented by financially troubled customers and suppliers. Witness for example the recent chapter 11 filings of Lee Steel Corporation and Chassix Holdings, Inc. In order to manage supply chain contracts during this period, manufacturers should identify early signs of financial distress in their customer or supplier base and quickly react to that distress in order to successfully navigate through stressful times.

Manufacturers should watch for supplier requests for price increases, accelerated payment terms, or customer financing support. In addition, a manufacturer’s failure to effectuate cost reductions, a deteriorating market position, and changes in key management positions are all factors that may indicate financial distress. Manufacturers should employ unique strategies in order to secure continued supply when faced with a financially troubled supplier. Manufacturers who manage their contracts during these stressful periods can usually improve their positions in the face of such pressures.

Manufacturers should prioritize, understand, and address troubled supplier situations with greater advance awareness. They should continually analyze their contracts to maximize leverage, and therefore make legal options available, when dealing with troubled suppliers. To alleviate the pressures of financial distress, manufacturers should exercise common law and statutory remedies in order to achieve proactive changes to standard terms and conditions of new contracts (or negotiated changes to existing contracts). A manufacturer’s existing contracts with a given supplier have a substantial effect on the manufacturer’s rights and remedies, both pre-bankruptcy and post-bankruptcy.

The terms of these contracts significantly impact the manufacturer’s ability to resource production to a healthier supplier, recover tooling, and utilize certain contract remedies. Common effective remedies include making demands of adequate assurance of future performance pursuant to section 2-609 of the Uniform Commercial Code or considering the contracts repudiated by the supplier. Contracts may also impact the supplier’s ability to stop shipment and impose “hostage” demands, while being able to assume and assign, or reject, the contract in bankruptcy. The contract’s terms have a significant impact on each party’s lien rights, setoff rights, and their ability to terminate the contracts. Furthermore it may affect whether a contract is considered an “executory” contract in bankruptcy, whether it is integrated with other contracts, and the impact of this on the duty to perform in bankruptcy.

Through the imposition and application of statutory and common law contract rights, manufacturers can avoid troubled companies’ use of their own ordinarily broad bankruptcy rights to reject contracts for continued supply of goods. Where signs of financial distress are apparent, or a manufacturer otherwise has reasonable grounds to believe that a supplier’s future performance under a contract for the sale of goods is in doubt, a manufacturer can usually demand adequate assurance of future performance from the supplier under section 2-609 of the UCC. If this assurance is not provided, a manufacturer may be able to consider the contract repudiated, enabling a manufacturer to resource or suspend shipment, to “shore up” contract rights before a bankruptcy filing. These strategies can drastically alter the parties’ rights after a bankruptcy filing and provide greater leverage in negotiations.

Manufacturers also may participate in a pre-bankruptcy workout, intended to keep troubled suppliers who are on the verge of bankruptcy from filing, by restructuring the supplier’s debt and capital structure. These transactions often include tripartite agreements among the troubled supplier, its significant customers, and its secured lenders to solidify the commitments of each party to keep the supplier operating while the workout (or bankruptcy) is progressing. These agreements commonly consist of access and accommodation agreements, and subordinated participation agreements. Through an accommodation agreement, the customers may provide (often as a group) accommodations that solidify the lenders’ collateral base through protections on inventory and receivables, commitments to continue sourcing of existing parts to the troubled supplier and limitations on setoffs, while the lender agrees to provide working capital financing and not to foreclose. Furthermore, customer accommodations may include financing support, in which case the customer should obtain a participation agreement to acquire collateral for any financing it provides. An access agreement permits the customer, under certain circumstances threatening production and only as a last resort, to access the supplier’s plant to produce parts pending transfer of the contract or facility to a healthier supplier.

Finally, buying assets or an ongoing business from a company while it is in bankruptcy can be an excellent means of acquiring valuable assets free and clear of liens, claims, encumbrances, and other interests. Many opportunities exist to obtain such assets at bargain prices. There are many advantages that come from these types of sales under Section 363 of the Bankruptcy Code. These sales are often attractive because a debtor’s assets can be acquired free and clear of lien claims. These sales avoid risk of the transactions being characterized as a fraudulent transfer or a preference, and the transaction can be consummated over creditor objections. Section 363 sales minimize the risk of successor liability, while ensuring that the buyer has a convenient and accessible forum to enforce its rights.

Despite the benefits of buying from a company in bankruptcy, one must not overlook the existing disadvantages. Section 363 sales are subject to higher and better offers until they are approved by the bankruptcy court, which may result in the buyer being used as a “stalking horse,” along with the imposition of auction procedures. Bankruptcy courts are often sympathetic to the debtor in the event of a dispute with the buyer; representations and warranties of the debtor typically will not survive the closing. Additionally, the bankruptcy court may not approve break-up fee or expense reimbursement provisions in the amount requested. Considering multiple constituents have a voice in the case, the sales process may be delayed or impeded. Still, for the successful purchases, Section 363 sales are an effective means to acquire assets and help to grow a manufacturer’s business.

About the Authors:

Ann Marie Uetz (Twitter@amuetz) is a Partner and Vice-Chair of the Bankruptcy and Reorganizations Practice at the national law firm Foley & Lardner LLP, where she represents manufacturers in all aspects of supply chain contracts.

John Simon is a Partner and member of the Bankruptcy and Reorganizations Practice at Foley & Lardner LLP, where he represents clients in acquiring assets from debtors in bankruptcy. The authors are grateful to Claudia Ajluni (University of Richmond 2019) and Amanda Lee (University of Michigan 2019), who assisted in writing this article.


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