Chinese Manufacturers

Manufacturer's Right to Stop Goods in Transit

When a manufacturer discovers that a buyer to whom it has sold goods on credit is insolvent or is bankrupt, it may stop delivery of goods that are still in the possession of a carrier. UCC ' 2-705(1). To exercise this remedy, the manufacturer must notify the carrier in sufficient time so that the carrier can prevent delivery to the U.S. buyer. UCC ' 2-705(3). Although such notification is not required to be in writing, it is good practice for the manufacturer to send any request for stop delivery to the carrier in writing, with a copy of the notice to the U.S. buyer.

To make it easier for the carrier to execute on a stop-delivery order, the notice should identify the goods in transit by invoice number, date, amount, and container number. After a carrier receives the manufacturer's notice to stop delivery, it must hold the goods and deliver them according to the manufacturer's instructions.

The right to stop delivery of goods in transit is recognized even when the buyer is in bankruptcy. In re Coast Trading Co. Inc., 744 F.2d 686, 693 (9th Cir. 1984); Matter of Marin Motor Oil, Inc., 740 F.2d 220, 225 (3d Cir. 1984); Matter of Pester Refining Co., 845 F.2d 1476, 1480-81 (8th Cir. 1988). Generally, the filing of a bankruptcy petition by a debtor triggers the imposition of an “automatic stay” of all enforcement action against the debtor and the debtor's property. 11 U.S.C. ' 362(a). Courts have held, however, that the seller's right to stop delivery does not violate the automatic stay. In re National Sugar Refining Co., 27 B.R. 565, 572 (S.D.N.Y. 1983).

The right to stop delivery terminates when the buyer receives possession or control of the goods. UCC ' 2-705(2)(a). Receipt of goods means “actual, physical receipt” by the buyer. UCC ' 2-103(1)(c); In re Trico Steel Co., LLC, 282 B.R. 318, 323-24 (Bankr. D. Del. 2002). Almost all international carriers have global tracking systems to track delivery of shipments, so it should be relatively easy to obtain information on when certain shipment of goods arrives at the buyer's destination.

In addition, a buyer who receives and negotiates a negotiable bill of lading will also cut off the manufacturer's right to stop delivery. UCC ' 2-705(2)(d). Therefore, just as actual receipt of the goods themselves terminates the right to stop delivery, receipt of the negotiable bill of lading by the buyer has the same effect.

Manufacturer's Right to Reclaim Goods Already
Delivered

A manufacturer could also reclaim goods already delivered to an insolvent U.S. buyer, so long as the reclamation demand is made within ten (10) days after the U.S. buyer actually received delivery of the goods. UCC ' 2-702. Because the exercise of this remedy is time-sensitive, a Chinese manufacturer who invokes this remedy should make its demand to the U.S. buyer in writing to prove the existence and timing of the demand.

U.S. bankruptcy law has expanded the right to reclaim goods from bankrupt customers. Under U.S. bankruptcy law, a manufacturer can reclaim from a bankrupt U.S. buyer goods sold on credit to such buyer within 45 days before its bankruptcy filing. 11 U.S.C. ' 546(c). Furthermore, a manufacturer has 20 days after the U.S. buyer's bankruptcy filing to send its reclamation demand. Id.

Although the U.S. bankruptcy law appears to augment a manufacturer's ability to reclaim goods, reclamation is actually not a strong remedy for manufacturers in most cases in at least two respects. First, a bank with security interest in the U.S. buyer's existing and after-acquired inventory would have superior rights than a reclaiming manufacturer with respect to the goods being reclaimed. Id. Since almost all debtors in financial distress have borrowed against their inventory, a manufacturer's reclamation rights are virtually valueless in those cases. Second, being able to reclaim goods often is not the desired result for Chinese manufacturers, many of whom do not want to incur the expenses to store and/or ship back the goods which could only be resold, in most cases, for scrap value.

Manufacturer's Right to Assert ' 503(b)(9) Claims

Under the U.S. bankruptcy law, a manufacturer's claim for goods delivered to a bankrupt U.S. buyer within 20 days before the buyer's bankruptcy filing (a “' 503(b)(9) claim”) is entitled to “administrative expense” priority relative to other unsecured creditors. 11 U.S.C. ” 503(b)(9) and 507. This means a Chinese manufacturer with an allowed ' 503(b)(9) claim would be paid ahead of general unsecured creditors to the extent the US buyer has unencumbered assets after satisfying the secured claims.

More significantly, administrative expense claims such as ' 503(b)(9) claims are required to be paid in full if a plan of reorganization or liquidation is to be confirmed. 11 U.S.C.
' 1129(a)(9). Thus, even in situations where the debtor may have insufficient assets to satisfy the secured claim in full, the undersecured lender may still, in certain situations, be willing to set aside some cash to satisfy the allowed administrative expense claims against the debtor so that a plan could be confirmed.

Unlike the right to assert a reclamation claim, the right to assert a ' 503(b)(9) claim is automatically available to creditors. Creditors need not send a written demand within a certain time period to activate its right to assert such a claim. In our experience, however, Chinese manufacturers often fail to assert their ' 503(b)(9) claims. Instead, many simply file a proof of claim asserting unsecured nonpriority claims for their goods. It is our practice to advise our Chinese clients to determine and assert, where appropriate, their ' 503(b)(9) claims immediately.

Negotiating for Critical Supplier Status

Typically, U.S. bankruptcy law prohibits a bankrupt debtor from making any payment to satisfy claims that arose prior to the bankruptcy filing (i.e., “prepetition claims”). However, in some U.S. states, it is permissible for a bankrupt debtor to seek authority from the U.S. bankruptcy court to pay, at least in part, the prepetition claims of certain suppliers whose continuing business relationships with the debtor are deemed to be critical to the debtor's survival in bankruptcy. 11 U.S.C.
' 105. Such suppliers are commonly referred to as “critical suppliers.” Therefore, when a U.S. customer files for bankruptcy, it is important for the manufacturer to determine immediately whether it qualifies as a “critical supplier.”

When negotiating critical supplier status, U.S. debtors often demand manufacturers to waive their ' 503(b)(9) claims and other rights they may have. Chinese manufacturers often unknowingly sign away their rights. It is therefore important for prudent Chinese manufacturers to engage experienced US counsel to review all the documents before agreeing to anything.

Participating in the Creditors' Committee

For Chinese manufacturers with particularly large claims against a U.S. debtor, it is imperative that they also consider participating in the debtor's bankruptcy case by serving on the creditors' committee. A committee consists of five to seven unsecured creditors who are appointed by the U.S. Trustee to act as a fiduciary for the class of creditors it represents and is statutorily empowered to monitor the debtor's activities, investigate the debtor's affairs, and negotiate a plan of reorganization. 11 U.S.C. ' 1102. A committee may retain counsel, financial advisers, and other professionals to perform services for the committee (Id.), and such professional fees are borne by the debtor's bankruptcy estate so there are no out-of-pocket expenses for committee members. 11 U.S.C.
' 330. Although serving on the committee will not confer any special advantage to the members themselves, the committee plays a critical role in maximizing recovery for creditors generally.

Because it is often inconvenient for Chinese manufacturers to attend formation meetings in the U.S., many ignore the opportunity to apply to be on the committee. Instead, they should consult experienced US counsel to see how they could participate in the formation meeting via proxy if they cannot attend in person. In our experience, sophisticated Chinese creditors have only recently begun to realize its importance and have gradually increased their committee participation. In these recessionary times, creditors can ill afford to overlook such an important remedy.

Other Practical Pointers

Trade creditors with long-term supply contracts with a debtor may have other issues of concern unique to them. The U.S. Bankruptcy Code gives the bankrupt buyer the right to assume or reject any such contract at any time before a plan is confirmed. 11 U.S.C. ' 365(a). If the buyer rejects the contract, the seller would have nothing more than a general unsecured claim against the debtor for the damages suffered. 11 U.S.C. ' 365(g). If the buyer assumes the contract, however, the debtor would have to cure all monetary defaults under the contract, i.e., pay the outstanding amounts owed, before the contract can be assumed. 11 U.S.C. ' 365(b). For this reason, Chinese manufacturers with a long-term contract with the debtor must pay special attention to any proposed sale of the debtor's business in Chapter 11 to see what is the cure amount, if any, proposed by the debtor.

Finally, it is important for Chinese manufacturers, when confronted with a U.S. customer in Chapter 11 bankruptcy, to consult experienced U.S. counsel to analyze their “preference” exposures. Under U.S. bankruptcy law, a debtor can sue its creditors to recover certain payments of debts owed to such creditors made within 90 days preceding the debtor's bankruptcy filing. 11 U.S.C. ' 547(b). Such debt payments are referred to as “preferences.” Furthermore, under U.S. bankruptcy law, a creditor that has received a preference must have its claim disallowed unless and until the creditor has returned the alleged preference. 11 U.S.C. ' 502(d). Therefore, filing a preference lawsuit can serve two purposes for the U.S. debtor ' to recover property from, and to disallow claims asserted by, creditors. Not surprisingly, in our experience, Chinese manufacturers are often the targets of such preference lawsuits. Therefore, it is our practice to advise our Chinese creditor clients to determine their preference exposures and analyze the defenses available to them at the beginning of the case. Otherwise, they might risk having their claims disallowed or, worse still, being compelled to return money to the U.S. debtor as preferences. Exposures can be great for those who fail to take precautions and act swiftly.

Simon Luk ([email protected]) is a partner in the Hong Kong office and Chairman of the Asia practice of Winston & Strawn LLP. He represents multinational corporations in cross-border mergers and acquisitions, U.S. capital market fund raising, compliance with regulation of SEC policies, and the acquisition of assets and brand names. Brian Lee ([email protected]) is a senior corporate associate in the firm's San Francisco office. His practice focuses on all matters in the insolvency arena, including acquisitions, restructuring, and bankruptcy cases.

China's exports to the United States, its top trading partner and export destination, have increased dramatically in the last decade. However, these manufacturers are increasingly finding themselves confronted with complex U.S. laws and legal systems when disputes arise with their U.S. customers. With the recent financial crisis that has affected many American importers, wholesalers, and retailers, Chinese manufacturers should be prepared to deal with financially distressed U.S. customers that seek to rehabilitate their businesses through Chapter 11 bankruptcy.

Cultural Differences

Chinese manufacturers are often unsophisticated about their legal rights and remedies under U.S. law because of cultural differences and the long distance between their two countries. In addition, Chinese manufacturers are reluctant to consult U.S. law firms for help because of their perceived language barrier and a general aversion to litigation. Legal costs may be another reason. As a result, many such manufacturers fail to maximize recovery on their claims against their financially troubled customers in the U.S. This article serves as a primer, from a Chinese manufacturer's perspective, of the remedies and strategies to creditors when dealing with financially distressed debtors to whom it has sold goods on credit in the U.S.

Manufacturer's Right to Stop Goods in Transit

When a manufacturer discovers that a buyer to whom it has sold goods on credit is insolvent or is bankrupt, it may stop delivery of goods that are still in the possession of a carrier. UCC ' 2-705(1). To exercise this remedy, the manufacturer must notify the carrier in sufficient time so that the carrier can prevent delivery to the U.S. buyer. UCC ' 2-705(3). Although such notification is not required to be in writing, it is good practice for the manufacturer to send any request for stop delivery to the carrier in writing, with a copy of the notice to the U.S. buyer.

To make it easier for the carrier to execute on a stop-delivery order, the notice should identify the goods in transit by invoice number, date, amount, and container number. After a carrier receives the manufacturer's notice to stop delivery, it must hold the goods and deliver them according to the manufacturer's instructions.

The right to stop delivery of goods in transit is recognized even when the buyer is in bankruptcy. In re Coast Trading Co. Inc., 744 F.2d 686, 693 (9th Cir. 1984); Matter of Marin Motor Oil, Inc., 740 F.2d 220, 225 (3d Cir. 1984); Matter of Pester Refining Co., 845 F.2d 1476, 1480-81 (8th Cir. 1988). Generally, the filing of a bankruptcy petition by a debtor triggers the imposition of an “automatic stay” of all enforcement action against the debtor and the debtor's property. 11 U.S.C. ' 362(a). Courts have held, however, that the seller's right to stop delivery does not violate the automatic stay. In re National Sugar Refining Co., 27 B.R. 565, 572 (S.D.N.Y. 1983).

The right to stop delivery terminates when the buyer receives possession or control of the goods. UCC ' 2-705(2)(a). Receipt of goods means “actual, physical receipt” by the buyer. UCC ' 2-103(1)(c); In re Trico Steel Co., LLC, 282 B.R. 318, 323-24 (Bankr. D. Del. 2002). Almost all international carriers have global tracking systems to track delivery of shipments, so it should be relatively easy to obtain information on when certain shipment of goods arrives at the buyer's destination.

In addition, a buyer who receives and negotiates a negotiable bill of lading will also cut off the manufacturer's right to stop delivery. UCC ' 2-705(2)(d). Therefore, just as actual receipt of the goods themselves terminates the right to stop delivery, receipt of the negotiable bill of lading by the buyer has the same effect.

Manufacturer's Right to Reclaim Goods Already
Delivered

A manufacturer could also reclaim goods already delivered to an insolvent U.S. buyer, so long as the reclamation demand is made within ten (10) days after the U.S. buyer actually received delivery of the goods. UCC ' 2-702. Because the exercise of this remedy is time-sensitive, a Chinese manufacturer who invokes this remedy should make its demand to the U.S. buyer in writing to prove the existence and timing of the demand.

U.S. bankruptcy law has expanded the right to reclaim goods from bankrupt customers. Under U.S. bankruptcy law, a manufacturer can reclaim from a bankrupt U.S. buyer goods sold on credit to such buyer within 45 days before its bankruptcy filing. 11 U.S.C. ' 546(c). Furthermore, a manufacturer has 20 days after the U.S. buyer's bankruptcy filing to send its reclamation demand. Id.

Although the U.S. bankruptcy law appears to augment a manufacturer's ability to reclaim goods, reclamation is actually not a strong remedy for manufacturers in most cases in at least two respects. First, a bank with security interest in the U.S. buyer's existing and after-acquired inventory would have superior rights than a reclaiming manufacturer with respect to the goods being reclaimed. Id. Since almost all debtors in financial distress have borrowed against their inventory, a manufacturer's reclamation rights are virtually valueless in those cases. Second, being able to reclaim goods often is not the desired result for Chinese manufacturers, many of whom do not want to incur the expenses to store and/or ship back the goods which could only be resold, in most cases, for scrap value.

Manufacturer's Right to Assert ' 503(b)(9) Claims

Under the U.S. bankruptcy law, a manufacturer's claim for goods delivered to a bankrupt U.S. buyer within 20 days before the buyer's bankruptcy filing (a “' 503(b)(9) claim”) is entitled to “administrative expense” priority relative to other unsecured creditors. 11 U.S.C. ” 503(b)(9) and 507. This means a Chinese manufacturer with an allowed ' 503(b)(9) claim would be paid ahead of general unsecured creditors to the extent the US buyer has unencumbered assets after satisfying the secured claims.

More significantly, administrative expense claims such as ' 503(b)(9) claims are required to be paid in full if a plan of reorganization or liquidation is to be confirmed. 11 U.S.C.
' 1129(a)(9). Thus, even in situations where the debtor may have insufficient assets to satisfy the secured claim in full, the undersecured lender may still, in certain situations, be willing to set aside some cash to satisfy the allowed administrative expense claims against the debtor so that a plan could be confirmed.

Unlike the right to assert a reclamation claim, the right to assert a ' 503(b)(9) claim is automatically available to creditors. Creditors need not send a written demand within a certain time period to activate its right to assert such a claim. In our experience, however, Chinese manufacturers often fail to assert their ' 503(b)(9) claims. Instead, many simply file a proof of claim asserting unsecured nonpriority claims for their goods. It is our practice to advise our Chinese clients to determine and assert, where appropriate, their ' 503(b)(9) claims immediately.

Negotiating for Critical Supplier Status

Typically, U.S. bankruptcy law prohibits a bankrupt debtor from making any payment to satisfy claims that arose prior to the bankruptcy filing (i.e., “prepetition claims”). However, in some U.S. states, it is permissible for a bankrupt debtor to seek authority from the U.S. bankruptcy court to pay, at least in part, the prepetition claims of certain suppliers whose continuing business relationships with the debtor are deemed to be critical to the debtor's survival in bankruptcy. 11 U.S.C.
' 105. Such suppliers are commonly referred to as “critical suppliers.” Therefore, when a U.S. customer files for bankruptcy, it is important for the manufacturer to determine immediately whether it qualifies as a “critical supplier.”

When negotiating critical supplier status, U.S. debtors often demand manufacturers to waive their ' 503(b)(9) claims and other rights they may have. Chinese manufacturers often unknowingly sign away their rights. It is therefore important for prudent Chinese manufacturers to engage experienced US counsel to review all the documents before agreeing to anything.

Participating in the Creditors' Committee

For Chinese manufacturers with particularly large claims against a U.S. debtor, it is imperative that they also consider participating in the debtor's bankruptcy case by serving on the creditors' committee. A committee consists of five to seven unsecured creditors who are appointed by the U.S. Trustee to act as a fiduciary for the class of creditors it represents and is statutorily empowered to monitor the debtor's activities, investigate the debtor's affairs, and negotiate a plan of reorganization. 11 U.S.C. ' 1102. A committee may retain counsel, financial advisers, and other professionals to perform services for the committee (Id.), and such professional fees are borne by the debtor's bankruptcy estate so there are no out-of-pocket expenses for committee members. 11 U.S.C.
' 330. Although serving on the committee will not confer any special advantage to the members themselves, the committee plays a critical role in maximizing recovery for creditors generally.

Because it is often inconvenient for Chinese manufacturers to attend formation meetings in the U.S., many ignore the opportunity to apply to be on the committee. Instead, they should consult experienced US counsel to see how they could participate in the formation meeting via proxy if they cannot attend in person. In our experience, sophisticated Chinese creditors have only recently begun to realize its importance and have gradually increased their committee participation. In these recessionary times, creditors can ill afford to overlook such an important remedy.

Other Practical Pointers

Trade creditors with long-term supply contracts with a debtor may have other issues of concern unique to them. The U.S. Bankruptcy Code gives the bankrupt buyer the right to assume or reject any such contract at any time before a plan is confirmed. 11 U.S.C. ' 365(a). If the buyer rejects the contract, the seller would have nothing more than a general unsecured claim against the debtor for the damages suffered. 11 U.S.C. ' 365(g). If the buyer assumes the contract, however, the debtor would have to cure all monetary defaults under the contract, i.e., pay the outstanding amounts owed, before the contract can be assumed. 11 U.S.C. ' 365(b). For this reason, Chinese manufacturers with a long-term contract with the debtor must pay special attention to any proposed sale of the debtor's business in Chapter 11 to see what is the cure amount, if any, proposed by the debtor.

Finally, it is important for Chinese manufacturers, when confronted with a U.S. customer in Chapter 11 bankruptcy, to consult experienced U.S. counsel to analyze their “preference” exposures. Under U.S. bankruptcy law, a debtor can sue its creditors to recover certain payments of debts owed to such creditors made within 90 days preceding the debtor's bankruptcy filing. 11 U.S.C. ' 547(b). Such debt payments are referred to as “preferences.” Furthermore, under U.S. bankruptcy law, a creditor that has received a preference must have its claim disallowed unless and until the creditor has returned the alleged preference. 11 U.S.C. ' 502(d). Therefore, filing a preference lawsuit can serve two purposes for the U.S. debtor ' to recover property from, and to disallow claims asserted by, creditors. Not surprisingly, in our experience, Chinese manufacturers are often the targets of such preference lawsuits. Therefore, it is our practice to advise our Chinese creditor clients to determine their preference exposures and analyze the defenses available to them at the beginning of the case. Otherwise, they might risk having their claims disallowed or, worse still, being compelled to return money to the U.S. debtor as preferences. Exposures can be great for those who fail to take precautions and act swiftly.

Simon Luk ([email protected]) is a partner in the Hong Kong office and Chairman of the Asia practice of Winston & Strawn LLP. He represents multinational corporations in cross-border mergers and acquisitions, U.S. capital market fund raising, compliance with regulation of SEC policies, and the acquisition of assets and brand names. Brian Lee ([email protected]) is a senior corporate associate in the firm's San Francisco office. His practice focuses on all matters in the insolvency arena, including acquisitions, restructuring, and bankruptcy cases.