Paper Source Bankruptcy Offers Lessons For Salespeople Who Play Their Cards | Dorsey & Whitney LLP

On March 2, 2021, stationery and gift retailer Paper Source filed for Chapter 11 bankruptcy, declaring in court that the effects of the COVID-19 pandemic have hurt its finances and operations. Paper Source said that in the event of bankruptcy, it seeks to sell its assets, reassess and renegotiate leases and continue to operate, while minimizing the negative impact on business partners and other stakeholders.

Soon after, however, cardmakers identifying themselves as Paper Source sellers hit social media and the press denouncing the debts Paper Source accumulated just before its bankruptcy for which they did not receive payment. According to some cardmakers, Paper Source placed orders up to four times larger than usual in January and February 2021. This left suppliers who had previously shipped merchandise to Paper Source with generous payment terms with relatively large payment terms (in the context of supplier operations) unsecured advance claims when Paper Source went bankrupt.

Some paper source suppliers received limited relief. In its bankruptcy case, Paper Source immediately sought and obtained an order authorizing it to pay up to $ 2 million in total on the pre-requisite claims of suppliers essential to its business operations, known as “critical suppliers”, in whole or in in part, on condition that the sellers agree to supply the goods on customary commercial terms or on other favorable commercial terms. Prior claims are claims for amounts owed by Paper Source on the date it filed for bankruptcy. The same court order allows Paper Source to pay these critical suppliers in the ordinary course of business if it fails to come to an agreement on business terms and Paper Source believes that failure to pay will cause irreparable harm to its business. Paper Source states that it has determined which of its suppliers are essential for the purposes of critical supplier relief based on a number of considerations, such as the volume of goods supplied, the existence of alternative suppliers and the terms of business of the suppliers. .

Paper Source’s “critical supplier” request for this relief indicates that the retailer typically pays for goods ordered through a purchase order within 30 to 60 days of receiving the products. It also indicates that the requested $ 2 million will cover less than 20% of its unpaid trade debts at the date of its filing for bankruptcy. As a result, not all suppliers are considered critical, and even critical suppliers cannot count on full and immediate recovery of their pre-critical supplier relief claims. According to media reports, some critical vendors see only 10% recoveries of their prior claims under claim under critical vendor relief.

Paper Source’s Supplier Experience Report highlights the surprise, frustration and uncertainty that suppliers can face when a customer files for Chapter 11 bankruptcy. The impact can be particularly profound for suppliers who are small businesses or primarily captive to the customer, as appears to be the case with some Paper Source suppliers.

The initial effects of the Paper Source bankruptcy on its suppliers and its limited critical supplier relief have garnered public reaction and attention. But there are other procedures in Chapter 11 bankruptcy that can affect (and help) sellers and the payment of their claims against debtors.

Claims for reimbursement of administrative costs. In some cases, sellers may be entitled to assert claims for administrative costs, which are paid before any payment to unsecured creditors, for at least a portion of their claims against a debtor. For example, Article 503 (b) (9) of the Bankruptcy Code provides for a request for reimbursement of administrative costs for the value of the goods supplied to the debtor within 20 days of the date on which the bankruptcy case was filed, at provided that these goods have been sold to the debtor in the ordinary course of its business. Notably, it is not clear whether a situation in which the debtor ordered significantly more product than usual before filing for bankruptcy, as has been asserted about Paper Source, would be considered “in the ordinary course. »Business of a debtor. In addition, a seller may have the right to assert a claim for reimbursement of administrative costs under Article 503 (b) (1) of the Bankruptcy Code for goods supplied to the debtor after the commencement of the business of the bankruptcy, if the debtor has not paid for these assets in the ordinary course of business.

Administrative expense claims are preferred over general unsecured claims because they have priority of payment. But sellers should note that even if they have an authorized administrative expense claim, that doesn’t mean they’ll necessarily be paid immediately. Administrative expense claims may not be paid until the case is resolved, which can take months or years.

Recovery of goods. In some cases, a seller may prefer to collect the goods provided to the debtor rather than wait for payment through the bankruptcy process. Section 546 (c) of the Bankruptcy Code provides a mechanism for sellers to assert their rights to recover the goods supplied to the debtor within 45 days of filing for bankruptcy. If a seller wishes to pursue this option, he must act promptly by providing a written request for a claim to the debtor no later than (a) 45 days after receipt of the goods by the debtor, or (b) no later than 20 days after commencement of the bankruptcy file, if the 45-day period expires after the opening of the file. The seller must establish, among other things, that he has a common law right of complaint, that is to say that the goods which are the subject of the request are in the possession of the debtor and are identifiable. Notably, however, a bankruptcy court may determine that the “general lien” of a secured creditor outweighs the claims rights.

Heal claims. In some cases, a seller may have an enforceable contract with a debtor, which may be assumed or rejected by the debtor in his bankruptcy case. If the debtor wishes to continue his contractual relationship with the seller and assume the contract, he will be required to settle the overdue amounts due under the contract before assumption of responsibility. The amount required to remedy the defects is a “healing claim”. For many suppliers, such as those at Paper Source, who operate only on purchase orders, there is no binding contract subject to assumption and, therefore, debtors do not need to remediate. their current obligations.

Complaints on prior complaint. If a seller’s claim is ineligible or not satisfied by critical seller relief, any of the above options or otherwise, seller may file a proof of claim due to their prior claim. . Collections on supplier claims, which are generally general unsecured claims, and other claims are governed by a Chapter 11 plan. In cases where a formal committee of unsecured creditors is formed, the committee will often negotiate collections at name of all unsecured creditors. These creditors committees are generally made up of a variety of unsecured creditors. For example, the committee in the case of Paper Source is made up of two product providers, two owners, and one service provider.

The existence, availability and extent of remedies available to sellers in a particular bankruptcy case, including the payment options set out above, will vary from case to case. Many factors affect potential collections by sellers in a bankruptcy case, including the identity of the debtor, his or her circumstances, the purpose of the bankruptcy filing, events that occur during the bankruptcy case, and the final outcome of the bankruptcy case. Therefore, sellers should seek the advice of a bankruptcy advisor to ensure that they are protecting their rights and optimizing their collections.

As more retailers seek Chapter 11 bankruptcy law protection due to the COVID-19 pandemic, more sellers will be faced with situations like Paper Source’s. Sellers should be prepared to navigate the bankruptcy process, and possibly retain the services of legal counsel, to protect their interests in the event a client files for bankruptcy.

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