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Seller Beware: New Case Counsels Caution to Those Dealing with Debtors in Bankruptcy Cases

March 18, 2010

The Eleventh Circuit Court of Appeals has just issued an opinion that should concern anyone doing business with a debtor in bankruptcy. In short, the court ruled that a company that supplied $1.9 million worth of goods to a debtor after the petition date had to return the debtor's payment. The reason? The debtor did not have permission from the court or its secured creditor to use the money. The payments were for value given post-petition and were apparently made in accordance with the pre-petition practice between the parties. There was no assertion that the seller had knowledge that the payments were unauthorized, nor was the secured creditor harmed by the use of the funds. Nonetheless, the court held that if the debtor did not have authority to make the payments, the seller must return the money to the bankruptcy estate. In re Delco Oil Co. (Marathon Petroleum Co., LLC v. Cohen), Case No. 09-11759 (11th Cir., March 16, 2010).

Background

Most debtors enter bankruptcy with at least one secured creditor that has a lien on its receivables and proceeds and on the cash in its bank account. These types of assets are known as "cash collateral." The Bankruptcy Code prohibits a debtor from using such cash collateral without either court authority or the consent of the secured creditor. In most instances, a debtor will immediately apply for and obtain a court order for authority to use such cash collateral, unless its secured creditor has consented to its continued use. Indeed, secured creditors generally demand a court order as a condition for the debtor's use of their cash collateral. In most instances, the debtor does not spend money it is not authorized to spend; if it does, the secured creditor will often file an emergency motion to stop its use.

In dealing with a debtor in bankruptcy, suppliers generally derive comfort from the fact that their post-petition claims will be afforded administrative priority, which authorizes payment of such claims before the payment of pre-petition claims. They assume that the money they receive from a debtor post-petition is theirs to keep and no one can sue to get it back. This case suggests that such comfort may sometimes be unwarranted.

In re Delco

Delco is particularly troubling because no one was harmed by the payments made. The bankruptcy estate simply traded dollars for the goods received. The secured creditor had not been harmed, since the debtor received goods at least equal in value to the amount paid for the goods, and the secured creditor would have had an interest in the newly delivered goods under its security agreement. The seller also asserted that it was an "innocent vendor" that provided goods in good faith and without knowledge of the debtor's lack of authority to pay for the goods. The court held, however, that neither the lack of harm to the secured creditor nor the seller's innocence was an adequate defense. The court held that the debtor's failure to obtain the secured creditor's permission or, alternatively, to obtain a court order authorizing the use of the creditor's cash collateral was fatal. The court ordered that the money had to be returned.

Conclusion

It is unclear whether other courts will follow Delco. However, the holding in Delco should act as a wake-up call to all sellers or service providers doing business with debtors in bankruptcy proceedings, as well as to landlords whose tenants are in bankruptcy. Each of these post-petition creditors should consider requiring the debtor to provide it with a copy of the court order granting it authority to use its lender's cash collateral or with written authority from the secured creditor that the debtor has authority to use the money with which it is paying for post-petition goods or services. While it may be difficult to ascertain whether the debtor has such authority, dealing with the debtor without such assurances may put the seller at risk of having to return the funds received in the event that the debtor was not authorized to use its lender's cash collateral.

For questions about this alert, contact one of the listed members of the Bankruptcy and Restructuring practice group, or your Dykema relationship attorney.


As part of our service to you, we regularly compile short reports on new and interesting developments in Antitrust and Trade Regulation law and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments on this newsletter, or any Dykema publication, are always welcome. © 2010 Dykema Gossett PLLC.

As part of our service to you, we regularly compile short reports on new and interesting developments and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments are always welcome. © 2017 Dykema Gossett PLLC.