26 May 2020

My supplier filed bankruptcy. What steps should I take?

In light of the current state of the economy, which in large part has been shut down due to COVID-19, we anticipate seeing a large uptick in bankruptcy filings over the coming months.  It is important that businesses are familiar with the proper course of action to follow if they have a supplier file bankruptcy.  Every case and scenario is different, and therefore all supplier insolvencies are unique, so the following summary should not be used in lieu of consulting with legal counsel regarding the particulars of each situation.  However, the following considerations may be useful in making business decisions in tandem with seeking advice from bankruptcy advisors.

  1. Communicate early and often with your supplier. Quickly determine if (and for how long) the supplier intends to continue supplying parts and whether it plans to reorganize and continue operating or liquidate and close its doors.  Confirm with the supplier that it has the raw materials on hand to meet upcoming orders, whether all of its sub-suppliers are continuing to supply, etc.
  2. Immediately identify the current inventory, parts, products or other goods (collectively “Products”) on-hand at your location and at the supplier. Determine how quickly your production will be impacted if the supply of Products is interrupted.  Determine how quickly and how difficult it would be to resource production.  Determine what size bank of Products will be necessary to complete such resourcing.  If necessary, commence discussions with the bankrupt supplier regarding production of a bank of Products.
  3. Identify alternative sources of supply regardless of whether resourcing is necessary or imminent. Identify how quickly the alternate sources of supply can be up and running.  Identify the incremental costs associated with the alternate source of supply.
  4. Determine whether the bankrupt supplier has entered into an Accommodation Agreement with any of its other customers. An Accommodation Agreement is an agreement between the bankrupt supplier, its lender, and its customer(s), providing that the supplier will continue providing Products and give its customer(s) other accommodations (like access to their tooling, production of a bank of Products, etc.) in exchange for loans, financial support, or other accommodations from the customer(s).  Decide whether you should join any existing Accommodation Agreements or enter into a separate Accommodation Agreement with the bankrupt supplier.
  5. Freeze payables to the bankrupt supplier pending confirmation that the supplier will continue to make and ship Products during its bankruptcy case. This ensures that you will not lose any leverage you may have to negotiate with the bankrupt supplier or its lender to continue supplying your Products or produce any necessary bank.  Review your right of setoff with respect to any resourcing damages.
  6. If the bankrupt supplier is not responding to your inquiries or reasonably communicating, consider whether sending a demand for adequate assurance regarding post-bankruptcy future supply is warranted.
  7. Consult with your sales representatives in order to ascertain the potential impact on your customers in the event the bankrupt supplier ceases supplying to you. Coordinate communication with customers through your sales representatives.  Discuss with customers the potential effects of changes in supply from the bankrupt supplier.  Engage the customer, if necessary, in discussions with the bankrupt supplier if doing so would be helpful in negotiating with the bankrupt supplier or if your customer is also a customer of the bankrupt supplier.
  8. If the bankrupt supplier is critical or a large volume supplier, ascertain whether a representative (either an employee or an independent consultant) should be on site at the bankrupt supplier’s production facility. Consider whether an Access Agreement, which would permit you, under limited circumstances, to access the bankrupt supplier’s plant to produce Products pending transfer of the work to a healthier supplier, is warranted.
  9. Keep a record of incremental costs that you incur and review whether you have any claim for damages against the bankrupt supplier. File a Proof of Claim in the bankrupt supplier’s bankruptcy case, if warranted.
  10. Notify your legal counsel of the filing so that a request for notices can be filed in the bankruptcy case, if necessary, and the bankruptcy case can be monitored with respect to other issues that might have a potential impact on supply, such as motions to sell assets or divisions of the bankrupt supplier, a chapter 11 plan, or a subsequent conversion to a liquidating bankruptcy.

The above is meant only to provide a short primer on the general steps a business should take in the event a supplier seeks bankruptcy protection.  To the extent specific issues arise during the course of the dealings with the supplier, legal counsel should be consulted.  Most importantly, however, while we should always hope for the best, we must be prepared for the worst.  Following these general guidelines should ensure that you are in position to address any worst case scenarios that might arise.

If your supplier (or customer) files bankruptcy or is otherwise showing signs of financial distress, the Miller Johnson bankruptcy and debtor/creditor rights team can provide guidance.  Please contact the authors if you would like to schedule an appointment.