Seller Beware - If You Sell Goods to a Debtor in Bankruptcy, You May Lose Both the Goods and Your Payment for the Sale

In a recent bankruptcy case, the debtor bought goods from the vendor and paid the vendor $1.9 million for the goods.  A court held that the vendor had to return those payments because the payments were not properly authorized by the bankruptcy court.  The payments - for the purchase of inventory from the vendor in the ordinary course of business - were made from the debtor’s operating account, and had to be repaid by the vendor even though the vendor gave the debtor equivalent value in inventory.  This painful lesson for that vendor is a warning to all that a vendor’s obligation to return payments from a bankruptcy debtor is absolute when the payments have not been authorized by the bankruptcy court.  There are no “harmless” or “innocent vendor” exceptions to a bankruptcy trustee’s power to recover such payments.

In a bankruptcy, cash collateral is cash or its equivalent, in which both the debtor and another entity, usually a secured lender, have an interest.  A debtor cannot use its cash collateral unless the secured lender consents or the bankruptcy court authorizes the debtor to use these funds. In this case because the bankruptcy court had not authorized the payment, the vendor suffered a double whammy – it was forced to return the $1.9 million to the bankruptcy estate, and it could not recover the inventory it had transferred to the debtor.

If a vendor’s customer has a secured lender, and the customer files bankruptcy, the vendor must be aware of potential cash collateral issues and should not enter into sales transactions with the customer until the bankruptcy court approves use of cash collateral for that purchase.  Until the court does so, any payments received from cash collateral may have to be repaid to the bankruptcy estate, exposing the vendor to a potential loss of both goods transferred and payments received.  For more information on selling goods to a debtor and other bankruptcy topics, contact Alan Grochal via email.

Source:  Marathon Petroleum Co., LLC. v. Cohen, U.S. Court of Appeals, Eleventh Circuit.

This alert has been prepared by Tydings for informational purposes only and does not constitute legal advice.