A Supplier Goes Under

Why this matters

When a distributor fails, every owner chases the same thing first: the money they are owed. That is the one with the worst odds and the least urgency. Meanwhile the shortest clock belongs to a customer standing in a house on Thursday with no material coming, and the longest tail belongs to a warranty that quietly stopped existing on product you installed three years ago and sold as covered.

So this is not one problem. It is four, they recover differently, and they run on different clocks. Sorting them in the first hour is most of the work. Nothing here is legal advice; there is one point below where it stops being a business decision and needs your own attorney, and it is named.

The day-one moves, before you sort anything

Three things are true on every branch and none of them wait for information.

Stop adding to the exposure. No new orders transmitted, no prepayment released, no invoice paid for goods you have not received. Paying a deposit on Wednesday to a company that filed on Monday is volunteering for the worst branch on this page.

What you owe them does not go away. Accounts payable are an asset of the estate and get collected by a trustee, or by a factor who bought the receivables, generally harder than the supplier ever collected.

This is the lawyer fork, and it is right here. If they owe you and you owe them, setting one against the other looks obvious and is the easiest way to turn a nuisance into a real problem. Setoff in bankruptcy is governed by 11 U.S.C. 553, and exercising it unilaterally after a petition can violate the automatic stay under 11 U.S.C. 362, which stops collection activity against the debtor the moment the case opens. Take the account statement, the open orders, the prepayment receipts and the filing notice to an attorney before you net anything.

One more fact to establish in that hour, because it changes what is still possible: going under is not always a bankruptcy. A quiet wind-down, or an assignment for the benefit of creditors, which is a state-law liquidation, are both common and neither creates an automatic stay.

Sorting what you have at risk

The rows run in the order the branches run below, which is not the order to work them in. Work them by clock: customer commitments today, claim paperwork on whatever deadline the notice names, the warranty count in between. Note what the first row is: worst recovery odds and the longest wait, which is exactly the combination that gets chased first and should not be.

One shop runs through all four below. It learns on a Tuesday that its second-largest distributor has filed.

Branch one: money you already paid them

The shop had prepaid in full for a special-order item on one job, because that distributor had started requiring prepayment on special orders a few months earlier. The requirement was itself the warning.

A trade prepayment is a general unsecured claim, behind secured lenders and behind priority claims, and in a liquidation the practical recovery is a fraction of the claim and frequently none of it. File the proof of claim before the bar date named in the notice anyway: it costs an hour, and there is no version where not filing pays better.

One narrow exception belongs with the attorney rather than in your hands. Where goods have been identified to your contract and you have paid part or all of the price, UCC 2-502 as enacted in your state gives a buyer a right to recover those goods from an insolvent seller, on conditions including a tight timing test tied to when the seller became insolvent relative to your first payment. It is narrow, and it collides with the automatic stay the moment a petition is filed. What you can do unaided is establish the facts it turns on: what you paid for, on what date, whether the goods exist, and whether they carry your name, job number or purchase-order number. A photograph this week of a pallet with your tag on it is worth more than the argument later.

Then plan as though the money is gone. A shop that builds its month around a recovery here has added a cash-flow error to the loss.

Branch two: material committed to a job you already sold

This branch has nothing to do with the supplier. The commitment is yours, the customer does not care why, and the only question is how many dates you can hold.

The shop has material on order for six sold jobs. Its second supplier covers four of the six items on a 9 working-day lead time and quotes 4 to 6 weeks on the two special-order items. Three of the six jobs are scheduled inside the next two weeks, and of those three, two are in the fast group and one is in the slow group.

So exactly one customer gets a reschedule call this week, the other slow-group job gets one later as its date approaches, and the remaining four hold. Two reschedules out of six, a different conversation from the one the owner was having with himself on Tuesday morning, and it took one lead-time call to find out.

Triage by whether the work can wait, not by job size or by who shouts loudest. A no-heat, no-water or active-leak job cannot move and has to be solved another way, including buying the part at retail at a loss. The upgrade that has sat on the calendar for a month can move a fortnight without anybody being harmed. See related: Deferrable Versus Non-Deferrable Work and What a Downturn Touches, which derives that split.

Call before the customer notices, and give a new date rather than a warning. The shop that offers a date holds the job; the shop that offers an explanation loses it.

Branch three: warranty on product they supplied

The branch nobody checks, and the one that bills you for years.

Read the written warranty on the families you bought from them and find the named warrantor. Where the manufacturer is named, the distributor's failure changes nothing: the obligation was never theirs and is honoured through whoever now carries the line. Where the distributor is named, which is normal on a house-brand item and on any extended coverage they sold you, it has failed with them. Under the Magnuson-Moss Warranty Act, 15 U.S.C. 2301 and following, a written warranty on a consumer product must make its terms available, so the document that settles this is one you can get.

The shop has installed about 40 units of one family over three years, sold as carrying a 5-year parts warranty. Reading the paperwork: 32 name the manufacturer and survive. Eight are the distributor's house label with the distributor as warrantor, and those eight are now uncovered parts, with between two and five years of term still running depending on install date.

Two consequences, and the second is the expensive one. Those eight customers were told five years and the shop cannot make that true from the parts side. And its own workmanship warranty is untouched, so a failure inside that term means supplying labour against a part it now has to buy.

Decide the policy once, this week, because one call at a time is how a shop ends up treating two identical customers differently. Absorb parts on eight units, or honour labour and charge parts with an explanation, or contact the eight in advance and offer something. All three beat discovering it in year four with a technician improvising in a kitchen.

Branch four: accruals, credits and the tier

The open return credit and the rebate accrual are unsecured claims like the prepayment, and usually smaller than the feeling attached to them. Write them off and file them on the same proof of claim.

The real loss here is forward-looking. Volume rebate tiers reset annually and are per-supplier, so volume moving to your second supplier starts that supplier's tier from zero. A shop quoting off a landed cost that quietly assumed a tier it will not now reach is pricing below its own cost on a whole category, and will not see it until the year-end reconciliation fails to arrive. So the action is a pricing review, not a claim: pull the rebate assumption out of the cost basis for the rest of the year.

One thing to check before writing anything off. If that supplier paid you a refund or credit shortly before filing, a trustee can seek to recover it as a preference under 11 U.S.C. 547, so it goes to the attorney with the setoff question.

Seeing it coming, and the second source that has to have been used

No branch here has a good outcome, which makes the warning signs worth more than any of the responses. A distributor in trouble shows it months before anything is announced:

• A manufacturer pulls a line. The strongest single signal, because the manufacturer sees a payment history you cannot. Two or three lines leaving inside a year is close to conclusive.
• Terms tighten toward you when nothing about you changed. A credit limit cut, COD on a line you always bought on account, prepayment on special orders. That last one is this shop's own example, read at the time as an annoyance.
• Credits and returns slow. A return credit that used to land on the next statement now taking two cycles is cash being held.
• Stock gaps stop being line-specific. One line short is an allocation problem upstream. Thin shelves across unrelated lines is working capital.
• People leave, starting with inside sales and credit. A credit manager who has gone is a person who saw the ledger.
• The truck stops running. Delivery quietly becoming will-call is a cost cut you pay for in windshield time.

Then the lever, which has to exist before any of that: a second source you have actually used. An account opened and never bought from has no real credit limit, no stocking profile matched to your work, and nobody who takes your call on a bad morning. So the discipline is a standing minority share rather than a dormant backup: buy an ongoing slice of your volume from source two, enough that they know your part numbers and your name. It costs price breaks and slows your climb up both rebate tiers, and that cost is the premium on the insurance. How much you could actually move, and to whom, is an absorption question rather than a preference. See related: Supplier Concentration and What a Top Five List Hides.

What changes all of this: which chapter. A liquidation ends the relationship. A reorganisation under Chapter 11 does not, and goods ordered after the filing generally sit in a better priority position than the money owed before it, so the supplier may keep trading and want to keep you. But a debtor in reorganisation can reject its contracts under 11 U.S.C. 365, so a price hold you were relying on may not survive. Keep buying while they ship, keep the second source warm, and treat no forward commitment from them as a commitment.

References

• 11 U.S.C. 362 (automatic stay), 553 (setoff), 547 (preferences) and 365 (rejection of executory contracts), all questions for your own attorney rather than to act on
• Uniform Commercial Code section 2-502, buyer's right to goods on the seller's insolvency, as enacted by the state whose law governs the order
• Magnuson-Moss Warranty Act, 15 U.S.C. 2301 and following, for the written warranty terms that name the warrantor
• See related: Supplier Concentration and What a Top Five List Hides, Choosing a Primary Supplier, Building Supplier Leverage as a Small Shop
• See related: Deferrable Versus Non-Deferrable Work and What a Downturn Touches, Responding to a Supplier Price Increase