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Manufacturer’s Corner: When Bankruptcy and Your Shipping Terms Collide

In recent installments of the Manufacturer’s Corner, we have discussedhow to protect yourself from insolvent customers and how your shipping terms can expose you to unexpected risk. Thanks to the Bankruptcy Court for the Eastern District of Pennsylvania, we can explore how those two issues play together.

Recall from our earlier column about insolvent customers that you have two powerful protections when your customer enters bankruptcy: (1) a right to reclaim goods you sold to the debtor, and (2) a right to receive priority payment for the goods you sold to the debtor (that is, a right to be paid before many other creditors).  Critically, your ability to assert these rights is keyed to whether the debtor received the goods within a certain amount of time before filing its bankruptcy petition – 45 days[1] in case of reclamation, and 20 days in case of administrative priority.

And, recall from our earlier column about shipping terms that the shipping designations you use – e.g. FOB, ex ship, etc. – have important implications for when the risk of loss in the goods transfers from you to your buyer.

Those issues came to a head in this recent decision.  Several creditors shipped goods from China to the debtor in the United States.  The sales contracts provided that shipments were to be made FOB China.[2]

The debtor filed a bankruptcy petition.  It was undisputed that the debtor physically received the goods within twenty days before the date of its bankruptcy petition – the cutoff for administrative priority treatment. The creditors argued that this entitled them to administrative priority. The debtor (and some other creditors) argued that, because the shipping terms were FOB China, the debtor “received” the goods when they were put on the ship in China, which was more than 20 days before the bankruptcy petition was filed.

The Court sided with the debtor. In doing so, it noted that the term “receive” is not defined in the Bankruptcy Code. The Court instead looked to the UN Convention on Contracts for the International Sales of Goods[3] and the trade terms incorporated in it. The Court (correctly) found that the trade terms incorporated in CISG provide for the risk of loss in goods to transfer to the buyer upon delivery of the goods to the ship when the contract calls for shipment FOB Seller’s Place of Business. From this, the Court concluded that the debtor received the goods at that same time, and therefore the creditors were not entitled to priority treatment since they were outside the 20-day window.

I can’t say I agree with that reasoning, but I could certainly be persuaded that it’s the correct outcome.[4] That’s beside the point, though.  What you need to take away from this is that if your customer files for bankruptcy protection, you need to act fast, and one of the first places you need to look to determine your rights is the shipping terms of your contract. Your goods may still be on the boat, but your reclamation period is already running.[5]

[1] Remember that the 45-day limit can be shortened.  See footnote 9 in the earlier post.

[2] Not really “FOB China,” but “FOB [some city or port in China near the sellers].”

[3] I wrote a bit about CISG here.  CISG applied in this case because the sale contract was between parties with their respective places of business in China and the United States – both signatories to the treaty.

[4] A couple of concerns spring to mind.  First, it conflates transfer of risk of loss with transfer of title.  Under CISG (and the Uniform Commercial Code), those two often occur at the same time, but not always.  Second, the UCC and CISG allow a seller to divert goods in transit upon learning of the buyer’s inability to perform, including an inability to pay.  Has a buyer really “received” goods when the seller can lawfully and properly divert delivery and cancel the contract, thereby revesting title in the seller?

I’m also not sure it’s appropriate to look to CISG to supply a definition for the Bankruptcy Code in the first instance, but I don’t have a very strong opinion on that either way.  It looks from the opinion that the creditors argued the UCC’s definition of “receive” should apply, and I get the appeal of that from a legislative intent perspective.

With all that said, title likely passed when the goods were put on the ship.  Assuming the Bankruptcy Code means “received title” rather than “received possession,” it looks like the correct outcome obtained.

[5] Of course, the Court’s opinion only addressed administrative priority, not reclamation.  But the term “received” is used in both sections of the Code, and I expect that future courts would find that the term has the same meaning in both sections.