CREDITORS' RIGHTS SUMMERY POTPOURRI

By Dorman Wood, CEW, CCE
Guest Column, Blakeley & Blakeley LLP
The Trade Vendor Quarterly

Linens Holding, Co., et. al. (Linens 'n things, Inc.) [08-10832 Bk. S.D., New York] update:

At the time L & T filed for Chapter 11 protection on 5/2/08, their top 50 creditors were owed slightly over $64M.

As of 5/12/09, 55 preference suits had been filed alleging preference payments totaling &105.4M and open credit memos totaling $30.6M for a total of $136M; $72M more than was owed to the top 50 creditors.

Creditors defending these preference suits will be tasked with proving that the preference payments were in the ordinary course of business between the parties, or were in the ordinary course of business within the relative industry. Additionally, they will have to prove that an open credit memo is not a preference and is in the ordinary course of business between the parties.

On the surface, proving ordinary course between the parties or within the relative industry should be fairly straightforward. The terms and conditions of vendor agreements issued by chain stores like L & T have long dictated how business transactions between the parties are carried out. Vendors to chain store customers have long understood that adhering to the terms of a vendor agreement is a 'necessary evil' if they want the business.

With regard to the issue of whether an open credit memo constitutes a preferential transfer, the answer may be found in the details of such transactions. In the simplest accounting terms, every entry has an offset; i.e., for every credit entry there must be a debit entry.

Vendors do not issue credit memos without reason, or 'backup.' Credit memos are generally issued by a vendor to offset deductions or chargebacks taken by a chain store customer. The vendor's credit memo should automatically offset or match a debit created by the chain store customer's deduction or charge-back. Each party is responsible for seeing that their own accounting system properly records and/or offsets these types of transactions. A vendor's efforts to keep its accounts receivable up to date and "clean" of open credit memos are completely separate from any such effort, taken (or not taken) by a retail chain customer to keep their accounts payable accounts 'clean.' A vendor should not be held accountable or penalized if a retail chain customer does not do the diligence necessary to offset the vendor's credit memos against their debits or charge-backs.

In the L&T preference suits, many of the open credit memos alleged to be preferential occurred well before the 90 day preference period. How then, can these "old" open credit memos be considered preferential?

No doubt there will be more issues raised in the prosecution and/or defense of the L&T preference cases. However, the two raised above seem obvious and it will interesting to see how the Court rules on these issues.

Automotive supplier preference suits update:
As we stated in our Special Automotive Industry Issue released 12/29/08, the downward spiral of the automotive suppliers began in early 2005 when Tower Automotive, Inc. filed for Chapter 11 protection. Since then, eight more Tier 1 suppliers have filed: Meridian Automotive Systems, Inc.; Collins & Aikman Corp.; Delphi Corp.; Dana Corp.; Dura Automotive Systems, Inc.; Metaldyne Corp.; Visteon Corp.; Lear Corp., and J. L. French Co. Total amount due to creditors by these suppliers at the time bankruptcy petitions were filed exceed $8B.

To date, several hundred preference suits have been filed in the above listed bankruptcies. The majority of these suits were filed against "John Doe" creditors, with any settlement agreements sealed. However, it appears that many are yet to be resolved. It remains to be seen if the exit from bankruptcy by GM and Chrysler will have any affect on these suits.

Despite the fact that GM and Chrysler have exited bankruptcy reorganization, bankruptcy filings within the automotive industry are expected to continue. It is estimated that there are 30,000 individual parts in a modern domestic automobile for which there is no single source. Suppliers provide components and systems that constitute an estimated 70% of the value of the average vehicle. Each auto manufacturer has an estimated 900-1,000 Tier 1 suppliers. Industry sources indicate that up to half of these suppliers could file for bankruptcy protection during the remainder of 2009 and well into 2010. Predictions of failure among Tier 2 and 3 suppliers have not been seen at the time of this writing. However, restructuring by auto manufacturers will continue to apply downward pressure on the supplier base to take on more functions such as design and sub-assembly . As a result many suppliers providing services and/ or products to the upper tier suppliers are not expected to survive such pressure.

Creditor's Rights Odds 'n Ends:
Data warehousing [offsite storage] has long been used by medium to largesized companies for collection, storage and staging of corporate data. Offsite storage of historical corporate data allows ERP system users to utilize their memory capacity for daily or current data processing. While the concept of data warehousing makes good business sense for storage of historical data, creditors and attorneys frequently forget about the data in litigation proceedings. Rule 34 of the Federal Rules of Civil Procedure [FRCP], amended 12/08, describes electronically stored information as "any designated documents or electronically stored information- including writings, drawings, graphs, charts, photographs, sound recordings, images, and other data or data compilations-stored in any medium from which information can be obtained either directly or, if necessary, after translation by the responding party into a reasonably usable form;"1 Since most creditors' rights or preference litigation actions occur months or even years 'after the fact,' creditors often forget about transactional data stored offsite.

Written Corporate credit/collection policies and procedures are important in providing ongoing guidance for the performance of daily credit and collection functions. They also form the basis for the manner in which a creditor may conduct its business relationships with customers. Such policies and procedures should be frequently reviewed and updated to keep pace with any changes within the creditor's industry or its business operations. Observance or non-observance of a creditor's policies and procedures has been raised as an issue in numerous preference suits. Plaintiff's counsel often claim that nonadherence to its policies and procedures by a creditor is not in the ordinary course of business. Also, plaintiff's counsel have claimed that creditors have not equally or fairly applied their policy and procedures to all of its customers and therefore, is not in the ordinary course.

EDI, EFT, etc. Electronic Data Interchange and Electronic Funds Transfer have long been used by large corporations for dealing with their vendors. As an example, Wal-Mart and The Kroger Co. both require that all business transactions with vendors be conducted via EDI. The Kroger Co.'s EDI Programs & Requirements web site states "The EFT program will consolidate payments for all Kroger divisions into one payment made to a particular vendor on a given day. Electronically transferring the funds and remittance detail benefits both the Kroger Co. and its vendors. Integrating the payment information with a company's existing cash management system and payment application processing, will maximize these potential benefits."2 Advances in software and technology have allowed more and more companies to conduct business with vendors and customers electronically.

ANSI (American National Standards Institute) through various subcommittees developed codes for use in electronic data transfer and refer to the 'transaction set' for a single business documents; I.e., 850-Purchase Order, 810-Invoice, 856-Shipping Notice, 812-Credit/Debit Adjustment, and 820- Payment Order/Remittance Advice. ANSI standards govern the translation of 'human readable' data to 'machine readable' formats to electronically transfer business transactions between parties. Although EDI and EFT have been in use for more than 30 years, users were generally limited to large companies. However, advances in software and hardware development have made their usage more commonplace. The use of EDI and EFT by creditors can play a role in and ordinary course of business defense in a preference action when determining payment history and industry standards.