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eNews December 14, 2017

Indiana Bankruptcy Court Rules Creditor’s Liens Trump Reclamation Claims

The U.S. Bankruptcy Court for the Southern District of Indiana Indianapolis Division recently ruled that a lender’s blanket security interest in all of the debtor’s inventory trumps the reclamation claims from a supplier in a bankruptcy case.

The court’s decision came as no surprise to Bruce Nathan, Esq., partner with Lowenstein Sandler LLP of New York. The court agreed with the holding of other courts that as long as the debtors’ secured lender has a blanket security interest in all of the debtors inventory, including goods subject to reclamation, prior to a reclamation demand, the lenders’ rights trump and defeat reclamation rights. Nathan said this was made even clearer in the Chapter 11 financing order previously approved by the bankruptcy court that in no event were reclamation rights entitled to priority over the Chapter 11 lenders’ liens.

In the case, Whirlpool Corp. v. HHGregg, Inc. et al., Wells Fargo, the debtor’s pre- and post-petition secured lender, sought and was awarded by the court a motion to dismiss Whirlpool’s verified complaint for declaratory and other relief. The fate of the motion turned on the effect that the 2005 amendment to 11 U.S.C. §546(c)(1) has on a party’s reclamation claim against a debtor whose inventory is subject to floating prepetition and post-petition liens.

According to court documents, HHGregg and the other debtors filed voluntary Chapter 11 petitions on March 6, 2017, when Whirlpool operated 220 brick-and-mortar retail stores in 20 states. Whirlpool sold goods to the debtors in the ordinary course of business during the 45 days preceding the petition date. Whirlpool made a timely demand for reclamation seeking the return of the goods or proceeds from any post-petition sale of the goods. Prior to the petition date, certain debtors had a revolving credit facility with Wells, whose advances under the prepetition credit agreement were secured by first priority floating liens on all of the debtor’s assets, including inventory. The court gave the debtors authority to obtain debtor-in-possession (DIP) loans with Wells as the administrative agency, while the DIP lenders were given primary first priority liens on virtually all of the debtor’s assets, including inventory. Wells was given a replacement lien on the debtor’s assets, subordinate only to the DIP liens to secure Wells’ prepetition secured claim.

When the debtor’s reorganization was ultimately unsuccessful, it sold its inventory, including the Whirlpool goods.

Under Section 2-702 of the Uniform Commercial Code (UCC), a seller seeking to reclaim goods from an insolvent buyer must send a written demand to the buyer within 10 days after the buyer’s receipt of the goods. The buyer still has to have the goods in its possession, and the goods must be identifiable and not incorporated into another product. The seller’s ability to recover the goods also is subject to the rights of other parties, such as buyers in the ordinary course of business. Under federal law, in 2005, 11 U.S.C. §546(c)(1) was amended to provide that reclamation rights are “subject to the prior rights of a holder of a security interest in such goods.”

Whirlpool had argued that Wells was not acting in good faith when it continued to lend under the prepetition credit agreement in the case on the eve of bankruptcy allegedly knowing the debtors couldn’t repay their vendors, the court documents state. Wells argued that good faith is irrelevant under the amended federal statute and Whirlpool’s reclamation claim was subject to their prior lien rights, rendering those claims worthless.

– Nicholas Stern, managing editor

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Don’t Wait to Serve a Prelim Notice in South Carolina

Being first doesn’t always mean you’re the best, but when it comes to public construction projects in South Carolina, that can be the case. Material suppliers should be prepared to serve their preliminary notice to the prime contractor as soon as possible. This is done to trap unpaid funds.

All potential claimants who don’t have a direct contract with the general contractor need to serve this preliminary notice to fully protect their entire payment, according to NACM’s Secured Transaction Services (STS). However, if the general contractor doesn’t file a Notice of Project Commencement within 15 days of the start of the project, the prelim notice is not necessary but still recommended by STS. The Notice of Project Commencement is for entities entering into a direct agreement with the project owner. It is filed with the clerk of court or register of deeds in the county where the project is located. STS suggests serving the prelim notice within 30 days after first furnishing to protect lien rights on unpaid funds.

Should you remain unpaid, there is a 90-day window from last furnishing of labor, materials or services to file a claim against the bond. Going further, for non-highway work, there is a one-year deadline from last furnishing to file a suit against the bond. Why is this important? If you are a supplier waiting for payment, you might not be the only one in line, which was a possibility after a lawsuit was filed last month in Charleston.

A $200 million facelift was completed last year at Charleston International Airport. More than 10% of the project was subcontracted to Bell Constructors, whose agreement went from $17.4 million to $22.4 million after change orders. Bell claims it has not been paid almost $900,000 and sued two contractors, but not the owner, for breach of contract for its work at the airport. Bell was a first-tier subcontractor and a third-party beneficiary of the bond.

The airport case illustrates another reason why it is important as a supplier to do your due diligence on a project. You don’t want to be caught in the middle of a dispute between your customer, the subcontractor and the general contractor. Among the actions to be taken are asking for a copy of the payment bond, which has come under fire as well in this recent example at the airport. Bell is also suing three bonding agencies over the payment bond.

Know your rights as a supplier or a sub-subcontractor. File the preliminary notice no matter what as soon as you can and keep a watch as the 90-day bond claim deadline approaches if you haven’t been paid.

– Michael Miller, associate editor

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EU Food Industry Vulnerable to Brexit

The food industry as a whole has a stable outlook and has seen solid credit risk situations in many countries, according to the sector’s market monitor from credit insurer Atradius. This is due to the food industry’s resiliency to downturns compared to other industries. Within the industry, however, there are certain sectors that are facing risks due to price and health issues. Atradius took a look inside 10 countries, mainly from the European Union (EU), with full reports, performance snapshots and brief overviews to access credit risks and financial conditions among other factors in the food industry. Brazil was the lone country from outside the EU, and the United Kingdom is on its way out.

Brazil’s 2018 outlook is helped by a good harvest this year as well as China’s demand for Brazilian exports. The positive harvest reduced prices for products such as breads, rice and cereals. Nonpayment trends during the last six months have improved as have profit margins and sales. Payment delays are expected to continue declining into 2018, as are insolvencies.

In the Netherlands, nonpayment trends and insolvencies are stable. The country is second in the world to the U.S. as far as exporters of agricultural-food products, and roughly one-sixth of Dutch industrial employees work in the food industry. Food industry insolvencies are fairly low in the Netherlands (5% of insolvencies between April and September of this year), and the average payment in the industry is 40 days. Despite its solid outlook, the Netherlands is threatened by outside risks—e.g., the Russian import ban and Brexit.

Also affected by the United Kingdom’s referendum to leave the EU is Ireland. The agri-food and beverage industry is more than 7% of the Irish economy and more than 10% of its exports. Ireland is the EU’s largest exporter of dairy ingredients, beef and lamb. Atradius expects payment delays and insolvencies to increase in 2018 despite a currently good performance assessment. A hard U.K. exit from the EU could be devastating to the industry in Ireland. Cheddar cheese exports to the U.K., which are valued at $350 million, would face a 55% tariff.

Meanwhile, the U.K. is seeing deterioration in nonpayments and insolvencies in the last six months and in the coming six months. Both are predicted to increase, while high pressure on profit margins will also go up due to a rise in import costs. This is a cause for concern since nearly half of the food consumed in the U.K. in 2016 was imported. The pound has also decreased roughly 15% against the euro, causing commodity prices to rise. Payments take on average between 45 and 60 days.

German payment terms can vary depending on the sector. Producers and wholesalers pay on average within 30 days, while retailers can range from 45 to 90 days or more. “With food processing companies and retailers demanding longer payment terms from their immediate suppliers to improve their working capital, a wave of longer payment terms is being created along the whole supply chain,” explained Atradius.

In the food industry, the Netherlands, Hong Kong and Taiwan were the only countries with an excellent rating, while the United States was rated good.

– Michael Miller, associate editor

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IFRS 9 Implementation in APAC Unlikely to Bring Ratings Changes

Fitch Ratings recently surveyed a group of banks in 13 different markets in the Asia-Pacific (APAC) region and found that while the initial implementation of IFRS 9 is likely to spark high provisioning, the overall impact should be manageable and is unlikely to prompt immediate ratings changes.

The introduction of the IFRS 9 accounting standard by the International Accounting Standards Board (IASB) for most major APAC markets on Jan. 1, 2018—European banks will see the new standards come into effect on the same date—is expected to have wide-ranging effects on bank processes and loan performance assets, according to a recent report by Fitch Ratings. It requires banks to switch to recognizing and providing for expected credit losses on financial assets, instead of the current common practice of providing only when losses are realized. Banks will need to set aside provisions for expected losses over the next year for performing assets, dubbed “stage 1” under IFRS 9, as well as provision for lifetime expected losses for underperforming or “stage 2” and nonperforming “stage 3” assets, Fitch said.

Mostly, banks and insurance companies will be more affected by the change, while corporates will be impacted to a lesser degree, Veit Gerlach, senior manager of BDO AG’s Accounting Advisory Group, told Business Credit magazine in a recent article. The new standard will be a positive for corporates because of the simplification of the expected credit loss model for trade receivables and enhancements regarding the flexibility of hedge accounting, he said. Firms will have to deal with the credit risk of financial assets more intensively, giving companies the ability to better reflect their risk management activities in the financial statements.

For the 59 APAC banks Fitch recently surveyed, most expected they’d have first-time provision hikes of less than 20%. “We did not observe significant differences in responses across markets,” Fitch analysts said. “Banks in some jurisdictions highlighted the inclusion of off-balance-sheet items as a driver of higher provisions, while a few linked the expected increase to specific products, such as unsecured retail credit and micro loans. Respondents that expect lower impairment provisions cited more granular assessments, the removal of the loss-emergence period and a benign economic outlook as reasons. Pre-emptive increases in provisioning levels ahead of implementation could also be a factor in some instances.”

After the transition to the new standard, analysts said they expect provisioning to fall more during cyclical upswings and grow faster during downturns. “The importance of unbiased expectations of economic conditions when estimating credit losses could be a challenge to the new standard's credibility, which auditors will have a crucial role in addressing,” the ratings agency said.

Overall, the new standard should serve to strengthen banks’ risk management and improve transparency for outside parties, but the long-term impact is still too early to assess, Fitch said. “We observe varying degrees of readiness among APAC banks, which reflects the significant work needed to adopt the new standards.”

– Nicholas Stern, managing editor

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