Understanding Suppliers’ Rights and Remedies in Retail and Hospitality Bankruptcies

Within one week, on May 19, Red Lobster, an Orlando, Florida-based chain of seafood restaurants, and numerous affiliates, filed for Chapter 11 protection. The filing was made in the Bankruptcy Court for the Middle District of Florida and is jointly administered under the case title In re Red Lobster Management LLC, Case Number 6:24-bk-02486-GER.

In the wake of the recent bankruptcy filings by Foxtrot Market and Red Lobster, with more likely to come, it is crucial for suppliers in the retail and hospitality sectors to fully comprehend their legal standing and options. Although leases often catalyze bankruptcies of this nature, suppliers find themselves in a uniquely challenging position, facing distinct impacts and possessing different options compared to other creditors. As financial distress increases within certain parts of the industry, understanding and effectively managing rights and remedies in bankruptcy scenarios is vital for the resilience and financial health of suppliers. Each remedy discussed below offers unique advantages and protections, specifically designed to mitigate the risks faced when a customer enters bankruptcy. Employing these remedies strategically can greatly improve a supplier’s ability to recover the value of goods or services provided.

1. Reclamation Rights

Reclamation rights, as provided under Section 2-702(2) of the Uniform Commercial Code, permit a supplier to reclaim goods if they discover the buyer is insolvent, provided they make a demand within 10 days of delivery. Establishing a reclamation claim prior to a bankruptcy filing can be complex and heavily reliant on specific facts, often necessitating a detailed inquiry of the debtor’s financial information.

When the buyer enters bankruptcy, Section 546(c) of the US Bankruptcy Code alters how sellers can exercise these state-law reclamation rights. Under this section, suppliers are granted reclamation rights, enabling them to reclaim goods delivered to a debtor prior to bankruptcy. These rights apply if the goods were delivered in the ordinary course to the debtor within 45 days before the bankruptcy petition was filed and the debtor was insolvent at the time of receipt. To exercise these rights, suppliers must submit a written demand for the return of the goods within 45 days of delivery, or within 20 days if the 45-day period concludes post-bankruptcy filing.

The value of reclamation rights in the retail and hospitality sectors is significant. They provide suppliers a means to potentially retrieve their goods or secure a priority claim within the bankruptcy estate, thereby enhancing their prospects for recovery. However, the effectiveness of these rights can be limited by factors such as the debtor’s prior use or sale of the goods, as well as their subordination to the prior liens of secured creditors on the debtor’s inventory. As such, while reclamation rights offer a powerful tool for suppliers, their practical utility may differ based on the specific circumstances surrounding the debtor’s bankruptcy.

2. Administrative Expense Claims

Under Section 503(b)(9) of the US Bankruptcy Code, suppliers to the retail and hospitality sectors are afforded a valuable remedy when a customer declares bankruptcy. This section enables suppliers to claim administrative expense priority for goods received by the debtor within the 20 days preceding the bankruptcy filing. To be eligible, the goods must have been sold in the ordinary course of business, and the debtor must have physically received them during this specific period. This provision is particularly advantageous because administrative expense claims are prioritized higher than general unsecured claims in the bankruptcy payment hierarchy. Claims under Section 503(b)(9) are paid from the bankruptcy estate before many other claims, thereby enhancing the likelihood that the supplier will recover a greater portion, if not all, of the owed amounts. This remedy offers a critical financial safeguard for suppliers.

3. Critical Vendor Status

Suppliers may also be classified as “critical vendors” during bankruptcy proceedings. This status is awarded at the bankruptcy court’s discretion, typically upon a motion by the debtor, and recognizes certain suppliers as essential to a debtor’s ongoing operations. As critical vendors, these suppliers are permitted to receive payment for pre-petition debts during the bankruptcy process — something that is otherwise prohibited. Being designated a ‘critical vendor’ provides significant benefits to suppliers by providing them with a level of payment security in otherwise uncertain circumstances. However, achieving critical vendor status will require the debtor to bring a critical vendor motion and show the court the goods or services provided are indispensable to the debtor’s operations and that discontinuing their supply would significantly hinder the debtor’s operational capabilities. Moreover, in connection with negotiating with a debtor in the hopes of being designated as a critical vendor, suppliers may be forced to agree to provide favorable terms to the debtor, such as extending additional credit, etc. This strategic positioning can result in more stable and predictable cash flows for suppliers throughout the bankruptcy proceedings, particularly critical in the volatile environments of retail and hospitality.

4. Statutory Lien Claims

Suppliers in the retail and hospitality industries, particularly those dealing with perishable goods, can benefit significantly from statutory liens that provide enhanced protection during a customer’s bankruptcy. Key protections are available under statutes like the Perishable Agricultural Commodities Act (PACA) and the Packers and Stockyards Act (PASA), which are particularly relevant for suppliers of perishable agricultural commodities and livestock, such as fruits and vegetables. Under PACA, for instance, suppliers of perishable agricultural products are automatically granted a trust over the commodities they sell, as well as over any receivables or proceeds derived from their sales. This trust ensures the commodities and their proceeds are not considered part of the debtor’s bankruptcy estate, thereby shielding them from claims by other creditors. To maintain these rights, suppliers must adhere to specific statutory requirements, such as including a notice on invoices indicating that the commodities are sold under the protection of the PACA trust.

5. Proactive Steps for Suppliers Risk Management

As a supplier, it is crucial to take proactive measures when facing a customer’s potential bankruptcy. Start by reviewing recent transactions and invoices to identify any goods that may be reclaimable or qualify for administrative priority claims under bankruptcy laws. Additionally, closely monitoring bankruptcy filings is essential to enable a swift response and ensure your rights are asserted within the required deadlines. The timing of these actions is critical, as delays can compromise the effectiveness of your claims and the ability to secure your interests. Given the technical nature of the remedies discussed, consulting with legal counsel specializing in bankruptcy is also vital. This will help you fully understand the impact of potential bankruptcy on your contractual obligations and allow you to effectively strategize to protect your interests.

ArentFox Schiff is committed to providing the guidance and representation needed to navigate the complexities of bankruptcy proceedings in the retail and hospitality sectors. We are prepared to assist you in safeguarding your interests.