Beware of Unexpected Big Orders: Lessons from The Paper Source Bankruptcy

Stocking the Shelves Without Paying the Bills

Shortly after the Christmas holidays, Paper Source turned up the volume on ordering from many suppliers. These larger than expected, somewhat out-of-season orders were a welcome bright spot after a difficult year for many businesses, especially small makers. While suppliers geared up for on time delivery of goods, Paper Source was gearing up to file Chapter 11 Bankruptcy on March 2, 2021.  

The result of this last minute order surge was that the debtor was flush with extra assets that could be grabbed by other creditors, while the original suppliers faced unprecedented shortfalls in their income due to non-payment for the orders. Paper Source stocked their shelves on their suppliers dime.

At this point in time, it appears likely that Paper Source will reorganize and stay in business in some format, a turn of events that would normally give hope to small creditors that they could eventually be repaid. The bankruptcy process is different however.  

In bankruptcy cases, assets are apportioned among existing creditors, often amounting to a partial repayment (e.g., 50%) and the remaining portion of the debts are permanently discharged and uncollectible after the bankruptcy case closes.  

For most creditors, what this means is that they need to actively pursue their claims against the debtor in the bankruptcy proceeding itself, rather than wait until after the end of the case to pursue the newly reorganized debtor.

The rules about the rules about the rules

As we have come to expect from the law, there are exceptions to the exception.  

The bankruptcy discharge of unpaid debts is an exception to typical state laws. However the Bankruptcy Code has its own exceptions to the dischargeability of certain debtsSection 523 of the Bankruptcy Code outlines several scenarios in which a debtor may be prevented from discharging certain debts in a bankruptcy proceeding.  

The small Paper Source creditors should take particular note of subsection (a)(2)(B) of section 523, which exempts from discharge of claims for money, property, services, or credit obtained by the debtor a written statement that was materially false about the debtor’s financial condition upon which the creditor reasonably relied and the debtor made with intent to deceive.

In practice, if Paper Source wrote to its suppliers before the bankruptcy and intentionally misrepresented its ability to pay for its pre-bankruptcy orders, these suppliers may have nondischargeable claims against Paper Source that survive beyond the end of the bankruptcy proceeding. However if Paper Source made only oral promises about its ability to pay for the orders, the suppliers cannot readily avail themselves of this exception to dischargeability.

Protect Yourself (and your cash flow).

If you suspect that a customer may have financial difficulties, ask for a written affirmation of the customer’s wherewithal to timely pay for the order. This written statement can help you argue that their debt to you should be treated as non-dischargeable in the bankruptcy court.

What if it’s too late?  If you just completed a sale to a company that promptly filed for bankruptcy before paying you, there are other expert strategies to potentially recover all your property or receive full payment for it. But you need to act quickly!  Drop us a note at Proxifile to learn more. info@proxifile.com