When dealer termination and bankruptcy collide

Jeremy I. Silberman and Gary N. Marks -
Your Focus
- 23 Apr 2009 ( #407 )
5 min read
Jeremy I. Silberman and Gary N. Marks
Jeremy I. Silberman and Gary N. Marks
Jeremy I. Silberman and Gary N. Marks are members of Norris McLaughlin & Marcus, P.A., a full service law firm located in Bridgewater, New Jersey and New York City. Jeremy specialises in franchise and distribution law with emphasis on the materials handling industry. Gary, head of the firm's bankruptcy group, represents both debtors and creditors in bankruptcy proceedings, including materials handling equipment dealers and other franchisees. For more information visit www.nmmlaw.com.
In our last column (Forkliftaction.com News #402), we addressed protections to which materials handling equipment dealers may be entitled under state franchise laws and other dealer protection statutes. In this column, we look at the initial effect of a dealer filing for bankruptcy on its dealership agreement and the interaction with franchise protection statutes.

When economic times were good, equipment dealers survived and even prospered, helped along by low interest rates and a strong demand for their product and services. However, in today's haemorrhaging economy, as revenues decline, cash flow tightens and balance sheets turn upside down, some companies can no longer meet their current obligations as they come due. Once-healthy, profitable businesses may find themselves struggling to keep their heads above water.

It is at times like these that companies often seek refuge from their creditors by filing for protection under the federal bankruptcy law, specifically by filing a petition for relief under Chapter 11 of the US Bankruptcy Code.

The process is simple enough to initiate. A voluntary Chapter 11 petition is only two pages long and it is accompanied by a list of the company's 20 largest unsecured creditors. The goal is for the company to reorganise its business and eventually exit Chapter 11 as a viable entity or, failing that, to engage in an orderly liquidation with a view towards maximising the value of its assets for distribution to creditors. The consequences of filing, however, will be far reaching, not only for the company, called a "debtor" or "debtor-in-possession" under the Bankruptcy Code, but for its creditors as well.

Similar mechanisms exist in most countries, but clearly the details differ from jurisdiction to jurisdiction.

When a Chapter 11 petition is filed, a bankruptcy "estate" is created which consists of all of the assets or property of the company - tangible and intangible. All property of the estate is protected by the "automatic stay", an injunction against any creditor action to enforce collection of pre-petition claims. The automatic stay is effective immediately upon the filing of the petition and a creditor's wilful violation of the stay is potentially punishable as a contempt of court.

Dealership agreements often state that the mere filing for bankruptcy is an event of default that terminates the dealership agreement. These provisions are generally unenforceable. However, whether a bankruptcy will protect a dealer from a termination started by the manufacturer before the bankruptcy was filed becomes an issue of timing, the wording of the dealership agreement and the state franchise or dealer protection laws if the dealer qualifies for protection under those statutes. An important issue is whether the contract or applicable laws require the manufacturer to give notice before terminating the dealer, and whether the contract or laws provide the dealer with an opportunity to cure any defaults.

Often, a manufacturer sees signs that a dealer is financially troubled, for example, when the dealer's orders have dropped significantly, the dealer's payments have slowed or stopped, the dealer is selling off its rental fleet to stay afloat, or the manufacturer's representative reports that the dealer is in bad shape. If the manufacturer reacts quickly to a financially distressed dealer's default under a dealership agreement by serving a termination notice prior to the dealer filing a Chapter 11 petition and if the notice period (whether in the dealer agreement or by statute) expires before the dealer files a bankruptcy petition, then a court would likely find that there has been a complete termination of the dealership agreement before the "automatic stay" took effect. Under these circumstances, the dealer agreement is not considered property of the dealer's bankruptcy estate. The manufacturer is not stopped by the bankruptcy from cutting off the dealer and appointing a new dealer in its place.

If, however, the dealer files a Chapter 11 petition before the contractual or statutory notice period expires, the dealer may be able to utilise the automatic stay to preserve the franchise as the centrepiece of its reorganisation plan. The issue becomes whether the franchisor is now subject to the automatic stay or it can complete the termination post-petition. The answer to this question depends on how the franchise agreement and relevant statutes have been written. If they simply provide that termination will be effective a certain number of days after the giving of the notice, but neither the agreement nor statute give the dealer the right to cure the default, and there are no further steps that the manufacturer must take to conclude the termination process, then an intervening bankruptcy petition will not stay termination. The mere passage of time alone is not subject to the automatic stay.

However, if the dealer agreement or the state's laws permit the dealer an opportunity to cure a default, and the cure period has not already expired at the time the petition is filed, then the Bankruptcy Code affords the dealer an additional 60 days in which to cure and avoid termination. In the meantime the business operates under Chapter 11 in the ordinary course protected by the automatic stay.

Finally, if the agreement or the franchise law require the manufacturer to take any further action after giving a termination notice to complete the termination process, and the dealer files for Chapter 11 before such action is concluded, then the manufacturer is subject to the automatic stay and must first file a motion for relief from the stay in order to complete termination - a motion that may be difficult to win. At this point the manufacturer has likely lost control of the termination process, and may be in for a long and expensive ride as the dealer attempts to reorganise or sell its business. The dealer can seek to remain in business, and "assume" the dealership agreement as an "executory contract" in the bankruptcy proceeding. The manufacturer, however, can employ strategies that amount to a near veto power over the dealer's plan of reorganisation. These issues will be covered in a future column.

On June 16, 2009, Norris McLaughlin & Marcus, PA will host a free seminar on legal issues facing material handling and industrial equipment businesses in the current economy. Issues to be covered include protecting your dealership using state franchise and dealer protection laws, collecting from financially distressed customers, when to consider filing for bankruptcy protection, updates on the Employee Free Choice Act and other labor law issues, and succession planning to minimize costs and risks when selling your business or transferring it to a family member. For information call Jeremy Silberman or Cassie Coldreck at 908-722-0700, or visit Norris McLaughlin and Marcus's website, www.nmmlaw.com.
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Blog articles provide perspectives and opinions and therefore may contain inaccurate or incomplete information. Forkliftaction Media accepts no responsibility for errors or omissions. If you feel that significant facts are overlooked, or have a different viewpoint on a topic addressed, we invite you to open a conversation in our Discussion Forums.

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