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Protecting Carrier Interests in Shipper and Broker Bankruptcies Featuring:

Protecting Carrier Interests in Shipper and Broker Bankruptcies Featuring: Henry E. Seaton, Esq. and John T. Husk, Esq. of Seaton & Husk, LP FirstAdvantage Audio Conference June 10, 2009 / 1:30 p.m. CST.

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Protecting Carrier Interests in Shipper and Broker Bankruptcies Featuring:

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  1. Protecting Carrier Interests in Shipper and Broker Bankruptcies Featuring: Henry E. Seaton, Esq. and John T. Husk, Esq. of Seaton & Husk, LP FirstAdvantage Audio Conference June 10, 2009 / 1:30 p.m. CST

  2. "It's only when the tide goes out that you find who has been swimming naked. The tide is going out and it won't be a pretty sight." -- Warren Buffett

  3. Troubled Industries • Automotive – GM, Chrysler • Ripple Effect on Second Tier Suppliers • Trend in Retailer Bankruptcies: • Sharper Image, Tweeter, Circuit City, Mattress Discounters, Mervyn’s, Steve & Barry’s, Bosco, Linen’s and Things, Lillian Vernon, Domain Furniture, Progressive Auto Parties, Goody’s, KB Toys

  4. Insolvency Adversely Affects Carriers, Shippers and Brokers freefoto.com

  5. Summary • Unsecured creditors finish last. • Banks win because of secured position. • As a general unsecured creditor, absent “something else” carriers and brokers can expect little or none of pre-petition receivables to be paid.

  6. Strategies to avoid losing receivables as mere unsecured creditor: • Interest and attorney’s fees • Non-recourse financing LOCs • Spreading liens • Critical vendor • Recourse

  7. LIGS 102-BItem 35Collection of Charges • Any suit arising from the payment and/or collection of carrier’s freight charges shall be filed in Florida and/or the United States of America; • Should carrier retain an attorney to collect the charges accruing on the property covered by carrier’s bill of lading, the party or parties responsible for payment of the charges will be liable to carrier for attorney’s fees in the amount of thirty percent (30%) of said total unpaid charges or $200.00, whichever is greater; and • Should carrier file suit to collect the charges, the party or parties responsible for payment of such charges will also be liable to carrier for court costs, and interest charges at the rate of eighteen percent (18%) per annum of the total unpaid charges, such interest to begin to accrue from the date carrier’s bill of lading was issued, however if the interest rate provided for herein is found to be usurious, then the maximum interest rate allowed under applicable usury laws will be the chargeable interest rate.

  8. Letters of Credit, Guarantees, Non-Recourse Factoring • Consignor execution of Section 7 is waiver of bill of lading guarantee. • By credit application, carrier can seek personal or bank guarantee, letters of credit, subordination agreement. • Consider placing future loads on C.O.D. or reversing credit terms when customer insolvency is issue.

  9. LiensPossessory liens trump secured creditors. Be sure you have something the bankrupt needs to reorganize and the “right” to hold it.

  10. Trucker’s “Statutory Lien” is of Little Value • 49 U.S.C 80110 – only the freight charges on the loads in your possession at time of bankruptcy. • Statutory lien does not apply to past freight charges • Warehousemen, on other hand, have “spreading lien” in warehouse receipt and UCC authority to hold goods for payment of charges past and present. • Customs brokers, 3PLs and other sophisticated supply chain participants negotiate priority liens. • E.g. Dan River Bankruptcy - Expediters’ preferential lien extends to draymen with 154 container loads of bed-in-a-bag at port and over $1 million in receivables. • State statutory liens – CA, GA – Mervyn.

  11. Carriers and brokers can negotiate contractual spreading liens too: • Spreading liens can be incorporated into your credit applications • Lien language can be placed in your rules circular with language as follows: • Item 670 - LIEN FOR FREIGHT CHARGES. “Carrier shall have a possessory lien on shipments in its dominion and control for the payment of freight charges past and present.” • Anticipation of bankruptcy provisions can be placed in negotiated contracts. • For example: “Upon the insolvency of any party, Shipper shall have the right of immediate delivery for all shipments in transit upon payment of outstanding freight charges past and present.”

  12. Critical Vendor Status • Commonly referred to as “doctrine of necessity” or “necessity of payment rule” See In Re: Ionosphere Club, 98 B.R. 174, 175 (Bankr. S.D.N.Y. 1989) • Debtor in Chapter 11 gets to choose who gets paid its “pre-petition” payables. See In Re: Just for Feet, 242 B.R. 821, 825 (D.Del. 1999); In Re: Lehigh and New England Railway Co., 657 F.2d 570, 581 (3rd Cir. 1981) • Affect of customer bankruptcy on poor creditor is not court’s concern

  13. If you are “essential” and “irreplaceable” on petition of debtor, bankruptcy court will approve payment to unsecured carrier provided you continue to serve the debtor-in-possession. • Critical vendor petitions are usually part of “first day” motions. Don’t accept traffic department’s word for it.

  14. Payment of common carrier charges and related fees in large Chapter 11 cases under the “critical vendor” or “doctrine of necessity” theory is a frequent occurrence. • In Re: Linens Holding Company, Case No. 08-10832 (Bankr. D.Del. 5/2/08) • In Re: Lillian Vernon Corporation, Case No. 08-10323 (Bankr. D.Del. 2/21/08) • In Re: Sharper Image Corp, Case No. 08-10322 (Bankr. D. Del. 2/2008 • In Re: Wickes Holding, Case No. 08-10212 (Bankr. D. Del. 2/5/2008) et al.

  15. The threat of liens motivates the grant of critical vendor status. See Mervyn Holdings, Case No. 08-11586 (Bk. Dist. Del.) Order authorizing Debtor to pay pre-petition accounts owed to common carrier, p. 8: “The Debtors anticipate common carriers may argue there are entitled to possessory liens for transportation and/or storage of merchandise in their possession and may refuse to deliver or release such goods before the liens are satisfied. Under the laws of certain states, carrier may have a prior lien on goods in its possession to secure the charges … pursuant to Bankruptcy Code 363(e) such carriers would be entitled to protection of such a valid possessory lien … The value of the merchandise in the possession of common carriers, as well as the potential harm to debtor’s business if the goods are not released or timely delivered and sold, far exceeds the amount of any pre-petition shipping and storage charges.” Note: Our major clients are frequently offered critical vendor status. (Mervyn, Goody’s Quebecor, Heilig-Meyers, et al.)

  16. In Re: Pilgrim’s Pride; U.S. Bankruptcy Court, ND TX; Case No. 08-45664 • At time of filing in December 2008, owed $34.6 million in freight charges on $810 million worth of product. • Debtor filed a critical vendor motion relating to creditors other than motor carriers. • Debtor filed a separate motion with the Court for authorization to pay pre-petition common carrier fees separate and apart from the critical vendor motion. • Debtor acknowledged existence of motor carrier liens. • Debtor concerned that given the perishable nature of goods and sometimes live nature of the goods, there was a need for action. • Court granted separate motion and authorized Debtor to pay all undisputed pre-petition charges, “Provided however, that if the value of the Debtor’s goods in the carrier’s possession is less than the amount of carrier’s claim, payment of such claim may only be made pursuant to Critical Vendor Motion and Order.”

  17. Recourse – Bypassing the Deadbeat and its Secured Lender • The bill of lading is the contract of carriage. Its terms and conditions bind all the parties. See Texas Pacific Railroad v. Leatherwood, 250 US 470 (1919) • Consignor – primarily liable unless signed Section 7 or other negotiations for a release. • Consignee – becomes liable upon acceptance of goods. • Truckers Express/Landstar

  18. Most courts follow the strict position that the carrier has recourse to the shipper unless it affirmatively waives the right. • Southern Pacific Transportation Co. v. Commercial Metals Co., 456 U.S. 336, 342 (1982) • Missouri Pacific Railroad Co. v. Center Plains Industries, Inc., 720 F.2d 818, 819 (5th Cir. 1983) • Strachan Shipping Co. v. Dresser Industries, Inc., 701 F.2d 483 (5th Cir. 1983) • Contship Container Lines, Inc. v. Howard Industries, Inc., 309 F.3d 910 (6th Cir. 2002) • Hawkspere Shipping Company, Ltd. v. Intamex, S.A., 330 F.3d 225 (4th Cir. 2003) • National Shipping Co. Of Saudi Arabia v. Omni Lines, 106 F.3d 1544 (11th Cir. 1997) • Oak Harbor Freight Lines, Inc. v. Sears Roebuck & Co., 513 F.3d 949 (9th Cir. 2008)

  19. Exel Transp. Servs. v. CSX Lines L.L.C., 280 F. Supp. 2d 617 (D. Tex. 2003) • The bedrock rule of carriage cases is that, absent malfeasance, the carrier gets paid. It is superficially unfair that [consignors] must pay for shipments twice. However, allowing them the benefit of carriage without compensating the carrier would eventually cripple the shipping industry and the economy generally, as carriers devoted their time to investigating potential customers ...it is [the shipper’s] responsibility to choose a subcontractor that can forward money as well as freight ...

  20. A broker can be the agent of the shipper, the agent of the carrier, or an independent contractor depending upon the facts. See 49 C.F.R. 371

  21. RULES CIRCULAR 101Item 650THIRD PARTY BILLING • Carrier does not employ property brokers or other intermediaries as its agents for the solicitation of shipments or the collection of freight charges. Carrier will invoice the shipper’s broker, bank or other agent for freight charges. Carrier reserves the right to bill and collect freight charges from the shipper on prepaid shipments or the consignee on collect shipments in the event full payment of freight charges is not received pursuant to third party billing. • A shipment in which charges are to be paid by a party other than the consignor or consignee will be accepted provided recourse to the consignor is preserved with the carrier picking the shipment up at origin. The consignor and consignee guarantee to pay the charges if the third party fails to do so in the time allotted under the applicable credit regulations. Any such shipment will not be accepted if the consignor executes a nonrecourse provision of the bill of lading.

  22. Practical Settlement Issues When Broker Fails to Transmit Funds • Shippers feel victimized by “double payment” demands. • Shipper will voluntarily withhold payment if convinced broker is engaged in malfeasance or misfeasance. • Carrier should offer shipper indemnity against demand by broker for payment made by offset. • “Splitting the difference” and workouts make business sense (e.g. Enron, Lighthouse, Partners).

  23. Effect of Stay on Recourse • Filing of bankruptcy stays suits against the bankrupt estate. • Bankruptcy stay does not effect third party recourse. • See Old Dominion Freight Lines, Inc. v. Amazon.com, Inc., U.S. Dist. Ct., E.D.Va., Case No. 02-1006-A (2002). • Third party lawsuit against shipper may be referred to bankruptcy court, though, as related proceeding.

  24. Preference Actions – “Feeding on the Victims”

  25. 11 U.S.C. 547(b) • Permits the Trustee or the Debtor-in-Possession to recover payments made to the unsecured creditors within 90 days of the filing of its petition. • The intent of this statute is: • to preclude an insolvent debtor from favoring particular creditors and scaring off trade accounts from doing business with it when bankruptcy seems inevitable. See Luper v. Columbus Gas, 91 F.3d 811, 815 (6th Cir. 1996)

  26. What the Trustees must prove: (1) that payment was made to creditor (2) on account of an antecedent debtor (3) while the debtor was insolvent (4) payment made within the 90 day preference period prior to filing (5) the creditor got more than it would have in liquidation

  27. Why the Preference Statute is not Fair • Because little if any of the money collected from unsecured creditors is ultimately redistributed to members of the class. • Because the trustees indiscriminately sue every unsecured creditor in sight. • Because the law is applied to require unsecured creditors who are slow paid to give back payments “made outside the ordinary course” because the creditor could not motivate more timely payment. • In practice, trustees demand return of all payments made within 90 days and shift the burden to the transportation creditor. • IN OTHER WORDS, IF YOU DON’T COLLECT FREIGHT CHARGES ON TIME, YOU MAY NOT GET TO KEEP WHAT YOU DO COLLECT!

  28. (1) The amount of preference payments reclaimed by trustees under the statute are huge. (2) Often the creditor doesn’t find out about the preference claims until 2 years after the bankruptcy is filed (3) The bankruptcy court has jurisdiction and venue. You can be served by mail and forced to come to Delaware on short notice.

  29. The primary defenses to preference actions are “ordinary course of business” and “new value” 11 U.S.C. 547(c)

  30. Ordinary Course of Business Defense to Preference Actions • Ordinary course defense does not mean only the creditor who got special preferential treatment must return payments for redistribution!!! • Most creditors were “slow walked” by the deadbeat in the 90 day period and slow pays like fast pays are often considered outside the “ordinary course of business” defense.

  31. To prove ordinary course of business defense, creditor must show: • The debt was incurred in debtor’s ordinary course of business; and • The payment was made in “ordinary course” of affairs between debtor and transferee

  32. Because freight charges are usual and ordinary expenses incurred by most bankrupts, the first prong is not an issue, but to prove that the payment was made in “ordinary course of affairs” between the debtor and the transferee, you must show that the payment was neither inordinately late or early.In re: Fred Hawes Org.,957 F. 2d 244 (6th Cir. 1992)

  33. A variation in contractual terms is not fatal, but it will be used against the creditor unless you show a long history before the preference period of accepting similar tardiness.Fiber Lite Corp. v. Molded Acoustical Prods., 160 Bankr. 608, aff’d 18 F.3d 217, 223(3rd Cir. 1994)

  34. Days-to-Pay analysis showing course of dealing before and during preference period is the most effective evidence providing ordinary course defenseSet up and manage “Days to Pay” data to prevent slow pays and defeat preference demands.The role of interest and attorney’s fees.

  35. The Role of Bank Wires and ACH in Avoiding Preference and Effect of Bankruptcy

  36. Do not ignore preference demand letter. Respond with analysis with letter of counsel and assure trustee of a fight.Do not be “low hanging fruit” - consolidate defense costs with other victims to overcome “home court advantage”(e.g. Delaware Counsel; Pacer)

  37. New Value Defense to Preference Actions • A trustee may not avoid monies paid to a carrier during the preference period to the extent that after the alleged payment, the motor carrier gave new value. 11 U.S.C. 547(c)

  38. Under the new value analysis you: • Look at the data you received payment for the alleged preference. • Look at your unpaid invoices arising after receipt of the alleged preference and reduce the preference obligation, not otherwise avoidable, dollar for dollar starting with the oldest subsequent invoice first until the preference claim or available new value is extinguished.

  39. Caveat: Giving up “new value” to extinguish a preference reduces your claim, but as a claim the amount owed an otherwise unsecured creditor is worth little if anything.

  40. When the Bankrupt is the Intermediary

  41. The inadequately resolved issue is whether the freight charges paid to a broker represent assets of the broker’s estate to the extent that the payment represents freight charges due to the carrier.

  42. If the broker functions as an agent working on an undisclosed commission like a realtor or an insurance agent, then arguably it owes the shipper and the carrier a constructive trust duty to transmit payments and should not be pleading or hypothecating its gross receipts to a second creditor.

  43. The broker regulations support this view of the broker as a constructive trustee of funds: • Broker must segregate accounts • Broker must account on shipment-by-shipment basis for payments received from shippers and payments to carriers. 49 C.F.R. 371.3(a)(4)(5)

  44. Broker InsolvencyThe Conduit Theory:Tracing and Special Motor Carrier Creditors Committee

  45. The Conduit Theory or Interline Trust Theory holds that a broker’s receivables and the payments it receives are not assets of its bankrupt estate to the extent such payments or receivables represent unpaid freight charges due to the motor carrier. • In Parker Motor Freight, Inc. v. Fifth Third Bank, 116 F.3d 1137 (6th Cir. 1997) the Court recognized the interline trust theory to hold that the rights of the motor carrier trump the rights of the secured creditor with respect to such receivables.

  46. The conduit theory is consistent with the broker regulations requiring the broker to segregate funds and to keep load-by-load accounting of freight charges received, commissions earned and carrier payments made. • While brokers typically do not maintain escrow accounts, the conduit argument suggests that they should and that brokers should not pledge or hypothecate receivables to be collected for the benefit of carrier to secure unrelated loans. • Although transportation factors are aware from experience that the carrier’s recourse rights to collect from the shipper can defeat their security interests in broker receivables, large lending institutions typically take an arrogant and uninformed position, claiming in bankruptcy their perfected security interest trumps the carrier’s collection rights.

  47. Increasingly motor carriers are combining efforts in intermediary bankruptcies to assert their special interests under the conduit theory to: • To oppose the estate and the secured creditor, collecting through recourse their unpaid freight charges from the shippers; • To challenge the secured creditor’s right to cash collateral to the extent the broker has failed to segregate and pay carrier bills; • To argue that the secured creditor and the broker have engaged in equitable subordination by applying collected motor carrier receivables to pay broker’s debt (the “sweep account” problem); • To defeat the estate’s inevitable preference action, arguing that the monies paid to the carrier were not recoverable assets of the estate but monies transmitted to the carriers in trust.

  48. How these cases have played out thus far can best be shown in the following examples: • In Re: Worldpoint Logistics, Inc., Case No. 02-23448, U.S. Bankruptcy Court, Western District of Washington (At Seattle) • Computrex • Transportation Revenue Management d/b/a TRM, Assignee of Mastertrans, Inc., et al. v. Freight Peddlers, Inc. et al., 2001 Fed. Carr. Cases 84,181 • In Re: Air Cargo, Inc., Case No. 04-37512, U.S. Bankruptcy Court, District of Maryland (Baltimore) • In Re: Blue Thunder Auto Transport, Inc., Case No. 07-61268, U.S. Bankruptcy Court, Northern District of Georgia (Atlanta) • Pending Case: In Re: Gary W. Schulte, Case No. 08-36130, U.S. Bankruptcy Court, Southern District of Texas. Schulte is the owner of serial brokerages personally liable for fraud and embezzlement. • Pending Case: In Re: Gulf Coast Transport, Inc., Case No. 09-31896, In the U.S. Bankruptcy Court, Northern District of Texas. Can a broker factor its receivables and direct funds through its carrier affiliate?

  49. For more information please visit:Seaton & Husk, LPwww.transportationlaw.netandTransportation Revenue Management, Inc.www.trmcollect.netPlease direct any questions or comments to: info@transportationlaw.netThank you!

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