JUNE 2007
National Association of Credit Management
T h e P u b l i c at i o n F o r C r e d i t & F i n a n c e P ro f e s s i o n a l s
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credit colu m n
Deborah Thorne, Esq.
Stoppage in Transit:
Useful and Reliable Remedy for the
Diligent Seller Facing the Insolvent Buyer
T
he Uniform Commercial Code, which has been adopted
in all 50 states and in U.S. territories, generally protects
sellers from buyers who are unable to pay for the purchased goods.
Some of the remedies are more effective than others: for example,
the right to cancel credit terms and sell for cash in advance or cash
on delivery. Reclamation may protect sellers if the goods have been
delivered to an insolvent buyer and the seller makes demand for
the return of the goods during the 10 days after delivery. The right
of reclamation is not effective if the buyer has already sold or incorporated the goods into the buyer’s manufacturing process prior
to the receipt of the reclamation demand. In such cases, the seller’s
right of reclamation is not enforceable. Moreover, if the buyer’s
lender has a floating lien on the buyer’s inventory, the lender’s lien
will be deemed to have attached to the seller’s goods and will be
superior to the seller’s right to reclaim. Thus, it is a rare case where
sellers with reclamation rights actually get to exercise the right.
The right to reclamation is even more problematic if the buyer has
filed a bankruptcy petition. The bankruptcy debtor seldom enters
bankruptcy without a lender holding a blanket lien on all inventory. And although the recent amendments to the Bankruptcy Code,
referred to as BAPCPA, expanded the reclamation time period to
45 days, the right remains as illusory as under state law.
Stoppage in Transit
Another right that the Uniform Commercial Code gives to sellers
is that of “stoppage in transit” or “stoppage of delivery.” This right
may be exercised by a seller who has shipped goods to a buyer and
during the delivery process, but prior to the buyer actually receiving the goods, the seller becomes aware of the buyer’s insolvency.
Section 2-702(1) of the Uniform Commercial Code states the following:
Where the seller discovers the buyer to be insolvent he may refuse delivery except for cash including payment for all goods
theretofore delivered under the contract, and stop delivery under this Article….
Stoppage in transit also provides the seller who has delivered the
goods to a third-party carrier or a bailee with the right to stop the
delivery so long as the goods are not in the physical possession of
the actual buyer or the buyer’s warehouse. Section 2-705(1) of the
Uniform Commercial Code states:
The seller may stop delivery of goods in the possession of a carrier or other bailee when he discovers the buyer to be insolvent….
Even if title to the goods passed at the time of shipment, as it may,
if the goods are picked up by a carrier engaged by the buyer, stoppage in transit may be exercised. In such a situation, title is likely to
have passed at the time the goods are picked up, as the buyer now
has the responsibility to provide insurance and pay for the shipping. The key concept, which is required to exercise stoppage in
transit, is actual delivery to the buyer and not the passage of title.
Of course, the rights of the buyer and seller become more complicated if the insolvent seller files a bankruptcy case during the time
the goods are in transit. The story of two sellers who found their
buyers insolvent and in bankruptcy illustrates the strength of the
stoppage in transit remedy.
In re Trico Steel Company
Cargill entered into a contract with Trico Steel for the sale of pig
iron. Cargill purchased the pig iron from another company and
arranged for carriers to ship and deliver the
pig iron to New Orleans. In New Orleans,
the pig iron was loaded onto barges to continue the shipment to Trico’s plant in Decatur, Alabama. Trico arranged for the shipment after New Orleans. It engaged
stevedores to load the pig iron onto the
barges also engaged by Trico. While the pig
iron was in transit, Cargill became aware
that Trico was insolvent. Cargill notified
Trico under UCC § 2-205 that it was exercising its right to stop the shipment in transit. Because Trico had filed a bankruptcy
petition and was under the protection of
the bankruptcy court, Cargill also filed an
adversary proceeding in the bankruptcy
court seeking a determination that it was
entitled to immediate possession of the pig
iron. Trico argued that Cargill was not entitled to stop the shipment because Trico
had already received the goods. The pig
iron was in the possession of Trico’s stevedores and barges. Thus, the issue became
“What does it mean for the debtor to receive the goods?”
Trico had engaged the stevedores and the
barges that were transporting the pig iron
from New Orleans to Decatur. Therefore,
Trico argued that the pig iron had been delivered to its agents and as a result was now
already collateral subject to the lien of Trico’s lender. The court held, however, that
the pig iron was not actually in the possession of Trico. The final destination was
Trico’s plant in Decatur. The court explained that the seller’s right to stop the
shipment in transit remained so long as the
goods were not physically received by the
buyer. The fact that the goods were in the
hands of a carrier hired by the buyer was
not sufficient to place the goods in the buyer’s hands. Even if the goods were in a warehouse during the shipment process, the
only way the goods would be considered to
be in the “possession” of the buyer would
be if the goods were in a warehouse owned
or actually rented by the buyer. If the goods
were in a warehouse held for transit, then
the goods would not be considered in the
“possession” of the buyer.
The court in considering the case found
that Cargill had the authority under UCC §
2-205 to stop the shipment until such time
as Trico could pay for the pig iron. Because
Trico was a Chapter 11 debtor, Cargill was
also wise to have filed the adversary proceeding to determine the rights of the parties. Cargill preserved the status quo by informing the shippers and the buyer that it
was exercising stoppage in transit and then
going to the bankruptcy court.
Although the right to stop in transit was
one under state law, the attempt to obtain
payment was against a Chapter 11 debtor
and the approval of the bankruptcy court
was appropriate. Had the goods reached
Trico, Trico’s lender would have rightfully
claimed that the goods were part of its collateral base. In that event, Cargill would
have been left with only an illusory reclamation right.
National Sugar Refining Company
National Sugar Refining Company (“National Sugar”) purchased 6,550 long tons of
raw sugar from Czarnikow under several
contracts that required the sugar to be delivered in September. On August 27,
Czarnikow informed National Sugar that
the sugar was on board a vessel and
Czarnikow held the negotiable bill of lading that would be used to fulfill its obligations under the two contracts. At this point,
title to the sugar passed from Czarnikow to
National Sugar.
On September 3, National Sugar filed a
Chapter 11 petition. On September 11,
Czarnikow filed a motion in the bankruptcy
court and obtained a date by which National
Sugar would have to show cause why it
should not be required to assume or reject
the two “executory” sugar contracts and, if
the contracts were assumed, why National
Sugar should not be required to provide adequate assurance that it could pay Czarnikow.
Czarnikow also stated that it was exercising
its right to stoppage in transit under the
UCC sections 2-702(1) and 2-705(1).
On that same date, National Sugar’s lender,
Bankers Trust Company filed a motion
with the bankruptcy court asking for an order requiring National Sugar to sell the
sugar on the open market and have the proceeds paid into the court pending resolution of which party had superior rights to
the sugar proceeds. National Sugar argued
that the contracts were not executory, that
Czarnikow had no right to stoppage in
transit and that Czarnikow should immediately deliver the sugar to National Sugar.
National Sugar also argued that in the event
the contracts were executory, it could provide adequate protection to Czarnikow in
the form of a substitute lien on National
Sugar’s unencumbered property.
The bankruptcy court analyzed this intersection of the UCC and the Bankruptcy
Code. It found that the state law right to stop
goods in transit prior to actual physical delivery to the buyer was premised on the inequity of permitting the buyer to obtain
possession of goods when there has been a
prospective failure of the buyer’s performance. Thus, when a buyer is insolvent and
will not be able to perform its obligation to
pay for the goods, the seller, rather than deliver the goods and try to recover on the
price, may withhold the goods and suspend
its performance until it is sure it will be paid.
In effect, the seller has a lien on the goods
until payment can be arranged.
Under the Bankruptcy Code, many liens received or imposed during the 90 days prior
to the petition date may be avoided. Is the
lien imposed by the seller against the insolvent buyer one of those avoidable liens? The
right of a trustee or debtor in possession to
avoid these liens is called the “strong arm
clause.” The bankruptcy court reasoned that
the lien created by reclamation claims is not
avoidable by the trustee’s strong arm powers
under § 546(c) of the Bankruptcy Code and
similarly, it found it “highly unlikely that
Congress intended to grant these very same
powers as against a seller who succeeds in
‘reclaiming’ the goods prior to delivery, by
means of stopping them in transit.” To deny
the “lien” to the seller stopping in transit
would create a situation where the seller
would be better off allowing delivery and
then invoking reclamation.
The court further explained that Czarnikow
properly issued the stoppage in transit demand and was not required to file a motion
for relief from the automatic stay to do so.
Czarnikow was also proper in seeking an
order requiring National Sugar to assume
or reject the executory contracts. The exercise of stoppage in transit, merely suspends
the contract performance. The contract remains in effect and the future course of the
parties is governed under § 365(b) of the
Bankruptcy Code. If the contract is to be
assumed, the seller will be required to deliver the sugar and the buyer will be required to pay the contract price.
Practical Tips
A seller discovering that its buyer is insolvent prior to physical delivery to the buyer
should issue immediate instructions to the
third-party carrier that it is exercising its
rights under the Uniform Commercial
Code to stop delivery in transit. The “insolvency” of the buyer may be assumed if the
buyer files bankruptcy or there are other
indications that the seller will not receive
payment. The instructions should be issued
in writing and sent via email, overnight
courier and facsimile to the carrier and to
the buyer. The seller should be mindful that
it will be responsible for the costs of the
carrier returning the goods to the seller or
for storage until the issue is resolved.
If the buyer has filed a bankruptcy petition,
the seller makes the demand for stoppage of
delivery and also immediately files a motion
in the bankruptcy court asking for an order
to compel the buyer/debtor to assume or reject the executory contract for the sale of the
goods. If the buyer/debtor is not prepared to
make this decision at that time, the seller is
entitled to some form of adequate protection so that it is not worse off during the
course of the waiting period. So long as the
buyer/debtor is not prepared to make the
decision, the seller has no obligation to deliver the goods to the buyer/debtor.
Finally, in a world of “just in time” inventory, the seller must be aware that other
parties impacted by the stoppage may attempt to seek damages from the party invoking the stoppage. Thus, communication
with all parties is of great importance so
that the risk of damages against the seller is
lessened. The communication with others
down the supply chain may also be a source
of resolution of the payment issue.
If the seller does successfully invoke stoppage in transit and retains the goods, it is in
a position where it has four options: (i) resell the goods and recover the difference
between the resale price and the contract
price; (ii) recover the difference between
the market price and the contract price;
(iii) recover the lost profit on the transaction; or (iv) recover the price when the
seller is unable to resell the goods.
Stoppage in transit is a far more reliable
remedy than reclamation. It must be properly exercised, however, by the diligent and
alert seller. n
Deborah Thorne, Esq. is a partner in the law firm
of Barnes & Thornburg LLP and is admin of the
Chicago office’s Financial Insolvency & Restructuring Department. She serves as co-chair of the
ABI Unsecured Trade Creditors Committee and is
a member of the ABI Board. She can be reached at
[email protected].
This is reprinted from Business Credit magazine,
a publication of the National Association of
Credit Management. This article may not be forwarded electronically or reproduced in any way
without written permission from the Editor of
Business Credit magazine.