The other shoe in the Fluid Routing Solutions (now know as Carolina Fluid Handling Intermediate Holding Corp.) bankruptcy has finally dropped. On September 14, 2009, slightly more than 5 months from the 363 sale of most it operations, the Debtors filed a motion for an order converting the Debtors’ chapter 11 cases to cases under chapter 7 of the Bankruptcy Code. The motion was granted on September 28, 2009 and the trustee was appointed on October 2, 2008. We have provided a DocSheet for the period after the conversion of the Fluid Routing Chapter 11 to Chapter 7.

For suppliers, this is not the worst of the bad news. The really bad news for suppliers – the only hope of the Debtors’ trustee to avoid administrative insolvency is recovery of $2.5 million in preference claims.

The Automakers’ Horror Story

The bankruptcy was planned from day one as a 363 sale to an affiliate of an insider and the DIP lender (the “Buyer”). The Debtors’ automotive customers, which included Toyota, Chrysler, Ford and General Motors (“Automakers”), were all over the case from the beginning. The Automakers seemed to be aware that this case required special attention. Then, when the Debtors supply contracts with the Automakers were put on the list of the contracts to be assumed by the Buyer, the Automakers seemed somewhat comforted.

The Automakers comfort on having been placed on the assumed contracts list was unjustified.  Two days after the sale hearing held on March 24, 2009, the Debtors advised the Bankruptcy Court that the Automakers’ supply contracts had been taken off the list of contracts to be assumed by the Buyer. (This seemed ironic since the frenzied atmosphere to get the sale approved largely had been justified on the grounds that the Debtors faced the prospect of the loss of the Automaker customers if there was a delay.)

Having their supply contracts taken off the list of assumed contracts was not the only problem for the Automakers. The Debtors had sold most, but not all, of there manufacturing operations to the Buyer. Some of the parts for which the Debtors were sole source suppliers continued to be manufactured by the Debtors. Simply, the Debtors, after the 363 sale, had to continue the remaining manufacturing operations.

The 363 sale, which was consummated on March 27, 2009, left the Debtors with no cash. The sale itself generated no cash proceeds since the purchase price was paid with a credit bid of the DIP financing. What cash the Debtors had at the time of the sale was grabbed by the DIP lender. The situation was described by Debtors’ counsel at an emergency hearing on April 1, 2009 (the “April Fools Day Hearing”):

On March 27th, 2009, in connection with the approval of the sale of the fuel business, the existing DIP facility expired. Mr. Krakora would testify that at that time the DIP lender swept all the cash of the Debtors and informed the Debtors that all amounts received by them representing payment of accounts must be paid immediately to the DIP lender.

As a result the Debtors currently have no cash whatsoever with which to operate. In fact, on March 30th, 2009, the Debtors had to shut down their operations of their fluid business due to inadequate financing. In connection with the Debtors’ continued efforts to liquidate the remaining assets and consolidate their affairs, including the ongoing operations of the fluid business, the Debtors urgently require additional liquidity.

The Automakers had no choice. As reported by Debtor’s counsel at the April Fools Day Hearing, the Automakers caved in. With respect to the parts to be manufactured by the Buyer, Debtors’ counsel explained to the Bankruptcy Court:

In between the time after you approved the order and the closing, the buyer at one point elected, as was its right under the APA, to delete all of those contracts from the list of assumed contracts, and then has now decided because the customers are back in the fold and we have reached an agreement with them to put those contracts back on the list.

With respect to the parts still being manufactured by the Debtors, while the Automakers resourced the parts, the Automakers “agreed to provide new financing up to approximately $8 million in order to fund the operations and the administration of the estates.”

Not many automotive parts suppliers are going to shed any tears for the Automakers. There may even be some suppliers who give a nod to the Debtors for finally getting a one up on the Automakers. But the Debtors are not an automotive supplier equivalent of Robin Hood and his merry men. The horror story for many suppliers is about to start.

Suppliers and Unsecured Creditors Face Zero Recovery of Pre-petition Claims and Bankruptcy Preference Recovery Claims

There never has been any realistic hope that the 363 sale or disposition of other of the Debtors’ assets would generate any recovery on pre-petition claims of suppliers. The focus of the Debtors has always been on maintaining the Debtors’ administrative solvency – i.e. ability to pay the administrative expenses of the bankruptcy, which include payments for post petition goods and services.

Throughout the various hearings on the 363 sale, the Debtors repeatedly assured the Bankruptcy Court that the Debtors were, and anticipated remaining, “administratively solvent”. This representation has been continued in the motion to convert the case to a Chapter 7, where the following explanation was provided:

Although the Debtors believe that they are administratively solvent, the likelihood of paying administrative expense claims in full is reduced if their stay in chapter 11 is extended, whereas such claimants likelihood of recovery is increased if there is a timely conversion of the Debtors’ cases to chapter 7.

On the face of the Monthly Operating Report filed by the Debtors for the period ending July 31, 2009, the basis for a claim of continued administrative solvency is not discernible.

• The Debtors burned through $697,000 in cash in July and at the end of the month there was only $361,000 of cash left. There is no operating income and the last round of professional fees are still coming in.
• Other current assets consist of $600,000 in “inventories”, which are valued at book, and with no customers, presumably consist of raw material and maybe some spare parts. (Good luck getting book.)
• Property and equipment consists of machinery and equipment booked at $152,379 with accumulated depreciation of $124,760. (The trustee is probably going to have to pay to have this machinery hauled away.)
• There are a couple of real estate assets but the schedules previously filed by the Debtors did not assign much value to this real estate and the current balance sheet assigns no value.

On the liability side, at the end of July, there are post-petition liabilities of $4,243,468.   However, in this respect, the Debtors did look out for suppliers. The post petition outstanding liabilities primary consist of secured debt of $2,576,939 (presumably Automaker loans) and post-petition unsecured liabilities of $1,125,000, which is attributed to accrued health care insurance. It appears that suppliers were fully paid for post-petition goods and services. (Those suppliers who signed trade agreements for payment of 503(b)(9) claims guessed right.)

Bottom line – total assets of $1,019,602 (at book value) against post-petition liabilities of $4,243,468.

So where is the trustee going to pick up the $3.2 million dollar plus shortfall?

At the April Fools Day Hearing, Debtors counsel acknowledged that there would still be a shortfall in funds for payment of administrative expenses after disposition of all real estate and equipment assets. The answer:

And then finally, Your Honor, neither Sun nor the customers have a lien on any of the Debtors’ causes of action. And if you recall from the last hearing we had on valuation, we have in excess of two and a half million of claims just on preference actions alone.

What is the timing of the trustee bringing these preference claims? While normally a trustee would take its time in bringing preference claims (the trustee has 2 years after the petition date), the trustee is going to take over largely out of cash. It is going to feel pressure to get collections going. The first round of bankruptcy preference demand letters likely will go out in 4 to 6 weeks. The Trustee may decide to tackle the easy ones first to get some cash flow. Given the potentially large number of preference claims it may take awhile for the trustee to do an assessment of all of them.

So what should a supplier do?

When a supplier, landlord or other unsecured trade creditor knows there is likelihood of preference claims being brought in a case involving a 363 sale, the first steps should include the following:

• Check the 90 day preference payment schedule filed by the debtors.  Confirm the numbers are right.  If there are multiple debtors, confirm that the payments are allocated to the correct debtor.

• Determine which of those payments (if any) were attributable to goods and services under a contract assumed by the Buyer. (If the payments were all under contracts assigned to the Buyer, do the happy dance. No preference claims for you.)  Keep in mind that signing a trade agreement does not mean that the supply contract was assumed.  Assumption of a supply contract requires an order of the Bankruptcy Court.  The supplier would have gotten a “notice of assumption and assignment” with an indication of the “cure cost”.

• Pull the contracts, purchase orders, invoices, bank account statements and other records with respect to the payments not attributable to assigned contracts. (This can take awhile and it is better to start sooner rather than wait for the demand letter.)

• Do a preliminary assessment of each of the possible defenses (most of which are discussed in detail on this website.)