Your major customer is bankrupt. Now what?

When a major customer gets into financial trouble, its problems become your problems. Knowledge of your rights and early action can help minimize the impact on your business.

Molded Acoustical Products Inc. (MAPI) had been doing business with Fiber Lite for about 18 months before MAPI's insolvency. When MAPI began to show signs of financial problems, Fiber Lite's president pressured MAPI to make larger payments than usual, which it did more than $450,000 during the 90 days prior to MAPI's bankruptcy filing (the crucial period under the Bankruptcy Code). Meanwhile, Fiber Lite shipped MAPI goods in excess of $275,000 in fact, some were still in transit when MAPI filed for bankruptcy.

After MAP1 filed for bankruptcy, it asked Fiber Lite to repay the $450,000 that its president pressured MAP! to make within 90 days prior to the bankruptcy filing. Such payments, MAPI alleged, were voidable "preferences." Fiber Lite refused to repay the money, denying any "preferences." The law voiding preferences tries to prevent favoritism toward particular creditors. ("Preferences" are explained below in more detail.)

Fiber Lite argued that slow and late payments was how business was routinely done in this industry, and, more particularly, it was the accepted way of doing business between MAPI and Fiber Lite. Therefore, Fiber Lite argued, MAPI's payments did not constitute a preference that it should have to give up ("disgorge").

The bankruptcy court agreed with Fiber Lite on part of its argument: It found that the industry norm for payment of bills was about 45 days and that before the bankruptcy filing, MAPI's accepted practice was to pay Fiber Lite in about 58 days. This longer period was not too different from the industry norm, especially in light of an 18-month history of such payment practices. Under such circumstances, these terms constituted "ordinary business terms," an exception to the preference statute.

But, the case went on to rule, Fiber Lite had taken a …