Spirit Airlines Files for Bankruptcy Protection

August 29, 2025 by Leave a comment

Spirit Airlines has filed for Chapter 11 bankruptcy protection. Chapter 11 means that they are seeking a reorganization (another one – remember that they just came out of chapter 11 earlier this year).

Spirit said it intends to conduct business as normal during the restructuring process, meaning that they will continue to need aircraft parts.

Spirit has published guidance on its restructuring plans. Part of that published plan involves “optimizing” the fleet which likely means that they plan to use bankruptcy to terminate some leases. Spirit will be sending out a Vendor Letter in which they confirm their plan to pay vendors in the normal course of business for goods and services delivered to Spirit on or after August 29, 2025 (today – this is the “post-petition” period). Any outstanding invoices for goods and services delivered prior to our Chapter 11 filing date are considered “pre-petition” claims and will need to be addressed as part of the Chapter 11 process.

It is not unusual to see a bankruptcy trustee seek to recover sums paid in the period immediately before the petition. If you get a letter like this, then please consult with an attorney before you agree to return money to the trustee. In my experience, there can be defenses to such trustee claims.

Those who are owed significant unpaid sums from Spirit should work with bankruptcy counsel to investigate options. Your attorney may be able to negotiate more favorable treatment if you have an ongoing relationship with Spirit, especially if they need your support to continue flying.

For ideas about how to protect your company from a customer’s bankruptcy, please look at some of our older blog posts on the subject:

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Protecting Your Right to Get Paid Vol. 3: Filing Security Interests For Work or Materials on a Specific Aircraft

June 22, 2022 by Leave a comment

In my last blog, I discussed how to establish and “perfect” a security interest related to an aircraft parts sale. I refer to such agreements as liens-by-agreement because they are typically founded upon a security agreement that establishes the rights and responsibilities associated with the secured transaction.

In today’s blog post, we will discuss how to establish a “lien-by-law.” Many states have laws that permit someone who adds value to an aircraft to assert a lien against that aircraft.

The name of these liens varies by state. In some states, the appropriate law might be called an artisan’s lien. It can also be called a mechanic’s lien but be careful of laws with this name because the term “mechanic’s lien” can also refer to a type of construction lien that does not apply to aircraft parts.

The scope of these liens can also vary. Some of the laws are limited to cases where labor is performed on the aircraft (e.g. repair station work), while others include provision of materials. Some of the materials-based lien laws could permit a distributor to establish a lien on an aircraft where a part was sold with the specific intent of it being installed on an an identified aircraft (depending on the state, you may need the signature of the owner/operator on a document in order to assert the lien). For example, Missouri law permits someone who furnishes materials for an aircraft to obtain a lien on the aircraft if he obtains:

  • a memorandum describing the material furnished, or to be furnished; that is,
  • signed by the owner, authorized agent of the owner, or person in lawful possession of the aircraft (such as the operator)

Such liens can be asserted over an aircraft, or they can be asserted over an aircraft part or assembly if that is what is being worked-on.

Possessory Liens

Some states have laws that allow someone who provides goods or services to retain a possessory lien in the aircraft. This means that the lien exists as long as the provider retains possession of the aircraft. California is one jurisdiction that has a possessory lien law. Typically, where there is a pure possessory lien law, the lien holder may lose the lien upon relinquishing possession of the aircraft. Such possessory lien laws are usually coupled with the right to retain the aircraft subject to the lien (to clarify that retaining possession is permitted). They may also provide a specific protocol for using the aircraft to enforce the lien (California lets the lien holder sell the aircraft after the debt becomes delinquent by ten days).

Filing Liens

Some states have lien laws that are not possessory. Typically, if the lien law is not possessory (doesn’t require the service provider to retain the aircraft) then the law will require notice as a means of perfecting the lien. Remember that the purpose of perfection is typically to establish constructive notice, which provides you with a priority relative to later-filed liens. “Notice” means that the lien-statement must be filed with a state agency, and/or the FAA. Which one do you have to file with? That depends on the requirements of state law!

As an example, let’s take a quick look at the current Florida aircraft lien law:

329.51 Liens for labor, services, fuel, or material expended upon aircraft; notice.—Any lien claimed on an aircraft under s. 329.41 [fuel] or s. 713.58 [labor/services] is enforceable when the lienor records a verified lien notice with the clerk of the circuit court in the county where the aircraft was located at the time the labor, services, fuel, or material was last furnished. The lienor is not required to possess the aircraft to perfect such lien. The lienor must record such lien notice within 90 days after the time the labor, services, fuel, or material was last furnished. The notice must state the name of the lienor; the name of the owner; a description of the aircraft upon which the lienor has expended labor, services, fuel, or material; the amount for which the lien is claimed; and the date the expenditure was completed. This section does not affect the priority of competing interests in any aircraft or the lienor’s obligation to record the lien under s. 329.01.

F.S. 329.51 (2022).

This clause explains that the enforceability of the lien is tied to filing a notice “with the clerk of the circuit court.” A separate statute (F.S. 329.01) also requires fling with the FAA in order to extend validity to third parties (perfection of the lien, as we discussed in the last blog post). Courts can read enforceability as being something different from perfection, which suggests that you need to file your lien notice with both the FAA and the circuit court clerk in order to fully secure your rights.

Note that Florida also makes it illegal in some cases to remove the aircraft from the service provider before the payment is tendered (if the removal is performed “with intent to defraud,” which includes situations like paying with a check and the ordering a stop-payment on the check), unless the service provider provides written consent for that removal.

Hybrid Lien Laws

Some states require the repair station to retain possession and also to file a financing statement. Some permit both options. For example, the Missouri law that was mentioned above permits assertion of a possessory lien, but it also allows the person furnishing the labor or material on the aircraft to retain the lien without possession by filing a statement in the office of the county recorder of the county where the owner of the aircraft or part or equipment resides (if this is not known then an alternative filing location would be where the recorder where the labor or material was furnished).

Conclusion

State lien laws vary widely, so it is important to identify the correct state laws that apply. Note that some states might have more than one law that applies (they may provide you with options). Look for both aviation-specific laws and also more general laws that permit providers across many industries to assert liens. It is important to identify all of your options so you can determine which option best-suits your needs.

It is equally important to identify how to perfect the lien, because perfection provides (constructive) notice that your lien has priority over other liens that are later-filed. Is possession sufficient? Do you need to file somewhere? Do you need to file with both the state and the federal government? The answers to these questions can be complex, and it may be worthwhile to employ an aviation attorney to help build an effective system for protecting your commercial rights.

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Protecting Your Right to Get Paid Vol. 2: Filing Security Interests

June 21, 2022 by Leave a comment

In my last post, I discussed the value of establishing a security interest to protect your right to get paid when you extend credit terms.  In this post I will discuss how to establish a security interest when you sell an aircraft part (and in my next post I will discuss how to establish a security interest in aviation maintenance transactions). I also discuss the concept of perfection, which helps to give your lien priority over other later-filed liens.

The typical security interest is reflected by two documents.  The first document is called the security agreement.  The second document is called the financing statement.  In addition to these two documents you generally need to think about how you will “perfect” the security interest. 

Security Agreement

A security agreement is the record that describes the relationship that gives rise to the security interest. It can be a stand-alone agreement or it can be part of a larger agreement (like a sales agreement). A conditional sales contract can be one form of a security agreement. In order to have a valid security agreement, you typically need to include:

  • A description of the asset that is secured by the Agreement (a “reasonable identification” sufficient to allow others to identify the collateral)
  • A signature or other authentication from the debtor (to confirm the Agreement)

In order to support a security agreement, there should be an exchange of value (known as “consideration”) and also the debtor should have the right to grant a lien in the asset (this includes the rights obtained through a purchase of the asset, even though the purchase is conditioned on the security agreement). One example of how this works is if a buyer purchases on credit, and signs a sales agreement that includes a security agreement, then the buyer’s promise to pay is part of the consideration, and the buyer’s acceptance of the asset gives the buyer the power to grant a lien against the title to the asset.

Most security agreements are going to be far more complicated than these simple bullets, above. Typical feature of the security agreement will often include:

  • Identification of the parties to the transaction (who is the debtor and who is the creditor)
  • The amount that is secured
  • Payment terms
  • Terms of default (e.g. when can the creditor foreclose)
  • Remedies in the event of default
  • Potential limits on what the debtor can do with the asset before it is fully-paid

The FAA has a template for an Aircraft Security Agreement when a security interest or other lien is established against an aircraft.

Financing Statement

A financing statement is used for giving the world notice of your security interest; as a consequence it will look a little bit like a summary of the key points in your security agreement.  A typical financing statement must include the following three elements at a minimum:

  • the name of the debtor;
  • the name of the secured party (generally, the creditor); and
  • the identification of the asset (collateral) covered by the financing statement.

Because the purpose of the financing statement is to provide notice of a security agreement, it allows such a notice to be provided without disclosing all of the elements of the security agreement.

There is a standard form for financing statements called a UCC-1. It is published in the Uniform Commercial Code and thus appears in the state versions of the Uniform Commercial Code.

Filing for Perfection

The terms of the security agreement will typically apply to the parties to that Agreement. But how do we make sure that it provides the creditor with priority against other creditors?

There is a concept in secured transaction law called “perfection.” The concept of perfection is that you need to do something in order to secure your rights relative to the rest of the world. Perfecting your lien typically give you priority against other lien holders who might perfect their liens at a later date.

It is normal to file a financing statement to perfect a lien. One important exception is that if you seek to perfect a lien by filing it with the FAA, then you will file the security agreement instead of the financing statement.

If you fail to perfect your lien then other lien holders who perfect their liens may take a priority over your rights, which means that in the event of a cash disposition of the collateral (like a judicial sale / auction), the other lien-holders with priority get their money first from the cash disposition proceeds.

Most normal rules to follow on how to accomplish perfection of a lien will be found in the state law of the state where the asset (collateral) can be found. So if the asset is added to an inventory in Florida, then Florida law typically applies. Although the Uniform Commercial Code helps to standardize commercial law, the specifics of perfection nonetheless vary from state to state.

Where Do You File?

Where to file can be a complicated question, especially in aviation. It is a question that is going to be based on state law. States can have different requirements about where and how to file and you need to identify the state whose law applies to the collateral.

Federal law can also influence filing requirements. Liens against aircraft, and certain engines and propellers, are filed with the FAA Registry Office in Oklahoma City. There are some state laws that specifically allow you to claim a lien in an aircraft if you furnish goods or services for that aircraft, so this may allow some parts sales transactions to yield a lien against the aircraft (but such a lien would likely be junior to other previous-perfected liens). If you establish a lien against an aircraft then you definitely want to file it with the FAA Registry to perfect it.

Some state laws can also require simultaneous filing with the state. The purpose of the federal registry was to preempt state filing laws, but state laws affecting the underlying validity of a lien will tend to be applied. If there is a state law requiring filing then you may want to follow both the state law and federal law in your filing practices, especially if past case law has been inconsistent in your jurisdiction. This is particularly true in cases of aircraft parts.

When it comes to aircraft parts, there are laws that permit some transactions (like transactions in air carrier parts) to be filed with the FAA registry. This can be found in federal laws and regulations, and you can find corollary requirements for federal filing in the laws of some states. Case law has even explained that if the collateral for a security agreement consists of “spare parts maintained by or on behalf of a certificated air carrier” then the security agreement must be filed with the FAA in order for the lien to be perfected. In re Avair, Inc., 98 B.R. 261 (Bankr. W.D. Va. 1988). The problem is that as a practical matter, the FAA Registry will not accept a filing of a lien in one or more discrete aircraft parts. Some courts have chosen to ignore this fact, and declared that federal filing for spare parts is nonetheless a necessity. It appears that filing the lien with the federal government (even if the filing is rejected) may be sufficient in some transactions but a state filing for a spare parts lien is probably a good idea (in many states) to ensure your lien perfection is recognized.

Failure to properly perfect the lien can mean that other (perfected) liens take priority over your lien. It can also mean that your non-perfected lien might be avoided by a bankruptcy trustee (treated as if there was no lien at all). For this reason it makes sense to work with an attorney to identify the sort of transactions that you want to secure, and to identify the compliance path for securing those transactions.

When the Security Interest Has Been Paid

Most states (and the FAA’s registry, too) have rules that say that when the lien has been paid, you must file a release statement expressing this full payment with the filing office. This action shows the world that the previously-filed security interest has been satisfied and no longer affects the title to the asset.

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Protecting Your Right to Get Paid Vol. 1: Security Interests

June 20, 2022 by Leave a comment

When you sell an aircraft part on credit, you want to make sure you will eventually get paid.  There are a variety of factors that can impede your payment.  This post offers one strategy for increasing the potential to get paid in adverse conditions (through security interests).

If you offer terms, then you are typically offering credit!  Offering credit to a customer is a normal business practice but it creates a risk of non-payment. 

In the most extreme situations, customers can find themselves seeking bankruptcy protection and this can result in their debts to you being reduced or even wiped out, depending on the nature of the proceedings. 

One way to increase your right to get paid is to establish a security interest in the article that is being sold.  One of the advantages of a security interest is if the debtor files for bankruptcy protection, then a security interest changes your payment recovery for the outstanding debts.  Security interests are given a “priority” in bankruptcy.  Typically, when there is a liquidation, certain priorities get paid (in the appropriate order) before unsecured debts.  With a security interest, the securing asset’s value will be applied to the debt. 

For example, let’s say you sell an aircraft asset to a customer for $1,000,000.  You secure the debt with a properly-perfected security interest.  The customer owes the entire purchase price on 90 day credit terms; but before the customer pays, the customer files a bankruptcy petition.

The bankruptcy trustee ultimately sells that asset at auction.  In scenario one, the unit fetches a price of $700,000.  That entire value is assigned to satisfy the security interest.  Which means that you get paid $700,000, and have a remaining unsecured debt of $300,000 (the unpaid balance).  You will get paid with the rest of the unsecured creditors, which might mean pennies on the dollar or it might mean nothing.   While $700,000 might be disappointing, it is a lot better than nothing. 

In scenario two, the unit fetches a price of $1,200,000.  That value is sufficient to fully satisfy the security interest.  Which means that you get paid the $1,000,000 that you are owed and the remaining proceeds of $200,000 will go into the bankruptcy estate (or pay any secondary liens).

Note that there are special bankruptcy rules that apply to certain aircraft and aircraft parts (and can allow for recovery of the complete asset). E.g. 11 U.S.C. § 1110.

You don’t have to wait for a bankruptcy to make use of your security interest. You can also foreclose your security interest upon a default in payment (specific procedures may depend on the language of your security agreement as well as applicable state law).

In my next post I will cover typical mechanisms for filing and perfecting security interests when selling aircraft parts.

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First Position: Priority in Security Interests

July 27, 2020 by Leave a comment

As the global COVID pandemic continues to substantially crimp air travel, we continue to see operators and other industry partners succumb to the economic realities of bankruptcy. As an industry, we’ve seen this before, and we will see it again. But that also means we know that we will come out the other side stronger than ever. One important way to make sure we do is to protect our interests when we extend credit to sell parts.

Last month we discussed steps to attach and perfect our security interest to guard against a customer’s bankruptcy. Perfecting a security interest gives us priority to the asset over any other later-perfecting creditors. Priority is important in deciding who takes proceeds of assets first when more than one secured party has a perfected security interest in the same goods or other assets. The goal is always to be first in priority with respect to the asset.

Generally, security interests are subject to a “first to file” rule (see UCC 9-322(a)), so whoever perfected their security interest first is first in line to the proceeds of those specific debtor assets in the event of bankruptcy. In many commercial instances this means that a bank or other lender that provided financing for the company will have a perfected security interest over not just the business’s assets at the time of the loan, but over all after-acquired assets as well. This so-called “floating lien” is a common way to secure loans to businesses.

Obviously, this sort of “all future assets” perfected security interest is problematic for a distributor who seeks to sell inventory to a customer on net 30 (or other credit) terms, because the inventory sold by the distributor, even upon perfection of a security interest by the distributor, would mean the distributor was secondary (or “junior”) to the lender even with respect to its own goods sold. As we have previously discussed, when assets are liquidated to satisfy all a business’s creditors there is generally not going to be enough money to go around. Securing first priority is therefore very important to a distributor seeking to protect against insolvent customers.

As you might have guessed, knowing that they could be subordinate to a previously secured lender (with the mega-resources to fight for its position in bankruptcy court) could easily discourage a business’s suppliers from selling to that business on anything other than a cash basis if the business hits a bumpy patch or the entire economy takes a negative turn. Reticence on the part of suppliers worried about getting paid can hurt a struggling business’s ability to continue in its ordinary course, creating a feedback loop that can doom the already struggling business, which likely does not have the cash on hand to buy inventory on cash terms.

Fortunately, the UCC anticipates this problem and has built in provisions to encourage suppliers to a struggling business to continue supplying (on credit) without sacrificing to a large lender priority in the goods they sell. Enter: the Purchase-Money Security Interest (“PMSI”).

Remember, to have a security interest we need attachment and perfection. And as we just discussed, perfection is generally subject to the first-to-file principle. A PMSI allows a seller of goods that sells on credit terms to gain a first-priority security interest—essentially jumping ahead of all other creditors regardless of when they perfected their security interests—in specific goods sold when the customer/debtor incurs a purchase money obligation to the seller of the goods in order to purchase the goods.

There are several variations on PMSIs, but for our purposes we are concerned with PMSI in inventory sold. (PMSI in equipment may also be important.) PMSIs in inventory sold can be slightly complex, so it is important to pay attention to the details and make sure each step is taken to secure your interests in your goods sold.

The key complication in a PMSI for inventory is the requirement that the security interest be perfected before the goods are received by the debtor. Ordinarily, perfection allows for the filing of a financing statement (usually the UCC-1) after the debt is incurred. This is also true of PMSIs in consumer goods, which allow a PMSI to be perfected if a financing statement is filed within 20 days. Distributors, however, are not generally viewed as selling consumer goods. Distributors sell inventory to their customers. Thus, special rules for PMSI must be followed (see UCC § 9-324).

As we said, for the PMSI in inventory to be effective we must perfect prior to the goods being delivered to the customer. This means filing our UCC-1 before delivery. Ideally, this will occur before the goods even leave our facility.

Next, we need to notify any other higher priority secured party in writing. So, if a lender has provided financing for our customer and has a floating lien over all of the customer’s assets, we are required to notify that lender in writing of our PMSI in the specific inventory (more on this in a moment).  You can find previously secured lenders and other parties with security interests by searching the UCC-1 filings in the state where the customer is incorporated or headquartered. (It is generally best to search both locations to ensure all your bases are covered, as well as, for companies with locations in multiple states, the state in which the actual destination facility is located.)

The notice to other secured parties should be sent by a secure, trackable system, like certified mail, return-receipt requested and—like PMSI perfection—the notice must be received before the goods are delivered to the customer. (Notice must also be renewed every five years in the event the security interest is held that long.)

Finally, the notice must state that the distributor has or expects to acquire a purchase-money security interest in inventory of the debtor (again, this is your customer) and describe specifically the inventory affected. This can be done directly in the notice, or by referencing and attaching a copy of the commercial invoice if it provides enough specificity to identify the inventory secured.

A PMSI in non-consumer goods takes much more effort than perfecting an ordinary security interest, so factors like the value of the credit extended, customer payment history, and current financial strength of the customer (or the economy more broadly) will all factor in deciding whether the additional steps to a PMSI are worthwhile.

Remember, priority of security interest is key to payment when a customer becomes insolvent. When the economy is rocky it is important to pay attention to the financial health and track record of your customers and the customers of your customers. Our industry has and will continue to see its fair share of liquidations and restructurings. By monitoring the health of your customers and taking the steps to meticulously secure your interests, you put your company in the strongest position to fight through troubling times.

As always, these things can be complex. When in doubt, contact your lawyer.

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Steps to Perfection: Security in a Time of Insolvency

June 12, 2020 by 1 Comment

Last week we had a brief overview of some bankruptcy issues and talked about the some of the risks presented by bankruptcy filings in these uncertain times. Today we are going to expand on ways to mitigate some of those risks when we aren’t in a position to demand and receive cash in exchange for goods.

The most important step to take to ensure you are protected against the risks of an insolvent customer is to attach and perfect a security interest in the goods sold to the customer. A security interest in the goods you sold on credit helps you to get paid first (before unsecured creditors, shareholders, and others, who often get nothing) in the event your customer enters bankruptcy.

Many companies are good at attaching a security interest to goods sold on credit by including terms that state the buyer grants the seller a security interest in the goods sold to secure the purchase price. If your sales agreements do not include such a provision you should work with a lawyer to make sure that they do.

An attached security interest on its own, however, has little effect in truly securing you as the seller (and more importantly, as creditor). In order to be effective, a security interest must be perfected. A perfected security interest gives notice to the world that you have a security interest in the particular goods so that others who may attempt to attach a security interest later know that they are behind you in priority.

Let’s drill down a bit deeper on the ideas of “attachment” and “perfection.”

Attachment

The Uniform Commercial Code (UCC) provides that “[a] security interest attaches to collateral when it becomes enforceable against the debtor with respect to the collateral . . . .” (UCC § 9-203). The debtor in this case is your customer. The UCC goes on to explain what it means for a security interest to become “enforceable.” (We have limited the text to be relevant for our purposes, because some very specific things, like descriptions of timber to be cut, simply don’t apply!)

Under the UCC, “a security interest is enforceable against the debtor and third parties with respect to the collateral only if:”

(1) value has been given

In this case, the goods sold in exchange for the promise to pay the purchase price in the future—for instance on net 30 terms—is value given.

(2) the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party

Here, the debtor (your customer) gains the rights in the collateral and power to transfer rights when they receive the goods.

And finally, (3) one of the following conditions is met (only one is applicable for the purposes of this discussion):

(A) the debtor has authenticated a security agreement that provides a description of the collateral

A security agreement is any agreement that provides a security interest, for instance our sales agreement (with appropriate terms, as mentioned above). To authenticate the agreement, the debtor (customer) merely needs to sign it (or otherwise accept the record through electronic sound, symbol, or process). The security agreement must also provide a reasonably detailed description of the collateral. The part number, nomenclature, and quantity that appears on our documentation is an example of a reasonably detailed description.

Although verbose, the process of attaching a security interest is relatively straight forward and many or most of you may be doing it now. You should review the terms and conditions that appear on your quotes, confirmations, invoices, and other sales documents to be sure. If there are questions, remember to consult your attorney.

Perfection

Merely attaching a security interest, though, is not enough to protect you. In fact, an attached security interest without more provides little security indeed. In order to protect your interests, you must perfect the security interest. This gives notice to others that you have a security interest (in the form of a lien) against the goods. That way if they attempt to attach their own security interest to the goods or other assets to protect their extension of credit (for instance in the form of a loan), they know that they are behind you in order of priority with respect to those goods. (We’ll have more to say about priority in our next post—sometimes a previous secured lender like a bank may have priority for even newly acquired goods).

The exact details of perfecting a security interest are a matter of state law, but in general the primary method of perfecting a security interest is by filing a financing statement with the relevant public office—usually the Secretary of State. The UCC specifies the elements required in a financing statement in § 9-502:

  • The name of the debtor
  • The name of the secured party
  • An indication of the collateral

Typically, you can use as your financing statement a Form UCC-1, which is a standardized form that is widely available online, often via the very state agency with which it must be filed.

The most important thing to note in completing the financing statement is that the name of the debtor (your customer) must be precise. The UCC explains that it should be the name that is listed on the company’s most recently filed document in its jurisdiction of registration. (See UCC § 9-503). Put another way, the debtor name on the financing statement should be the most up-to-date name of the organization as filed in its state of incorporation. This level or precision is necessary because the financing statement is recorded under the debtor’s name and it must be of sufficient detail to put other potential secured parties on notice.

The secured party’s name is more straight forward (your company) and the indication of the collateral can be the same as appeared on the security agreement we discussed above, for instance, part number, nomenclature, and quantity.

The financing statement is generally filed where the debtor is incorporated, so make sure you are identifying the appropriate jurisdiction’s requirements. You can often kill two birds with one stone because the Secretary of State is typically where the financing statement is filed (and can be found) and you should also be going there to identify the correct name of the debtor for the financing statement anyway. As always, if you have any questions, you should consult an attorney.

As a secured creditor you can have confidence you will get paid (at least in part) even if a company becomes insolvent, because the liquidated assets of an insolvent company are first used to pay secured creditors. Specifically, the money raised from the liquidation of your secured goods is used to pay your security interest. This also applies to proceeds from those goods when the proceeds are directly identifiable. Creditors with no security are often left hoping for a share of what little is left after the secured creditors are paid.

Attaching and perfecting a security interest in goods sold is a valuable risk mitigation strategy. While it may not be as relevant when the economy is hot, when the economy gets rocky and the industry sees upheaval it is an important way to protect yourself against the unpredictability of the global aviation market.

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Bankruptcies are Happening. What do you need to know to protect yourself?

June 3, 2020 by 1 Comment

It is no doubt that these are trying times. With air travel substantially curtailed the need for parts to support commercial fleets is significantly reduced. That means challenges for distributors. Adding to those challenges is a harsh reality: even when customers are buying parts,  they may have difficulty paying. And when a customer to whom you’ve extended payment terms becomes insolvent, you may be left holding the bag.  So far in 2020 we’ve already seen several operators enter bankruptcy, including Flybe (UK), Virgin Australia, Avianca, and LATAM.

Struggling operators still need parts to maintain their aircraft, and therein lies the rub. Distributors want and need to sell parts, and airlines want and need to buy them. With an airline that may be on the brink of bankruptcy, the question becomes how can a distributor make a much-needed sale, and protect itself against the risk that the customer may not be able to pay?

Obviously, the safest way to protect yourself is to require cash up front. If you and your customer are in a position to make such an arrangement, great! You can stop reading now. But the reality of our (and may others) industry is that goods are typically sold on Net 30 or similar terms. If you send goods to your customer and they declare bankruptcy before you get paid (or worse, have several outstanding invoices unpaid), you may be placed into a class with dozens of other unsecured creditors fighting for pennies on the dollar of what you were actually owed.

When cash is tight invoices can pile up. So, what steps should a distributor take to protect itself in the face of a struggling customer? In this series of articles, we’ll discuss the steps necessary to attach and perfect a security interest in goods, as well as mistakes to avoid to ensure payments your customer makes to you can’t be clawed back.

First, though, there are some things to know about bankruptcy filings. For the purpose of these articles we’ll be focusing on the US bankruptcy laws, which are found in Title 11 of the United States Code. The two types of bankruptcy filings most people are familiar with occur under Chapter 7 of the Bankruptcy Code (Liquidation) and Chapter 11 (Reorganization).

Under a Chapter 7 filing, an organization (like an airline) will cease operations and a trustee will be appointed to sell the company’s assets to satisfy creditors. Creditors are divided into classes with secured creditors being first in line to be paid, followed by unsecured creditors, and finally stockholders.

Secured creditors are those whose credit is backed by collateral. Unsecured creditors have extended credit but without the backing or security of collateral. Aircraft parts distributors can fall into either category depending upon whether they have taken the necessary steps to attach and perfect a security interest in the goods they’ve sold.

Secured creditors can sometimes have their collateral returned to them, though this process has some limitations and requires very quick action.  It also has very strict requirements that the debtor (customer) have been insolvent and the goods be delivered within 45 days before bankruptcy. A specific written demand for the goods must also be made within 45 days of delivery or within 20 days after bankruptcy if the 45 days expired after the declaration.  Chapter 2 of the the Uniform Commercial Code may also provide rights to reclaim goods. We’ll discuss these options in a future post.

It can often be difficult to reclaim specific goods, but a secured creditor still has a claim for the value secured by those goods if they are liquidated by the trustee in the course of the bankruptcy and in satisfaction of other secured debts. (If the value of secured collateral is insufficient to cover the amount owed, creditors become unsecured creditors for the balance due.) Because of the value of remaining assets when a company enters liquidation, unsecured creditors often receive only pennies on the dollar, if they receive anything at all.

Under a Chapter 11 filing the organization remains in operation and under management’s control, but major decisions must be approved by the Bankruptcy court. Rather than liquidate all assets in satisfaction of outstanding debts, a committee of unsecured creditors will be formed to develop a plan to allow the company to eliminate part of its debt to regain its financial footing. Committees representing secured creditors, stockholders, and other interested parties may also be formed. The plan the committees develop specify classes of claims and how those claims are to be treated, in addition to numerous other considerations to enable the company to continue to function.

Under Chapter 11, aircraft parts subject to a security interest may also be subject to special treatment. A customer filing under Chapter 11 may be preferable to Chapter 7 for a distributor who is unsecured because although the full amount owed may not be paid, partial payments may be made to encourage the distributor (and other suppliers) to continue selling to the company to allow it to operate. On the other hand, a distributor with a security interest in aircraft parts may have the right to take possession of the collateral or be assured of payment under the security agreement.

Being a secured creditor is always preferable to being unsecured. It puts the creditor in a position to reclaim its collateral or get paid to the greatest extent possible. Unsecured creditors are often left with significantly diminished claims if they receive anything at all.  In our next article, we’ll talk about the steps you need to take to attach a security interest to the parts you sell.

Bankruptcy is confusing and can be fast-moving, and we haven’t even scratched the surface here. Always be sure to consult a bankruptcy attorney if you have a customer file for bankruptcy that owes you a significant amount.

This post has been updated for clarity.

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