Extending credit to risky customers in the automotive industry has increasingly required active and careful management of the prospective sale and the account receivable to assure payment. The news of GM’s, Ford’s and Chrysler’s financial condition, and any likely affect of their bankruptcy on its suppliers, has changed the definition of “credit risk” to include otherwise traditionally “credit-worthy” customers that operate in financially-uncertain industries. This means your company needs to re-evaluate and address the risks of selling on open account to customers that have traditionally been “safe” credit risks. These customers could include public companies that either purchase a significant amount of product on open account or which have a long history of paying within invoice terms. In short, the companies we once thought of as the safest customers are now some of the riskiest.
Fortunately, there are steps and protections your company can take now to reduce the risk of selling in these unpredictable times. The key is to address the situation now - before a customer files for bankruptcy, or threatens to file.
Based on “lessons learned” from assisting clients implement successful strategies for both selling to and buying from financially-uncertain customers and suppliers, we have developed plans to assist your company to obtain the best collection protection available. For example, we can help your company develop a strategy that will help it qualify for “critical vendor/foreign supplier” status with respect to a customer that might be a bankruptcy risk. We have assisted clients with filing and pursuing reclamation claims in bankruptcy proceedings, as well as with asserting and prosecuting offset and recoupment claims. We have also helped clients navigate through the assumption of executory contracts. In many cases, the money owed to our clients by companies in bankruptcy, including prepetition debts, has been paid in full.
Whether you have a long-term contract in place that is up for renewal, or the business relationship is based primarily upon purchase orders issued by the potentially financially-uncertain company, we can help define the sales relationship in legally-favorable terms. Each sales transaction has its own practical business aspects, as well as legal obligations. We will review the transaction and the relationship to take advantage of all opportunities to protect your position.
Listed below are some of the pre-bankruptcy ways we can help (If your customer has already filed for bankruptcy protection, there are also actions you can take now in the bankruptcy proceeding to protect your interests and minimize your credit risk).
I. We Can Help You Develop Leverage Over the Customer.
If your company has a contract in place that is not profitable or is at risk, we can help you develop legal and business leverage over the customer so that you have options with respect to modifying or terminating the contract and get paid for past due amounts, including rights you can exercise, if the customer can be shown to be in financial trouble. The controlling contracts, purchase orders, and other relevant terms and conditions of sale should be reviewed with counsel to determine your rights and risks, and ability to increase leverage.
For example, if the customer is past due on prior obligations, do you have an on-going obligation to accept a new purchase order submitted under an existing contract? Can you terminate the contract and not be obligated to make or provide further supplies or services until you get paid for past due amounts, which would otherwise serve to increase the amount of the indebtedness? Can you renegotiate contract terms including payment terms? Can you recall shipments? Can you terminate the contract? How do you get paid for past due amounts? These are all questions that you will need to review with your attorney.
II. We Can Demand Reasonable Assurances Before You Begin or Continue to Perform.
The Uniform Commercial Code (the “UCC”) provides that, if a seller has “reasonable grounds for insecurity” that the customer will continue to perform its obligations (e.g., pay under an existing purchase order or contract), then the company can insist the customer provide adequate assurances in writing of the customer’s future performance. In certain instances, the seller may withhold its performance (i.e., refuse to sell or deliver) until it receives the requested “adequate assurance” of buyer’s future performance. The definitions of “reasonable grounds for insecurity,” and “adequate assurance” of performance will depend, in part, on subjective industry standards and the particular facts of the situation. Thus, you should consult your attorney to make certain your demand and actions are justified under the UCC.
III. We Can Negotiate or Re-Negotiate Contracts With a Financially Troubled Customer/Supplier.
Depending upon the amount of leverage you may have with a customer (which we can help you increase), such as when a customer is in need of your product, has few or no alternative sources of supply, or when the customer is in default, you may have the ability to negotiate or renegotiate favorable terms such as:
1. Obtain Advance Payment or Progress Payments. For any new order or contract, attempt to obtain payment in advance or progress payments, or at least obtain a large portion of the payment in advance. Alternatively, try to have the customer agree to pay cash upon delivery (“C.O.D.”). If that is not feasible, and depending on your willingness to incur risk, try to shorten the time frame in which payment becomes due.
2. Security Interest. Demand that the customer provide to you a security interest in the goods you are providing or in other collateral. This is important for all sales of goods, but especially if you are supplying large equipment or machinery. Unfortunately, large, publicly traded companies may insist that their internal policies prohibit them from granting any security interest. However, if you believe that the customer truly needs your product, and you are under no legal obligation to supply, you can refuse to sell without a security interest. It is possible that the customer may give into your demand for a security interest, but without ever asking, you will never know. We can provide you with the language you need to create a security interest and show you how to perfect your security interest in order to preserve your rights.
3. Escrow Account. Set up an escrow account from which you can make draws.
4. Letter of Credit. If possible, try to have the customer cause a reputable financial institution to offer a letter of credit in your favor in an amount equal to or somewhat greater than the amount owed.
5. Guaranty. Obtain a corporate or personal guaranty with the necessary waivers by the customer.
6. Withhold Future Shipments. Where appropriate, and if permitted by the UCC or the controlling contract, you can consider withholding the future shipment of goods, pending negotiation, or renegotiation, if a customer defaults on payments under the contract or depending on its financial condition. There can be serious legal consequences to withholding future shipments, so this should only be done after reviewing the transaction with your attorney.
IV. We Can Take Steps With Regard to Goods Already Shipped.
If the customer is already on the brink of bankruptcy or insolvency, and you have already shipped goods, some of the actions you can take to protect your company and the goods already shipped include:
1. Issue a Reclamation Demand. Issue a reclamation demand making sure that the reclamation demand uses the required language and is issued within the required time frame from the delivery date.
2. Stoppage in Transit. Consider stopping the delivery of any goods that are on the way to the customer. Once again, this course of action has serious legal consequences, and you should consult your attorney before stopping delivery of goods already ordered and review the terms of shipment.
3. Replevin. If you possess a security interest, you can file a replevin action to obtain possession of the goods, equipment, tooling, or other personal property.
V. We Can Assist You in Obtaining “Critical Vendor/Foreign Supplier” Status.
Has your company done all it can to obtain “critical vendor/foreign supplier” status. In the event a company files for bankruptcy, critical vendors/foreign suppliers are often paid 100% of the amounts owed to them by the bankrupt company. Not all companies are eligible for this designation. But there are steps you can take now, before a bankruptcy filing, to improve your chance of receiving this designation.
VI. We Can Review the Pros and Cons of Having Long-Term Contracts.
Do you have a long-term contract in place with the financially troubled customer? There are certain advantages and disadvantages to entering into long-term contracts with potentially financially-troubled companies. If you have such a contract in place that must be renewed or renegotiated, you should consider the serious implications a bankruptcy filing can have on such a contract.
VII. We Can Advise You Regarding Obtaining Credit Insurance/Put Contracts.
Credit insurance policies and put contracts can be purchased by which an insurance carrier or financial institution will cover your loss in the event you do not get paid by a customer. The customer can pay the premiums for you. Such policies and put contracts can be expensive or not available when the customer is already in financial trouble. Therefore, it is important to demand such protection early, before your customer exhibits serious financial stress.
VIII. We Can Assist You With Developing Procedures to Minimize Preference Claim Exposure.
Any payments you receive from a financially troubled company in the 90 days prior to its bankruptcy filing are subject to return to the bankruptcy estate. These are generally referred to as “preference claims.” There are steps you can take now to help assure that the payments you receive during that period are not considered preferential. We can help you develop a credit and payment program that maximizes the chances that these substantial payments are retained by you, and do not have to be returned to the bankruptcy estate.
IX. We Can Assist You to Assert Set-Off/Recoupment Rights.
You can setoff/recoup amounts owed from your customer against amounts you may owe your customer. We can assist you in reviewing your contracts and legal rights to make sure your application of such setoff/recoupment rights are permitted.
X. We Can Structure Contracts to Closely Protect Your Intellectual Property Rights.
Maintaining tight control over your intellectual property and confidential information and access to your customers’/ suppliers’ intellectual property will significantly decrease your risks in dealing with a financially-troubled customer/ supplier. This could include entering into a licensing arrangement or other relationship with your customer to increase your leverage if your customer becomes financially troubled.
XI. You May Be Able to Restructure Payment Terms to Reduce or Eliminate the Amount at Risk.
Depending upon your particular circumstances and agreements with your customer, you may be able to renegotiate the credit provided by shortening the payment term or even obtain cash in advance of shipment.
The above options are several of the many considerations to be made in the event you want to conduct business with a customer that is experiencing financial trouble or is conducting business in a financially-questionable industry.