If you are doing business with a company
that you suspect — or know — is in financial distress, or heading in that direction, there are numerous steps you should take to
protect yourself. And if the company files
bankruptcy, you have rights.
“If the signs are there that a company is in
distress, start preparing right away by reviewing your current contractual relationship and
learning what you can and cannot do under
the Uniform Commercial Code to reduce
your risk of loss,” says Sean D. Malloy, member of the business restructuring department
of McDonald Hopkins LLC.
If a company is in distress, it does not mean
you have to stop doing business with it.
“However, there are certain things you
need to be aware of as you move forward,”
adds Scott N. Opincar, also a member of the
business restructuring department.
Smart Business asked Malloy and Opincar
what owners can do to protect themselves
while doing business with distressed companies in troubled economic times.
Will current economic difficulties continue?
In 2007 and the first half of 2008, we saw a
significant increase in the number of companies filing for protection under Chapter 11.
Some are looking to reorganize; others to sell
their business. There is no reason to think the
rate of filings will decline during the rest of
2008. We are not economists, but everything
points to the business climate staying the
same or perhaps getting a bit worse.
Bankruptcy activity should remain fairly
steady, if not increase. Many factors are causing concern: rising commodity and energy
costs, tighter lending standards, increasing
foreign competition and production, and
consumer wariness. Thus, there is tightened
discretionary spending across the board.
If you are selling goods to a company and it
files bankruptcy, what do you do?
If you are an unsecured creditor, do not
assume that you are out of luck the day the
bankrupt company files. Act quickly to try to
limit your losses. Obtain counsel to ensure
your rights are protected. Unsecured creditors should calculate how much they are
owed and file a claim with the bankruptcy court. In addition, you may be able to recover certain goods or the value of goods.
Specifically, if you have delivered goods within 20 days of the bankruptcy filing, you will be
given a higher ‘priority’ for those goods than
other unsecured creditors. If you are one of
the largest unsecured creditors, you may
seek to serve on the creditors’ committee,
which acts on behalf of all unsecured creditors to negotiate the best terms for all. Be
sure to register to receive all notices in the
case and read all related documents, especially if you do not have counsel. Be careful
about litigation/collection actions due to the
automatic stay. Certain creditors who are
essential to the debtor’s business going forward have more leverage and might be able
to receive payment under the ‘critical vendor’
doctrine. Other leverage includes possessory
or tooling liens and whether or not contracts
are in place (contract relationships can force
assumption and payment if a long-term relationship is necessary to the debtor).
Can you plan for any of this in advance?
Look for warning signs. Is there an increase
in the number of days it is taking the company to pay accounts receivable? Quality control issues? Employee discontent? Rumors?
The Uniform Commercial Code (UCC) provides some safeguards. If you are unsure of a
company’s solvency, you may be able to
change your terms (absent a long-term sup-
plier agreement) by significantly reducing the
number of days it has to pay or by changing
to COD terms; suspend or retain performance; ask for adequate assurance of due performance; assert possessory liens; and/or
stop goods in transit, etc. Taking these
actions might get you threatened, but it is a
high-stakes game, and you have rights.
Do bankrupt companies sue their vendors?
Yes. Section 547, known as the ‘preference
law,’ gives the bankrupt company the right to
try to get back what it paid 90 days prior to filing, in certain circumstances. Even with the
2005 amendments to the Bankruptcy Code,
which strengthened vendor defenses, there is
significant exposure for preference payments. The best way to protect yourself is to
consistently enforce terms and not let customers slide, with all of your relationships,
not just troubled ones. The threat of preference exposure may lead a company to ponder whether it should accept a payment from
a troubled company in the first place. The
answer is yes. There are defenses in the
Bankruptcy Code. At a minimum, you will
never have to give back more than 100 percent of it, and even if it is technically a preference, you can negotiate some settlement.
What about doing business with a company
already in bankruptcy?
There are certain protections (e.g., administrative priority claims), but there are not
guarantees. Chapter 11 debtors have significant cash and liquidity issues, so you need to
look at the prospects for repayment carefully. You can receive information from the creditors’ committee or sit on the committee
yourself. You can negotiate terms and/or use
leverage of necessary supply. But there are
litigation risks when you have a long-term
contract, so it is important to get good advice.
A lot of creditors do not have the luxury of
just cutting off business. If you decide to keep
doing business with the company, understand your rights and take appropriate
actions to limit your credit risk and exposure.
Watch carefully as the case unfolds.
SEAN D. MALLOY and SCOTT N. OPINCAR are members of the business restructuring department of McDonald Hopkins LLC. Reach
Malloy at (216) 348-5436 or [email protected]. Reach Opincar at (216) 348-5753 or [email protected].