When your customer is going bankrupt…

Last updated on May 13th, 2019 at 02:40 pm

We have been somewhat blessed for the past few years with a fairly stable economy. However, experts are now predicting that within the next six to 18 months, there will be a surge in corporate bankruptcy filings.

Certain business sectors, such as real estate, construction, airlines, manufacturing and transportation, are seen as more vulnerable than others. Although there are a variety of reasons for these dire predictions, the result for participants in the business community will be the same:  If you are a vendor, supplier or customer of one of the fallen, you can expect an unpleasant financial impact on your own bottom line. 

To prepare for the impending bankruptcy filing wave, there are protective measures that businesses can take to help minimize or even avert some of the negative financial consequences that the bankruptcy of a client can produce.

The following is a “top 10 list” of those practical tips designed to help businesses become aware of and prepare for a customer’s likely bankruptcy reorganization or liquidation. 

10. Look for warning signs. These include increasingly late deliveries, requests for accelerated payments, increasing occurrence of quality issues, changes in CFOs or accountants, the appearance of business consultants, and rumors in the industry. The existence of one or two of these factors may not necessarily mean financial distress, but then again it might. So, it is imperative to obtain information now from whatever sources you can (Internet, trade publications, the customer, if possible) to get a better assessment of the financial health of your customer. 

9.    Obtain financial information. If possible, request your customer’s financial information so you can closely monitor its status. Be sure you understand what you are reviewing. Discuss changes or concerns openly with your customer. 

8.    Change your payment terms if you can. Pre-payment or cash on delivery (COD) is optimal for two reasons: prompter payment and potential preferential transfer prevention. Once the customer is in bankruptcy, payments you receive in the 90-day period prior to bankruptcy may be subject to avoidance and recovery by the debtor if the payment was for a prior invoice. Pre-payment or COD may eliminate this exposure.

7.    Shorten the leash.  If your customer cannot or will not be able to pay cash in advance (CIA), try to shorten the payment terms to minimize the size of your pre-petition exposure. If the customer is currently at 30 days, try to shorten to 10-day terms. Caveat: Too much pressure on the debtor to pay old invoices, however, can create a potential preferential transfer. If you find yourself in a dilemma determining whether you should take a payment that might later be found to be preferential, take the money. Unpaid invoices will be only paid a pro rata portion in bankruptcy, if that. So it is better to have that full payment in hand now and negotiate the preference claim later.

6.    Clarify ownership. If you provide inventory or tooling to the customer or the customer provides those things to you, clarify all ownership issues now so there is no question after a bankruptcy filing regarding what is or is not the property of the debtor’s bankruptcy estate. 

5.    Seek additional security. If feasible, take a security interest in the customer’s available unencumbered property to secure future payments (past debt will cause preference problems).  Typically, this will be an exercise in futility, but it’s worth a try. Consider whether getting a personal guaranty from a principal of the company with assets makes sense.

4.    See if you can help the customer. Consider buying your own raw materials and deducting those costs from the invoice. This may help with the customer’s cash flow but, again, clarify your ownership of those materials. 

3.    Look for alternative suppliers. If a supplier is in financial distress and you can afford it, create a “parts bank” so that a bankruptcy filing will not interrupt your own business operations.

2.    Keep detailed records of all transactions. This will be important for asserting your pre-petition claim and administrative claim (goods delivered within 20 days of bankruptcy can have administrative priority arise for another two years or for defending a preference claim). 

1.    Communicate with your customer. The more able you are to communicate openly about your customer’s financial condition and reorganization plans, the better equipped you will be to plan for and endure your customer’s bankruptcy. 

The financial and administrative pain of a customer’s bankruptcy can be minimized with early information gathering, pre-planning and maintaining good lines of communication with your customer.

Marie Nienhuis is an attorney in Godfrey & Kahn S.C. Business Finance and Restructuring Practice Group in the firm’s Waukesha office. She can be reached at (262) 951-7119 or mnienhuis@gklaw.com.

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