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Steps To Take To Minimize The Risks Posed By Financially Distressed Customers And Suppliers

Commercial Bankruptcy, Restructuring & Creditors' Rights Update

Since we first sent out this Update six months ago, economic developments - especially the growing crises facing the Big Three auto companies - have made its subject all the more important to our clients. Because our clients continue to ask these questions, we thought it a good time to revisit this Update.

Economic challenges have affected every business in every industry. We field questions daily from our clients who are looking for advice on how to minimize the adverse effects of a customer or supplier in financial distress. While you may view those problems as just some of the things you have no control over, there are some basic, proactive steps you can take right now to minimize your risks and possibly enhance your position relative to other creditors.

  1. Review your contracts and related documents to confirm your remedies upon default, whether you have any guarantees, and what, if any collateral you might have. This is the time to call your counsel about "cleaning up" documentation or negotiating enhanced protections.

  2. Monitor your accounts diligently and try to avoid getting "deeper in the hole". While it certainly makes good business sense to work with and accommodate existing customers, you should avoid supporting a customer at the risk of your own cash flow. Don't agree to stretched-out payments or modified delivery terms without proper documentation. Repeated accommodations may later be deemed to have been contract modifications with which you would then be bound to continue to comply. Accommodations should be made in consultation with counsel and, if possible, in exchange for enhanced protections.
  3. Push for payments from customers. The most frequently asked question is "I know if I take the money I may be taking a 'preference' - what should I do?". In general terms, a "preferential transfer" is a payment of money or transfer of assets or collateral to a creditor, made within 90 days prior to a bankruptcy filing (or within 90-120 days prior to some state court receivership proceedings), on account of a pre-existing debt, at a time when the transferor is insolvent, which enables the creditor to receive a larger distribution on account of its claim than it otherwise would have received. Not every transfer from an entity in financial distress will be deemed a preference. Consult with counsel to try to avoid "preference" exposure. However, fear of accepting a preference should not keep you from taking the payment. Your customer may not end up in a bankruptcy or state court restructuring proceeding at all. Even if there is such a proceeding, if the payment is made outside the recoverable period, it will not be avoidable. In any event, avoidance is not automatic; a lawsuit must be brought, and you may have defenses. The bottom line is, take the money, but discuss the risks and potential defenses with your attorney.
  4. Exercise rights and remedies. Refusal to ship until payment is made may be the most effective remedy. If your contract allows, impose shorter terms, COD or cash in advance payments for shipments. Consider terminating or modifying supply agreements, evaluating the cost and time delay of re-sourcing. Consult with counsel to avoid breaching the terms of your contract, and to avoid making contract modifications that are not properly documented. Note, too, that in a bankruptcy, enforcement of remedies is limited; actions should not be taken post-bankruptcy without consulting counsel.
  5. Consider requesting additional assurances of performance, e.g. security deposits, letters of credit, third-party guarantees or other collateral. Often, the most likely guarantor is the end user of the product which you manufacture. Consult with your attorney regarding the possibility of obtaining a "purchase money security interest" in the goods you ship.
  6. Consider with counsel whether you can exercise any statutory liens, e.g. mechanic's liens, tooling liens, artisan's liens, landlord's liens or shipper's liens. Also consider with counsel the applicability of other statutory protections, e.g. under the Perishable Agricultural Commodities Act (PACA) or the Packers and Stockyards Act (PASA). Most of these statutory rights and remedies require timely notifications or other affirmative action which counsel can assist you with.
  7. If you do learn of a bankruptcy, call your counsel for advice. Certain actions are prohibited by the "automatic stay", e.g. requesting payment of debt incurred prior to the bankruptcy filing or threatening to terminate your contract if you are not paid. You may also be entitled to priority treatment for a portion of your receivable; claims for goods delivered to the debtor within 20 days of the bankruptcy filing are afforded administrative status, which is a higher distribution priority than that afforded to general unsecured claims. However, mechanisms may be established for the timely filing of administrative as well as general unsecured claims; work with your counsel to avoid missing deadlines.

Now is the time to take action; don't wait until your customer or supplier has filed a bankruptcy or other restructuring or liquidation proceeding. Working with counsel early can help you make the best of a distressed situation. You can never be over-prepared. We at Quarles & Brady stand ready to assist you with all of your questions and concerns in these challenging times.

For more information please contact the Chicago Midwest Office Chair Faye Feinstein at (312) 715-5069 /, your local Quarles & Brady LLP attorney, or one of the following Commercial Bankruptcy, Restructuring and Creditors' Rights practitioners:

Phoenix John Harris
National Group Chair
(602) 229-5406  
Madison Roy Prange (608) 283-2485
Tucson: Susan Boswell (520) 770-8713