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January 20, 2021

Considerations for Dealing With a Financially Weak US Customer

In the world of commerce, it is always important to recognize the signs of an ailing counterparty so the proper actions can be taken to protect your company. This recognition has become even more critical as we battle the COVID-19 virus both on a micro, personal level and on a macro, global level affecting ourselves, our families, and our local, national, and world economies.

How can you tell that the company you are dealing with may be in trouble?

Luckily, there are overt manifestations of financial trouble. These include the counterparty asking to lengthen the terms—of payment, of delivery—or sometimes just paying late, without any communication. They can also include receiving letters from other creditors, other counterparties, accountants, or banks requesting confirmation of the company’s account status or a significant shift in the counterparty’s operations. We recommend periodically obtaining credit reports to determine if there are any unfavorable trends impacting your counterparty and checking with other suppliers or vendors for additional information concerning any changes in your counterparty’s finances.

What can you do to minimize your exposure?

You can always decide not to do business with the counterparty. If that is not an option, you can significantly change the terms by which you conduct business by:

  • Reducing the terms of payment or lengthening the terms of delivery since, for instance, 20 days or less may provide priority treatment in the event of the counterparty’s US bankruptcy
  • Limiting available credit
  • Requiring a deposit
  • Requiring the payment of any outstanding balance before a new shipment
  • Requiring cash on delivery
  • Requiring cash before delivery
  • Requiring a security interest

You may also want to require monthly financials to monitor the counterparty’s progress, which will keep you informed as to whether you should continue, reduce, or strengthen these protective measures or decide to terminate business relations until its finances improve. Note that the inability or unwillingness to provide current financials may also be a sign of financial distress.

What happens if you get notice the counterparty is engaging in an out-of-court workout, restructuring, wind-down, Article 9 sale, or assignment for the benefit of creditors (ABC)?

Stop deliveries or business relations until you understand the situation from communications with the people in control, which may not be the counterparty. Gather your transaction records and identify your claims (accounts receivable, work-in-progress, and any other allowable contractual, common law, or statutory costs) against the counterparty and vice versa. It probably makes sense to consult a lawyer, especially where there are court proceedings, such as in an ABC. Move quickly as these situations can develop overnight. 

If the counterparty files a petition for bankruptcy protection in a US bankruptcy court, then what? 

First, determine what kind of bankruptcy the counterparty has filed: Chapter 7 (liquidation with a trustee), Chapter 11 (restructuring or liquidation for a corporation or individual, with the debtor in control), Chapter 12 (family farmer reorganization), Chapter 13 (individual reorganization), or Chapter 15 (ancillary and other cross-border cases for corporations and certain individuals).

If the counterparty files a Chapter 7 petition, then it is no longer operating (unless under bankruptcy court order, which is rare and extraordinary) and, therefore, neither provides or utilizes further services nor receives or makes further deliveries.

If the petition was filed in other chapters, most likely Chapter 11 or 15, here are some of the steps that should be taken:

  • Stop deliveries until you receive assurances of payment for post-petition deliveries.
  • Identify what your counterparty owes you or what you may owe the counterparty, and preserve all transaction documentation.
  • Identify the value of goods delivered within 20 days prior to petition date for possible priority treatment.
  • Determine if any other enhanced treatment is available, such as statutory trusts or lien rights.
  • Watch for the setting of a bar date, and file a proof of claim (which may result in submitting to bankruptcy court jurisdiction).
  • Watch for plan and disclosure statement filings to determine the proposed treatment of the claim.
  • Talk to the counsel to the creditors’ committee about the case, or if none was appointed, to the debtor’s counsel or the Office of US Trustee to get a sense of where case is going, its timing, and other information.
  • Determine if you received debtor’s property, including cash, in two separate timeframes before the bankruptcy filing: 90 days (preferences) and 2 years or more (fraudulent conveyances); if so, collect and preserve records of the transactions and all related communications.
  • Analyze whether the customer’s distressed posture offers any opportunities.
  • Consider consulting with a bankruptcy lawyer to assist in reviewing your options at any point discussed above.

The earlier you know about your counterparty’s financial troubles, the more effective your protective measures will be.

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