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Developing a Systematic Action Plan for Managing Revenue Risk Posed by Financially Challenged and Bankrupt Customers

In the August 19, 2020 issue of Crain’s Cleveland Business, guest bloggers H. Jeffrey Schwartz and Gus Kallergis, co-chairs of the Business Restructuring and Insolvency group at Calfee, Halter & Griswold LLP, posted this blog highlighting the risk businesses will face in the coming months from customers going out of business or declaring bankruptcy, and therefore unable to pay their receivables.  At BG Consulting Group, we’ve identified this “trailing risk” of the pandemic induced economic downturn as one of the most significant issues our clients will be facing.  Messers. Schwartz and Kallergis describe the risk and some ways to plan for it, and we’re happy to repost their article here.

We encourage you to call BG Consulting Group at 216-956-0378 to discuss an assessment of your business’s revenue risks and get help creating a plan to weather them.

H. JEFFREY SCHWARTZ and GUS KALLERGIS

The global COVID-19 pandemic has savaged the domestic and global economies.

The U.S. and the global economies struggle in recessions with no firm endpoints in sight, and bankruptcy filings and real estate foreclosures continue to mount.

In these problematic circumstances, manufacturers and distributors face challenges to avoid incurring unnecessary significant accounts receivable losses by forming an internal and external experienced, capable team with the necessary expertise to anticipate and effectively respond on a real-time basis to write-down risks as and when they arise before and during bankruptcy cases.

A shot across a pre-bankrupt’s or bankrupt’s bow: Issuing threat of stoppage and recalling goods in Transit

Companies must be poised to act with dispatch.

For example, sellers with goods in transit to a buyer have full recovery rights. Both the Uniform Commercial Code and international law empower a seller that learns of a buyer’s insolvency to stop goods in transit before their physical receipt by the buyer.

A savvy seller weighs whether it should reclaim the goods or demand immediate payment or adequate assurance of performance prior to completing the delivery into the physical possession of the insolvent buyer.

Often, if the goods are critical to the buyer’s operations, a seller’s mere threat of stoppage suffices to leverage immediate payment in full from a troubled buyer. Companies lacking vigilance do so at their own financial peril.

Vendor entitlement to administrative expense priority for goods received by a debtor in the 20 days before bankruptcy and thereafter

Because the uninterrupted flow of goods to an insolvent buyer is necessary to its ability to continue business operations, bankruptcy law confers payment priority on claims for goods received by a financially distressed buyer both in the 20 days immediately prior to a bankruptcy filing and thereafter. This payment priority is meant to encourage sellers to continue to do business with a financially distressed company and to refrain from exercising their rights to stop goods in transit.

Companies as sellers must focus awareness on their “get out of jail free card” — that domestic or foreign goods physically received by a bankrupt or its agent in the 20 days immediately before a bankruptcy filing entitles the seller to payment in full. The transit time of goods bears no impact on the running of the 20-day period.

Similarly, account creditors must bear in mind their full payment entitlement for goods received by a bankrupt. A seller of goods ordered by a bankrupt company is entitled to payment in full for those goods. So, too, with claims for goods under pre-bankruptcy filing purchase orders delivered into the hands of a bankrupt entitles the seller to payment in full.

Companies that fail to assert their full payment rights against a bankrupt risk losing out on a valuable opportunity to emerge from a customer’s bankruptcy unscathed.

Best practices for business sellers

Successful business sellers know that the overwhelming majority of significant bankruptcy cases tend to be filed in New York City, Delaware or Virginia. As a result, experienced vendors turn to outside bankruptcy counsel who regularly represent major vendors in cases in those venues.

Only then can vendors stand poised to act on the necessary real-time basis in bankruptcy cases in those venues. Savvy business sellers also should be prepared to respond to aggressive bankrupt’s dubious arguments such as the 20-day period immediately before the filing of a bankruptcy case begins more than a month before the bankruptcy filing, such as when a business seller drops off goods with a common carrier in Asia.

Therefore, the best protection for a seller with goods in extended transit is to threaten the exercise (and, if needed, then exercising) its right to stop those goods prior to physical receipt by the bankrupt to leverage its acknowledgement that the seller’s full payment rights do in fact attach to the goods upon receipt by a bankrupt. Business sellers must accept the reality of the desperate tactics of bankrupts and be prepared to respond to that harsh reality both expertly and on a real-time basis.

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