Working Through Your Customer's Financial Distress

Many organizations these days find themselves doing business with companies that are in severe economic distress. In the past, the question was "Should I do business with an insolvent entity?" And the answer was generally "No, not if you can help it." Today, however, virtually every company will have business dealings with one or more entities in financial distress. Under these circumstances, the issue becomes "How do I do business with a financially distressed company?" Navigating these difficult and often uncharted waters requires creative legal counsel with experience in bankruptcy and insolvency matters to guide you through the risks.

The worst economy since the Great Depression has affected companies from every industry, including airlines, banks, commercial real estate professionals, contractors, health care providers, manufacturers, professional services firms, restaurants and bars, retailers, state and local governments, suppliers of raw materials, telecommunications businesses and utilities. No matter the industry or the issues, the overriding objective remains the same in good times and bad: to make wise business decisions. Utilizing counsel with a wealth of actual experience in bankruptcy and insolvency matters, along with a broad base of knowledge and resources, is imperative when you and your company are attempting to make the wise, back-to-basics business decisions necessary in this challenging economy. The goal is no longer to eliminate potential losses in a financially distressed marketplace (because that is impossible) but instead to minimize them.

In order to minimize the risk, it is critical that all companies dealing with entities in financial distress do two things: ask the right questions and get good direction.

Ask the Right Questions, the Hard Questions...the Ones No One
Wants to Talk About

If you are in the manufacturing, sales and services sectors, consider the following:

1. Where are receivables, orders and payables trending? If they are trending sharply, then it's time to review the situation with your lawyer and consider taking measures to minimize risk. Letters of credit have not always been safe in a bankruptcy proceeding, but recent cases make it clear that beneficiaries of letters of credit are well insulated from risk of non-payment.
2. Should you accept payments from financially distressed companies? If so, what about preference actions? Most businesspeople know enough about bankruptcy protection to cringe at the sound of that phrase. My rule is simple: If you have the money, keep it. Bankruptcy used to mean disgorging what little money the bankrupt debtor paid and still owes you. Under the 2005 revamp of the Bankruptcy Code, however, a preference disgorgement is now less automatic. So, it is worth stating again, if you get the money, keep it. Then, working with your attorney, you can argue about whether and to what extent you may ever need to pay anything back.
3. What can you do to realize collections on goods already shipped and received, or services provided? It is important to carefully review your rights relative to reclamation, recoupment, setoff and liens. Reclamation rights in bankruptcy are expanded, and can be used to negotiate better business and credit terms, rather than a recovery of the goods if the debtor needs the goods.
4. On the other side of the table, if your company is in financial distress, consider whether it is possible to obtain new credit terms and letters of credit. At times, weakness is actually a strength, especially in the upside-down world of insolvency and bankruptcy. A company that has nothing to lose can often obtain more favorable terms from its creditors than an entity that is financially strong. Creditors of a solvent company will demand cash. By contrast, creditors of a financially distressed company that have already lost everything will look for a way to recoup those losses, even if it means providing some incentive for the company to stay afloat or reorganize.

For companies involved in commercial real estate, think about these issues:

1. Has the property ever produced income? To determine the income, obtain the current rent rolls and the actual leases. Establish whether the current rents are sufficient to service the debt.
2. Is the building secure and properly maintained? Work with the owner to install a property manager. Absent cooperation, is it appropriate to move forward with a mortgagee in possession or receivership? Have the parties discussed the possibility of a deed in lieu of foreclosure?
3. Is the building still under construction? If so, is it at or near completion? Have any mechanics lien claim rights been asserted? Where do the letters of credit stand? What is the status of the prospective tenants? Be sure you contact the municipality that holds the letter of credit and attempt to obtain an extension, even though that is a delicate conversation to have. Remember that a municipality acts through its resolutions, just as a court acts through its orders. It is also important that you determine the validity of executed leases and deposits, as well as the cost of completion and mechanics lien claims. When possible, negotiate with those lien claimants in order to minimize exposure.
4. What is the status of the property's real estate taxes? You may be able to successfully challenge and reduce your real estate assessments.

Get Good Direction

A bankruptcy lawyer, of course, cannot be an expert in all of these areas of law. However, because any of these issues can arise during a typical business bankruptcy case, your lawyer should have a deep well of resources from which to draw—colleagues who are experts and specialists and have weathered the worst of storms, including helping a company navigate a Chapter 11 bankruptcy reorganization. Therefore, even if you have not filed for bankruptcy protection, you may need access to all sorts of professionals, such as valuation experts, accountants, financial consultants, auctioneers, mezzanine financers, factors, realtors, construction experts and contractors. Although these kinds of professionals are plentiful, it is not wise to take a "one size fits all" approach. Instead, your bankruptcy attorney should help you select the mix of experience and industry expertise that best suits your particular circumstances.

In the current economy, with financial problems begetting legal troubles in virtually every industry, you may need to distinguish between attorneys and firms that have merely seized bankruptcy law as the next legal area in high demand and those that have years of relevant experience under their belts. What you really need is a bankruptcy lawyer with a broad range of legal expertise and outside resources to address the vast economic challenges businesses are facing—including, but not limited to, insolvency and workout matters.