Top Ten Ways to Avoid or Minimize Credit Problems

April 24, 2002

"A warning light is flashing on the dashboard of our economy." Those were the words President George W. Bush used to explain why his tax relief proposal is necessary to help lift our nation out of an economic slowdown. Without debating a political issue or predicting whether there will be a recession or merely a "soft landing," the message is clear. A sign of the times is that bankruptcy filings remain at record levels and recently there has been a startling increase in Chapter 11 filings by large businesses in nearly every industry. If your business operates on credit, at some point you will be affected by someone's insolvency or bankruptcy filing. The company that recognizes and reacts to the "flashing warning lights" will be best suited to drive safely through the looming credit problems.

While minimizing credit risks and dealing with bankruptcy filings by your customers or suppliers are complex matters, here are the top ten ways to perform some preventative maintenance.

Review Documentation: First, make sure your agreement is properly documented. The written contract should completely and unambiguously reflect the deal. If appropriate, send notices or take any other action necessary to preserve your contractual rights. For secured transactions, make sure all UCC financing statements have been properly filed (and continued) and all required notices have been sent to prior perfected secured creditors.
Consider Restructuring the Arrangement: Even in bankruptcy, secured creditors are entitled to recover at least the value of their collateral. Therefore, consider whether your credit arrangement can be restructured into a secured transaction backed by a letter of credit, a purchase money security interest or other collateral. Also, consider whether you can protect your property through a consignment or whether you can obtain third party guarantees.
Review Terms and Conditions: Are the terms and conditions on your printed forms adequate and sufficient? For example, do they provide for a purchase money security interest, late charges, interest and the collection of attorneys' fees in the event of a default? Under certain circumstances, including properly perfecting any security interest, such rights may be enforceable even in a bankruptcy. Also, will your terms and conditions prevail if there is a "battle of forms?"
Minimize Preference Exposure: If you receive a payment on a past due debt outside the ordinary course of business and your customer files for bankruptcy within the next 90 days, you may be subject to a "preference" challenge; you may be required to repay some or all of the "preferential" payment. Recognizing potential risks and proactively planning may minimize or eliminate such exposure.
Create an Executory Contract: When an entity files for bankruptcy, it receives the right to assume or reject executory contracts. Rejection may permit a debtor to avoid future obligations. Assumption of an executory contract requires the cure (usually in cash) of any pre-bankruptcy default. Assumption of an executory contract, therefore, is one of the few exceptions to the rule that prohibits a debtor from paying pre-bankruptcy claims. While other issues must be considered, in some circumstances it may be beneficial to transform an open account into an "executory" supply contract.
Position Yourself as a "Critical Vendor": Many large Chapter 11 debtors recognize that they cannot successfully reorganize without the support of certain "critical vendors." To entice critical vendors to continue to provide normal trade credit, debtors request special approval to pay them some or all of their pre-bankruptcy debt. While not every supplier will be deemed a "critical vendor," if you are aware of your prospects, you may be able to increase your probability of becoming one.
Monitor the Debtor's Activity: Before steering into Chapter 11, most companies exhibit noticeable signs of "wear and tear." While it is impossible to predict precisely when a company may go into bankruptcy, recognizing the early warning signs increases your prospects of reacting accordingly so as to reduce your exposure and/or increase your recovery.
Be Prepared to Act: Unless you fully understand your available rights and remedies even after the bankruptcy filing, merely monitoring the situation will be insufficient. Many rights are time sensitive and can be lost if swift action is not taken. As just one example, you may be able to reclaim goods even after a bankruptcy filing by sending a written notice within ten (sometimes 20) days after the debtor's receipt of them.
Look for Opportunities: Financial troubles may force your competitors or even your suppliers to sell some or all of their business. Frequently, there are valuable buying opportunities, often at distressed prices, and there may be opportunities to take advantage of weakened competition in the marketplace.
Call Cohen & Grigsby: The Bankruptcy and Creditors' Rights Group at Cohen & Grigsby can provide a legal assessment of your current credit risks and determine whether a "tune up" would help you steer more safely and effectively through credit problems. As of January 1, 2001, the Group was expanded with the addition of two partners and two associates, and the firm is fully staffed to handle all creditors' rights and bankruptcy issues. Whether you contact us while the warning lights are still flashing or after a problem occurs, such as a party filing for bankruptcy, we can efficiently service your needs – bumper to bumper.

For more information, please contact wkelleher@cohenlaw.com.