Client Advisor - Risk Management in a Troubled Economy
Part Two of a Four-Part Series
In the previous advisory, “When It Comes to Troubled Customers, Knowledge is Power,” we discussed how to identify troubled customers. Now that you know who they are, though, what are you going to do about it? Risks associated with non-payment need to be balanced with potential loss of sales. You need to consider the practicality and risks (both business and legal) of potential actions and decide which are appropriate to each situation. Here are a few to consider:
Collateral, Security Interests or Insurance
Options include letters of credit, purchase money security interests and third-party guarantees. However, a customer experiencing liquidity issues will likely be unable to agree to these measures. Further, if the assets you want as security are already encumbered, your position may be junior and potentially of no value. Insurance may be difficult or expensive to obtain and an annual deductible may need to be satisfied. All of these methods require strict compliance with documentation and filing requirements.
Change the Terms
Included in this group are the conventional options of reducing the days allowed for payment, lowering credit limits, demanding a deposit or entering into consignment agreements. Care should be taken to properly document the changes in terms to reinforce your position that the reduction in terms is in accordance with risk management policies in the ordinary course of business. Ideally, terms should be reduced to 20 days or less to try to maximize the portion of any unpaid receivables that might qualify for administrative expense priority. If the customer is also a supplier, enter into a formal set-off agreement.
Exercise Your Rights
Mechanics liens should be filed if applicable. As is the case with letters of credit and other security filings, documentation must be exact and comply with all filing procedures and deadlines; otherwise the lien will be of no effect. Unless you have experience in making these filings, retain outside assistance. If you store or transport goods for the customer or have built or possess tooling, you may be able to enforce possessory or toolmaker liens.
During negotiations with the customer regarding changes in payment terms or security, the risk of possible exposure to future preference claims may be raised. When in doubt, get the cash or the security. Possession is nine-tenths of the law. Plus, the 2005 changes to the bankruptcy code made it easier for creditors to defend against or limit preference claims.
Part One - When It Comes to Troubled Customers, Knowledge is Power
Part Three - Response to a Bankruptcy Filing
Part Four - Preferential Transfer Claims, Adding Insult to Injury
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