With corporate bankruptcies increasing by 60% over the past 12 months, companies want to avoid getting dragged down by the failure of customers–especially key ones that might owe significant amounts of cash.
There are important early warning signs to look for, as well as steps companies can take to minimize losses if a customer goes bust, says attorney Rhett Campbell, who heads the corporate reorganization and creditors rights practice at Thompson & Knight in Houston.
Pay attention to bounced checks, chronic payment delays, layoffs or management turnover, news of distress in particular industries, sudden attempts to resolve outstanding payment or delivery issues, or the sale of a profitable division, he advises. "These are all warning signs of trouble at a customer's company," he says, "and they tell you that you need to take steps to protect yourself."
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What to do? There is of course a fine line between not helping to sink an important customer and not getting hurt by that customer's going under. Campbell says a company that could face significant damage from a looming customer insolvency, or multiple insolvencies, should develop a "coordinated internal response" and immediately consult with legal counsel. Steps include identifying and reviewing documents that confirm agreements reached with the customer and set forth rights and remedies in the customer relationship, evaluating the credit risk the company faces, crafting new purchase order protocols for the problem customer, and preparing guarantees and documentation to enhance creditor protections. With international customers, he adds that it's important to review the relevant foreign bankruptcy laws and prepare authenticated documentation of sales and amounts owed so these can be provided quickly should the need arise.
By being prepared, companies can often reach consensual agreements to settle debts or terminate a relationship before a bankruptcy closes off those opportunities. This can be important because once a bankruptcy action begins, debts won't generally be settled until a reorganization plan is approved (which can sometimes take years). But make sure those agreements will pass muster with a bankruptcy court.
Of particular concern are continuing supply contracts, says Campbell. Bankruptcy courts will often require companies to continue providing critical goods and services to a bankrupt firm–even if there was a default on payment prior to the bankruptcy–if those goods or services are deemed necessary for the continued operation of the company in bankruptcy.
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