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Managing Customer Relationships in a Down Economy

Even if predictions of a somewhat prompt recovery from the current recession are true, many companies will feel the financial pinch for years to come. Keeping a company out of financial distress caused by the problems of others is an important, but difficult task. Companies are well advised to constantly evaluate their customer relationships.

The following list summarizes ways to look for and respond to customers in financial distress.

  1. Learn to recognize the warning signs of a business in distress. Signs of financial distress include:

    • Bounced checks;
    • Frozen bank accounts;
    • Receipt of "lock box" payment instructions;
    • Increased payment delays;
    • Delayed response time to inquiries;
    • Suits by third parties against customer/vendor;
    • Management and/or employee turnover or reductions;
    • Industry rumors;
    • General industry distress;
    • Quick attempts to resolve issues (possibly to facilitate a bankruptcy filing);
    • Public filings concerning adverse events (e.g., a 10-Q); and
    • Sale of a profitable division or business to generate cash.

  2. Upon signs of financial distress, act quickly to understand the relationship between the parties to mitigate any potential loss. Review terms and conditions of existing agreements between the parties, evaluate the credit risk posed by a possible default and coordinate an internal response to open issues. By doing so, a party will understand its rights, remedies, and obligations and address the crisis quickly and effectively.

  3. Look for ways to decrease exposure. Contractual revisions and credit support may mitigate a loss. Possible ways to minimize losses include:

    • Revise contract provisions;
    • Price increases and accelerated payment terms;
    • Liens, guaranties and other credit support;
    • Standby and commercial letters of credit;
    • Take a purchase money security interest in goods delivered;
    • Periodic reporting requirements;
    • Craft purchase order procedures;
    • Performance bonds;
    • Suretyship obligations;
    • Credit insurance; and
    • Pursue possible litigation remedies

  4. Be proactive with the distressed business, not reactive. By staying ahead of the crisis, a party may achieve a consensual agreement or avail itself of available contractual and legal remedies in a deliberate fashion.

  5. Be conscious of pitfalls concerning any workout agreements reached between the parties. A consensual outcome is always preferable to litigation. It is important for a vendor to properly understand the risks of a consensual pre- or post- default workout agreement. Benefits obtained by a vendor through a workout will likely face scrutiny in a bankruptcy filing or similar proceeding. Courts and creditors may focus on whether the transaction constitutes a fraudulent conveyance, a preferential transfer or some form of overreaching or fraud. Work closely with counsel to avoid a subsequent unwinding of consensual transaction.

  6. Keep abreast of general commercial and contract law. Statutory remedies generally available to commercial parties, before and after a monetary default, include:

    • Adequate assurance (UCC § 2-609) remedies;
    • Anticipatory repudiation (UCC § 2-610) remedies;
    • Termination or modification of credit terms;
    • Stopping goods in transit;
    • Reclamation;
    • Identification and salvage of goods;
    • Resale of goods;
    • Damages for non-acceptance of goods or repudiation of the contract, including lost profit;
    • Action for the price of the goods;
    • Mechanics and materialman liens; and
    • Possible cancellation of the contract.

  7. Evaluate the effect of a customer/supplier bankruptcy on the business and monitor the bankruptcy process. Bankruptcy may lead to a new structure for the relationship between companies. In the event of a bankruptcy filing, parties will need to consider an array of bankruptcy-specific issues and action items, including:

    • Monitoring the bankruptcy case;
    • Seeking critical vendor status;
    • Focusing on financing and operational issues;
    • Preparing and filing proofs of claims;
    • Considering creditor committee participation;
    • Defending preference and/or fraudulent transfer claims;
    • Responding to claims objections;
    • Prosecuting administrative, priority and secured claims where such status is available;
    • Effecting setoff rights;
    • Assessing any plan of reorganization or liquidation proposed by a party; and
    • Determining whether executory contract issues exist.

  8. Understand the broad impact of the automatic stay in a bankruptcy proceeding. The automatic stay prohibits the exercise of creditor remedies upon the filing of a bankruptcy petition by a debtor entity. Violation could subject a creditor to sanctions and/or damages.
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