Prepare for the Next WaveWhole Lot of Shakin Goin On
Many of us remember the "good ol' days" of working on business bankruptcies in the 1980s like we remember songs of days gone by.3 Lately, we have all seen newspaper headlines like these that make us wonder if those days are coming around again: "Chapter 11 Filings by Large Corporations Increase;"4 "Firms...Shift Corporate Finance Lawyers"5 (into bankruptcy lawyers); "Economy Shows Signs of Slowing."6
The headlines show a storm brewing in business bankruptcies. No one knows exactly when it will hit (or if the first waves are now being felt). Most people in the financial world realize that what goes up will come down—particularly if it has gone up for years.
The Asian economic crisis and our own stock market "correction" this summer show that bad times can hit strong (and even seemingly invincible) economies. The question is not whether the United States will see economic problems, but when they will come and how severe they will be.
The U.S. economy has experienced an extraordinary expansion over the past 5+ years. Stock market indices were at or near all-time highs this summer. Thinking stock prices only go up, many newcomers in investing circles made the startling discovery that market values do fall, and sometimes fall very quickly. In fact, this realization caused many companies to mothball plans for stock or debt offerings. Acquisitions paid for with stock of the buyer and packages of debt that would have been "securitized" were instead held by their originators. This summer marked a "closing" of the public market to a great number of companies.
Concurrently, many banks went from "easy" credit to much stricter credit standards. This tightening occurred somewhat suddenly in U.S. banks (even though the Comptroller of Currency warned of loose lending practices as early as January 1998). Japanese banks, including those lending in the United States, imposed austerity on their lending officers (at the insistence of the Japanese government), further reducing the number of loans available.7
If companies cannot manage or resolve their liquidity problems with funding from the public markets, and if domestic banks become more selective and foreign banks essentially stop lending, the liquidity problems will immediately fall on the companies' trade creditors. Companies will stretch their trade creditors first since late payments there do not trigger foreclosures, management changes and the other immediately unpleasant consequences of defaults on bank and bond debts. The other source of quick credit, the U.S. government, exacts a severe price from those who "borrow" from their payroll "trust fund" taxes. Therefore, trade creditors undoubtedly will be the first to feel the credit crunch.
"So Get Ready, Get Ready"8
Ultimately, debtors' games of musical chairs cannot continue indefinitely. When the music stops, someone is going to be left without a chair. Prudent credit managers must lay groundwork now for the inevitable collection problems that a downturn will assuredly bring.
Review Your Credit Files Now!
Credit files should be reviewed to assure that you have the basic documentation you will need to collect your accounts. You will be amazed by what is not in your files (that you thought would be there). Do you have a signed credit application? Are the guarantees or other documents signed and up to date? Are your customers' payments to their other vendors timely? How are your largest customers' major accounts paying their bills? How recently have you confirmed your customers' taxpayer identification numbers? Have you received current financial statements? Is your Uniform Commercial Code search (or, perhaps filing) current?
These basic issues should be addressed because many things might have happened to increase your risk. For example, a new entity could have purchased your customer's business (which may have a different taxpayer identification number than the entity signing the credit application). Documents signed by the old entity would probably not be enforceable against the new one. Guarantors may have died, filed bankruptcy or become judgment-proof.
Reviewing credit information from other sources should show if your customers have problems that you do not yet see, such as slow payments and increased credit lines elsewhere. It could also show if they are stockpiling materials or inventory or have pledged either to a lender or another supplier. Slowdowns by their major customers could start a ripple that hits you like a tsunami—particularly if your customers supply a common end-user.
Review Your Forms and Procedures
Do you have proper procedures in place to immediately notify you of collection problems or, more importantly, a bankruptcy filing? Has your sales staff been trained to immediately report a filing (or rumors of a filing)? Does everyone in your department understand the consequences of a bankruptcy filing? Are your forms for demand and reclamation letters current? Do you have immediate access to reports listing all outstanding invoices, goods in transit and pending orders? Do you have the authority to stop goods in transit, and hold pending orders?
Many substantive rights are either exercised or lost in the first few days of a bankruptcy case. A reclamation demand must be exercised or lost shortly after a case is filed.9 Do you have a protocol or procedure to send people to a debtor's location(s) to see which, if any, of your products were in the debtor's hands when the reclamation demand was served?10
The creditors' committee is usually formed shortly after a bankruptcy filing. It is not unheard of for a debtor to inadvertently omit a large hostile creditor from its list of the 20 largest creditors and effectively exclude it from the committee. If you do not learn of the filing before the appointment is made or cannot show that you are one of the largest creditors, you might not be able to get on the committee later.
Have you reviewed your records retention policies for their impact on bankruptcy cases? During the early phases of a case, it is extremely rare for a debtor-in-possession to pursue preference litigation against its suppliers. That litigation usually occurs well after a plan has been confirmed or a case converted to a chapter 7 liquidation. Will you have the records to defend a preference suit filed almost two years after the bankruptcy—particularly if "ordinary course of business" or "subsequent new value" will be your primary defenses?11
"Just Called to Say 'Hello'"12
In case you have not been tracking this trend, professional firms (attorneys, accountants, etc.) have been merging, closing, rearranging personnel and otherwise going through tremendous changes in the past few years. If you have not talked to your favorite bankruptcy attorney or other professional recently, you might want to call him or her to know where you can find him. You never know when you will be in a hurry or faced with an emergency bankruptcy problem.
Prepare Your Action Plan
The period of strong economic growth is apparently ending. While there is no guarantee that business bankruptcy filings will surge, all signs point to more business bankruptcies on the horizon.13 You can protect your company by planning what you will need to do when the wave of bankruptcies crashes on your beach sometime in the coming months. It has been said that no one plans to fail, they only fail to plan. This is especially true when it comes to dealing with the issues presented in business bankruptcies.
11 Under §546(a) of the Bankruptcy Code, a preference case must be filed within two years after the bankruptcy is filed. This can be extended by as much as a year if a trustee is appointed during the two-year period. Return to article
13 Supertramp's "Goodbye Stranger," A&M Records, probably described debtors and possible bankruptcy filings best:
"Now some they do and some they don't
And some you just can't tell
And some they will and some they won't
And some it's just as well." Return to article