What should I Do If My Customer Isn’t Paying as Promised or Files Bankruptcy?
As noted in the previous client alert regarding supplier bankruptcies, the shut down due to COVID-19 is causing many companies to experience financial distress. It is important that businesses are familiar with the proper course of action if they suspect a customer is experiencing financial issues, and especially if a customer files bankruptcy. All insolvency situations are unique, so the following list should not be used in lieu of consulting with legal advisors. However, these considerations should be useful when making business decisions concerning financially distressed customers.
Receivables and Payment Terms. Monitor your receivables diligently. One of the first signs of a customer’s financial distress is typically an increase in time between invoice and payment. If you normally receive payments within 30 days of invoicing, and payments progressively get farther from invoice date, e.g. 45 days, then 60 days, then 90 days, and so on, it is time to contact the customer and asses their situation. If you are asked to extend or otherwise change payment terms, make sure to consult with counsel to properly document all agreed changes. Certain or repeated accommodations to a customer without proper documentation could be construed as contract modifications with which you could be forced to comply going forward.
Contract Rights. Review governing agreements, contracts, purchase orders, and other relevant documents with the customer (collectively, the “Contracts”), paying particular attention to the remedies you may have if the customer defaults. Examine whether you have any guarantees from the customer, liens, security deposits, letters of credit, or any other payment protections (collectively, “Enhanced Protections”). If you are asked by the customer to provide accommodations, seek the assistance of legal counsel to negotiate the addition of Enhanced Protections to your Contracts.
Exercise Remedies. If your customer does not pay as required or demanded, then consider refusing to ship any further goods or provide further services. If your Contracts permit, change payments terms to cash on delivery (COD) or cash in advance (CIA), and evaluate whether it makes sense to modify your Contracts to include new payment terms, Enhanced Protections or other changes, or to terminate the Contracts. Make sure to consult with counsel to avoid your own breach of contract, ensure that amendments to Contracts are properly drafted, and evaluate other legal remedies which may be available to you.
Bankruptcy. If you receive notice that a customer has filed for bankruptcy protection, consult legal counsel before taking any action. First and foremost, the Bankruptcy Code’s “automatic stay” prohibits many kinds of activity, including collecting payment of any debt incurred before the bankruptcy filing, terminating any ongoing Contracts[1], or taking other action without permission from the court.[2] Intentional violation of the automatic stay may result in the court imposing monetary sanctions against the violator. However, if you don’t have an ongoing contract with a customer who has filed bankruptcy the automatic stay should not prevent you from refusing to deliver additional goods or provide further services to the customer after the bankruptcy filing or requiring the customer to pay COD or CIA for all future orders.
Make sure to take note of any deadlines set in the bankruptcy case. For instance, claims for goods you delivered to the customer within 20 days before the bankruptcy filing may be entitled to priority treatment (payment before general unsecured claims). However, you could lose your priority treatment if you don’t act before certain deadlines. You should carefully review all documents received from the court and be sure to comply with all deadlines.
If your customer paid you for goods or services within 90 days before it filed bankruptcy, you may receive a demand to return the funds you received. (These funds are called “preference payments” or “preferences”). If you refuse to return the preference payments, a bankrupt debtor or bankruptcy trustee may file a lawsuit against you. However, there are numerous defenses to a preference action which may allow you to avoid repaying the payments you received, so you should not typically agree to repay a preference upon receiving a demand for repayment. Preference litigation is a specialized area of law which is generally in a state of flux. Therefore, if you find yourself the recipient of a preference demand letter or complaint, do not respond to the letter or answer the complaint before consulting bankruptcy counsel. To ascertain whether defenses apply, you may need to produce records showing your history of dealings with your customer for at least one year before the bankruptcy. As a result, it is important to keep detailed records of all dealings with each customer, especially if you suspect a customer is financially distressed.
Sometimes a chapter 11 debtor requests authority from the court to pay pre-bankruptcy amounts owed to certain “critical” suppliers in order to induce them to continue providing goods or services on customary payment terms and/or forego asserting liens against goods, tooling or other items which are owned by the debtor but in the supplier’s possession. If you are deemed “critical” by a bankrupt customer, you may be asked to sign an agreement which redefines both parties’ ongoing obligations to one another. Such agreements can be complicated, and therefore bankruptcy counsel should assist in negotiating their terms.
If your customer (or supplier) files bankruptcy or is otherwise showing signs of financial distress, the Miller Johnson bankruptcy and debtor/creditor rights team can provide guidance. Please contact John Piggins or Rachel Hillegonds if you would like to schedule an appointment.
[1] You may be barred from terminating Contracts if they are “executory”. An executory contract is a contract under which both parties to the agreement have duties remaining to be performed. Depending on the facts, such contracts can include supply contracts and purchase orders.
[2] The automatic stay typically remains in effect until the bankruptcy case is closed or dismissed, a discharge is granted or denied, or until such time as the court terminates the automatic stay upon the specific request of a creditor or interested party.