Magazine article Business Credit

Preventive Measures to Avoid Bankruptcy Risk

Magazine article Business Credit

Preventive Measures to Avoid Bankruptcy Risk

Article excerpt

For most unsecured creditors, a corporate bankruptcy filing spells disaster. Bankruptcy has increasingly become a vehicle for controlled auctions by Chapter 11 debtors that primarily benefit their banks. Unsecured creditors face the prospect of recovering only a few cents on the dollar.

In this climate, it is worth taking a few minutes to review possible strategies for increasing your chances of repayment on a commercial credit account. This article attempts to provide a few options for obtaining greater certainty of payment. It also outlines new bankruptcy remedies that may increase recoveries by unsecured creditors. Finally, this article briefly reviews the changes to the Bankruptcy Code, which may increase a creditor's chances of walking away from bankruptcy preference liability.

How Can A Commercial Creditor Avoid The Risk Of A Customer's Bankruptcy?

When you are unable to obtain payment in cash, several strategies may greatly increase your chances of getting paid. They include the following:

Obtain A Letter Of Credit

One of the best methods to gain certainty of payment is to obtain a letter of credit from the account debtor's bank. A letter of credit is a written agreement to pay money that involves three parties: (1) an account party (the debtor); (2) an issuer (typically, a bank); and (3) a beneficiary (the creditor). The central characteristic of a letter of credit is the absolute obligation of the bank to honor a draw on a letter of credit property presented by the beneficiary creditor.

Even if the account debtor rites a bankruptcy petition, the beneficiary of a letter of credit (the creditor) can took directly to the issuer of the letter of credit (the bank) for immediate payment. The bank's obligation is independent of any underlying obligation or transaction between the beneficiary and the bank's customer (the account debtor). Neither the letter of credit nor its proceeds are property of the debtor's bankruptcy estate.

Letters of credit are not appropriate for every transaction. However, you should consider them in significant transactions where the other party's ability to pay in the event of default is in question.

Obtain A Purchase Money Security Interest

Another strategy that may be effective for sellers of goods is obtaining a purchase money security interest (PMSI) in the goods they sell. If the buyer is witting to grant the seller a PMSI, following a few simple steps will ensure priority in payment. (1)

First, the seller must obtain an agreement signed by the buyer granting the seller the right to a security interest in the goods and the right to file a financing statement.

Second, the seller should file a financing statement with the secretary of state in the jurisdiction in which the buyer is "located" Under the revised Uniform Commercial Code, "a registered organization that is organized under the taw of a state is located in that state." In other words, if you are selling to a buyer, which is a corporation, limited partnership or limited liability company, which is organized in Delaware but its principal place of business is in New York, you file in Delaware. The financing statement is a relatively simple form to complete.

Third, after the seller has obtained a list of secured creditors who have made UCC filings against the assets of the buyer/debtor, the seller must provide those secured creditors with a notification of its security interest. A PMSI provides the supplier with priority in payment over all other creditors to the extent of the value of the goods.

Obtain A Third Party Guaranty

When obtaining collateral or a letter of credit is not possible, you should consider obtaining a guaranty from a financially viable third-party. Since guaranties are only as good as the financial position of those who sign them, you should obtain evidence of the guarantor's creditworthiness before extending credit based on the guaranty. …

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