Magazine article Business Credit

Chapter 11s on the Rise: Red Flags and Steps to Protect Your Credit Sales

Magazine article Business Credit

Chapter 11s on the Rise: Red Flags and Steps to Protect Your Credit Sales

Article excerpt

A record number of bankruptcies for businesses are being reported. Enron filed the largest Chapter 11 ever, with billions in assets and liabilities. Kmart followed, being the largest retailer to file, with assets and liabilities in the billions and 2,100 stores. The notion that a company is simply too large to file Chapter 11, as the company would be rescued by creditors or the government, is gone. Whether it is a local business suffering a downturn in business, or a public company with a billion dollars in assets, Chapter 11, the reorganization chapter of the Bankruptcy Code, is on the rise. The causes for the spike in Chapter 11 filings are varied. September 11 has been cited by companies as both a direct and indirect factor. Bank financing, bond offerings and IPOs are significantly down, making it difficult for customers to borrow. Commercial insurance premiums are soaring. Revenues for many companies are significantly down, resulting in missed payments to vendors.

A credit professional must pay close attention to existing customers, and scrutinize the financial ability of new customers to spot red flags of insolvency. To the credit professional never exposed to an economic downturn, a customer's bankruptcy may seem to appear with little or no warning, especially with the long-term customer that paid within credit terms. What are red flags that a credit professional may identify indicating that a bankruptcy may be in the offing? What steps can a credit executive take to protect open account sales in this environment, more than simply restricting credit or insisting on COD or CIA?

Many Reasons for Filing

Chapter 11

A customer may file Chapter 11 for a variety of reasons, such as to stay creditor collection actions, pare down pre-bankruptcy vendor debts, dispose of certain assets, renegotiate or reject leases and reposition itself in the marketplace.

Insolvency Not a Condition to Filing Chapter 11

The credit professional finds that the corporate customer unable to meet its debts seeks refuge with a Chapter 11 filing to stay creditors from collecting on their delinquent accounts. However, the Bankruptcy Code does not require a customer be insolvent to file bankruptcy. Indeed, Chapter 11 has been used by companies to shed burdensome leases, sell assets and deal with mass litigation, such as asbestos claims. The stigma of Chapter 11 seems to have disappeared, and companies that file for Chapter 11 view it as another tool to achieve a business objective.

Where the Debtor Files:

The Delaware Train

A credit professional may be surprised to find that a large, local corporate customer located, say, in Portland Oregon, files for Chapter 11 in Delaware (or New York). Major companies often can choose to file for Chapter 11 in a number of jurisdictions, most commonly where they are incorporated, have their headquarters or have major operations. This allows for the company with operations primarily in Oregon, but incorporated in Delaware, to file in that state. Of course, local vendors sense that the Delaware locale is chosen, in part, to make it inconvenient for them to be active in the proceeding. It also allows the company to find a forum more favorable to their interests. In recent years, Delaware's caseload was so heavy that it started importing bankruptcy judges to help.

Some creditors have objected to the forum shopping, complaining to the bankruptcy judge that Chapter 11 should proceed where the majority of creditors are located. In the Enron Chapter lls, creditors located in Houston filed a motion to have the bankruptcy cases transferred from New York to Houston, as the majority of the creditors are located in Houston. The bankruptcy judge in New York handling the cases declined the creditors' request to change venue.

Liquidation Versus Reorganization

As the number of bankruptcies of public companies increase, these companies are increasingly forced to liquidate and sell to the highest bidder instead of reorganize. …

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