Magazine article Business Credit

Watch for Financial Problems and Know How to Safeguard Your Business

Magazine article Business Credit

Watch for Financial Problems and Know How to Safeguard Your Business

Article excerpt

A company that works with suppliers, customers and other business partners facing financial troubles needs to be prepared to handle the consequences of others' fiscal problems. Knowing the signs of distress and taking defensive actions early can help strong companies avoid problems, and be better positioned in the case of a significant event, like a business partner filing for bankruptcy. A working knowledge of a handful of key principles, particularly those that apply in bankruptcy, can go far toward effective strategic planning.

Critical Information

Being aware of a partners financial problems is a critical first step to a company strategically protecting itself, especially when that partners problems ultimately lead to bankruptcy. Closely monitoring relationships with suppliers and customers-particularly payment patterns from customers-is essential. A company that has good reason to be concerned that a counterparty will not meet its obligations can employ certain state laws to require the struggling partner to show it has the ability to meet its commitments. Seeking letters of credit or alternative payment terms or security interests can be an opportunity for a financially sound company to better position itself.

A supplier can recover goods sold to an insolvent buyer under certain circumstances both before and after a bankruptcy. After filing for bankruptcy, a debtor can recover certain payments, so creditors should be on the lookout for key information that can help prevent return of those payments. And finally, knowing how a bankruptcy would affect an existing contract is valuable information for a company trying to make smart business decisions.

In addition to staying abreast of news and facts that are readily accessible to a company through both public and internal sources, outside counsel can provide valuable information. Many major law firms subscribe to and monitor data and news services providing information not just on legal developments that affect clients, but also on debt markets, restructurings and bankruptcy filings. These resources can provide vital clues and insights for companies on current conditions, anticipated future developments within their own industries and other helpful information.

Trouble on the Horizon?

After becoming aware of a business partners financial troubles, a quick and strategic response can put a company in a strong position to protect its rights and interests. Requiring assurances from the partner that it will meet its obligations under an existing contract, shoring up unsecured debts by seeking pledges of collateral and understanding bankruptcy's effects on certain kinds of contracts are just some of the strategies available.

When a company has a reason to feel insecure that a counterparty to a contract will fail to meet its obligations under that contract, one of the available options is to require the financially shaky party to demonstrate its ability to perform, and if it cannot, then let the financially sound party terminate the contract early. More specifically, the financially sound party can make a so-called "demand for adequate assurances" under the relevant state's commercial laws of the Uniform Commercial Code.

The demand for adequate assurances can only be made under the right circumstances-when there are "reasonable grounds" to believe the financially shaky party will not perform its obligations under the contract, and when an "objective factual basis" exists to feel insecure. That is to say, if there's concern a supplier will not provide promised goods or services, or that a customer will not pay its bills, the financially sound company can make a demand for adequate assurances. Courts analyze these situations on a case-by-case basis; no single formula or easy checklist exists to help determine whether the financially sound company meets the requirements to demand assurances. Remember, a demand for adequate assurances is different from a dunning letter-it's a right allowed by state law and is more than simply a demand to be paid. …

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