Bruce Nathan, Esq., Partner, Lowenstein Sandler PC, New York, NY, offered advice to credit professionals on how to better position themselves with customers who are facing financial insolvency. Nathan presented his valuable business credit insights during an NACM teleconference Nov. 29, entitled, “Dealing With A Troubled Company: No Need to Cry the Blues.”
Nathan pointed out that when a company becomes financially distressed, unsecured creditors are at the end of the list of creditors who get paid. He offered various ways creditors could better position themselves to enhance their chances of getting paid by a company nearing or in bankruptcy. The first method he talked about was through letters of credit. He pointed out that letters of credit, or LCs, involve three contracts. The first is between the trade creditor and customer or debtor. The second contract is between the debtor and Bank, which issues the LC. And the third contract is the LC itself. “LCs essentially deal in documents,” Nathan said. “If the required documents are presented, the bank has to pay. The issuer has to pay regardless of the situation. That’s the beauty of an LC.” LCs have an expiration date and a specified amount, Nathan noted. He also mentioned that it’s important that the required documents, such as invoices and shipping documents, match exactly how they are described in the LC in order to for the creditor to get paid.
There are two types of LCs. One is called a documentary LC, where the creditor looks to the bank for payment. The other is called a standby letter of credit, where the creditor looks first to the customer for payment, but if the customer defaults, the bank is responsible for payment.
Anther method of helping to bolster a creditors position is a guarantee. Nathan described it as a third party undertaking the credit risk that doesn’t pertain to documents, but is based on facts that there was a payment default. “The third party or guarantor is responsible for payment in the event the creditor defaults.“ He warned against getting a guarantee of collection because before getting paid, the creditor must exhaust all remedies for payment, such as obtaining a judgment. Nathan said to make sure you get a guarantee of payment instead of collection. On the matter of a guarantee based on an individual’s property or other assets, Nathan offered a note of caution about dealing with guarantors who are married and live in community property states. In such cases a judgment on one of the property holders in the marriage is usually not enforceable. He also said to be careful in obtaining the signatures on a guarantee. “You want to make sure the signatures are notarized and witnessed. Make sure the guarantee has a provision for the payment of legal fees.”
In a security interest, Nathan said, “The customer signs a security agreement specifying collateral. It should be signed by the debtor using his correct and accurate legal name.” There are two types of liens associated with security interests—consensual and non-consensual. Nathan noted that consensual liens specify assets, equipment or products sold to the customer that may be used for payment. Non-consensual liens were things such as mechanics liens, which involve certain legal requirements for their perfection. He advised filing a UCC (Uniform Commercial Code) financial statement to protect against other creditors claiming the assets involved in the security agreement. Most of these statements are filed in the appropriate state’s secretary of state office. He said UCC filings usually last five years, but they can be continued. “They can also be amended to reflect a name change of the debtor, for example.” He also said, “You will usually be behind others who have filed before you on the same assets.”
Nathan described a purchase money security interest as one that is applied to the goods a creditor sells to a customer. He noted that this security interest applies only to the inventory of the customer and not to their accounts receivable arising from the sale of the inventory.
Nathan also provided information on setoff and recoupment. He describes setoff as a process of offsetting mutual obligations between a seller and debtor. State law provides setoff rights and in bankruptcy, in order for setoff to occur, you must get relief from the automatic stay. Recoupment, however, does not require relief from the automatic stay. Reclamation was described by Nathan as a legal remedy that allows creditors to get back goods sent to a customer within 10 days of the delivery of a demand letter. The new bankruptcy law has broadened reclamation rights for creditors, Nathan said. Responding to one of the questions from teleconference attendees after his presentation, Nathan said that standby letters of credit do not protect creditors from being subjected to a preference payment action in a bankruptcy case.
NACM teleconferences are an inexpensive way to learn more about topics important to credit executives. For information on future NACM teleconference subjects, go to NACM’s website at www.nacm.org, put your cursor over the “education” circle at the top of the page and scroll down to “teleconferences” or just point your browser to: http://www.nacm.org/education/teleconfs/schedule.shtml.
Source: Bruce Nathan, Esq. and NACM staff writer Tom Diana