July 21, 2022

When most creditors braced for a wave of business insolvencies at the start of the pandemic, the number of bankruptcies actually dropped. But now, nearly every sign is indicating that a bankruptcy tsunami has begun.

“Over the past few years, many default models overestimated credit defaults,” wrote Martin Zorn, president of Kamakura Corporation a SAS Company (Honolulu), in a recent press release. “Part of the reason was government policies that distributed huge amounts of cash to consumers and businesses alike. We are now entering a period of correction and a reset of correlations. This reset will impact macroeconomic relationships, asset correlations and volatility, challenging portfolio managers and credit underwriters.”

The number of companies with a default risk between 1% and 10% increased in June, and those with a default probability of over 20% also increased slightly, according to the Kamakura Troubled Company Index. Of the 20-riskiest-related firms measured by the index, half were in the U.S.

“The Kamakura expected cumulative default models have been flashing cautionary signals for quite a while, and short-term default risk rose this month. … Defaults have been at multi-year lows, and some investors may have fallen into the same trap of complacency,” Zorn wrote. “Once the credit cycle turns, it is too late to adequately adjust your portfolio.”

Other experts are seeing warning signs that an increasing number of companies are in financial distress. Jonathan Friedland, Esq., partner at Sugar Felsenthal Grais & Helsinger LLP (Chicago) created the Chapter 11 Bankruptcy Alert System. At the beginning of the year, the alert system remained fairly quiet. But in recent months, the list of companies filing for Chapter 11 has gotten longer and longer.

“It appears to be a fairly broad-based phenomenon with no one particular industry impacted,” he said. “This seems to be completely industry agnostic. Right now, we are in the perfect economic storm that will drown companies already on the margin.”

Friedland expects Chapter 11 bankruptcies to increase for at least another year. But other types of bankruptcy filings and forms of corporate distress also are on the rise. “Regular Chapter 11 filings are up, but so are sub-Chapter 5s, and ABCs or Article 9s,” he explained. “What we are seeing today is a direct result of the rise in interest rates. When the Fed increases rates to combat inflation, the effects are not seen right away, so the full impact has yet to be felt.”

Moody’s raised its corporate default expectations from 3.3% to 3.7% this month in anticipation that the U.S. Federal Reserve rate hikes will “dampen consumer demand and erode corporate profits,” per The Times. “While corporate defaults were low in June, global credit conditions have turned more negative,” Moody’s wrote. “We expect credit conditions to tighten further for the rest of the year, driven by rising borrowing costs.”

Delays on construction projects are as common as shells on the shore. They can arise from contractor fault, owner fault or events beyond either party’s control—or any combination of these. Contracting parties contemplate the possibility of delays, and often include contract language to address them—sometimes with clauses precluding a contractor from any monetary compensation for delays, even owner-caused delays.

Such “no-damages-for-delay” clauses can take various forms, but they typically limit a delayed contractor (or subcontractor) to extensions of time for performance in the event of delays beyond the contractor’s control. While such time extensions may help avoid assessment of liquidated damages, they put no money into the contractor’s pocket for what can often be devastatingly expensive consequences of being on the job longer than anticipated.

Because freedom of contract is an overarching principle in the law, courts generally enforce no-damages-for-delay clauses. Still, contracts excusing a party from liability for the harm he causes have never been favorites of the courts, which have been willing to entertain exceptions to the enforceability of such clauses. While New Hampshire has yet to tackle this question, most jurisdictions refuse to enforce no-damages-for-delay provisions in certain circumstances, such as “if the delay: (1) was of a kind not contemplated by the parties, (2) amounted to an abandonment of the contract, (3) was caused by bad faith, or (4) was caused by active interference,” Peter Kiewit Sons’ Co. v. Iowa Southern Utilities Co., 355 F. Supp. 376, 397 (S.D. Iowa 1973).

Several states even have statutes disallowing such clauses. Ohio’s statute, for example, declares that any clause in a construction contract “that waives or precludes liability for delay...when the cause of the delay is a proximate result of the owner’s act or failure to act, or that waives any other remedy...when the cause of the delay is a proximate result of the owner’s act or failure to act, is void and unenforceable as against public policy.” R.C. 4113.62(C)(1).

The “active interference” exception to enforcement of no-damages-for-delay provisions dovetails nicely with New Hampshire's longstanding rule that "if it can be shown that the performance of the contract was prevented directly or indirectly by the act of the promisee, its non-performance will be excused,” Famous Players Film Co. v. Salomon, 79 N.H. 120, 122 (1918). No bad faith need be shown. And the modern trend elsewhere is that “a plaintiff contractor or subcontractor claiming active interference on the part of the defendant owner or contractee need only to show that the defendant committed an affirmative, willful act that unreasonably interfered with the plaintiff’s performance of the contract, regardless of whether that act was undertaken in bad faith.” Tricon Kent Co. v. Lafarge North America, Inc., 186 P. 3d 155, 161 (Colo. App 2008).

One example of active interference is issuance of a notice to proceed before the jobsite is ready for the contractor’s work. U.S. Steel Corp. v. Missouri Pacific Railroad, 668 F.2d 435, 439 (8th Cir. 1982). After commencement, suspension of work by the owner beyond the time reasonably justifiable can likewise overcome a no-damages-for-delay clause—regardless of other contract language affording the owner a right to suspend. Sarasota County v. Southern Underground Industries, Inc., 333 So.3d 285, 288 (Fla. App. 2022).

Indeed, schedule and sequencing changes have been found to justify an award of delay damages even in the face of other contract provisions giving one party the right to dictate progress and sequence of the other party’s work. J.J. Brown Company, Inc. v. J.L. Simmons Co., Inc., 2 Ill. App.2d 132, 140, 118 N.E.2d 781 (1954). (“The provision of the subcontract giving defendant the right to direct the sequence or general progress of work does not release it from liability for delay. It implies an obligation on the part of the general contractor to keep the work in such a state of forwardness as to enable the subcontractor to perform within a limited time.”)

The common thread here is that owners must give their contractors (and contractors must give their subcontractors) a fighting chance at timely performance—and if they interfere with that chance, a no-damage-for-delay provision likely won’t save the day.

Days sales outstanding (DSO) is deteriorating for one-third of U.S. companies across all industries, according to the Atradius Payment Practices Barometer. As a result, many businesses are setting tighter payment terms for B2B customers and buying trade credit insurance for added protection.

“We found a focus on the policy of offering discounts for early payment of invoices, as well as far more regular credit checks on customers,” the report reads. “Some companies polled set aside funds to cover bad debt losses, although this had a downside risk of potentially hurting growth. The value of having credit insurance cover was widely reported.”

Compared to the last survey, 25% more companies set shorter payment terms for customers, with businesses in the agri-food sector setting the tightest payment terms to try and convert overdue invoices into cash. According to the survey, half the total value of B2B credit sales is unpaid on the due date.

The deterioration in DSO can be linked to the ongoing impact of the pandemic, supply disruptions, inflation and rising interest rates. But late payments also are a result of “administrative inefficiencies in the customer payment process, according to 48% of companies polled in the U.S., and this was a particular issue in the chemicals industry,” per the report. “Another frequently reported reason for payment default, especially in the steel/metals sector, was the financial weakness of customers. This helps to explain the increased alertness to customer payment default reported by 70% of businesses in the steel/metals industry.”

Businesses are taking the following proactive steps to mitigate further credit risk:

• Setting aside funds to cover potential losses
• Purchasing trade credit insurance
• Outsourcing payment issues
• Giving more attention to credit checks

Despite these findings, companies still expressed a generally positive outlook for the future of B2B credit. 78% of companies “expect an improvement [in] B2B payment practices and also a strong expansion of trading on credit,” the report reads. “This is because they consider customer loyalty and repeat business from established B2B customers, as well as the desire to win new business domestically and abroad, to be the driving force behind business growth.”

However, 62% of companies are still concerned about the further deterioration of their DSO. “The anxiety is triggered by the interplay between adoption of a more liberal credit policy and lower efficiency of their credit management process.”

Credit professionals’ worries don’t stop with DSO, however. The top five concerns for business profitability in 2022 are:

1. Matching rising demand
2. Addressing the impact of the pandemic
3. Rising inflation
4. Falling demand for products and services
5. Maintaining adequate cash flow

If you are interested to learn about the different ways to measure DSO, and the pros and cons of each calculation, download NACM’s newest white paper: Keep DSO in Its Place.

There will always be a place for individual geniuses—for the lone wolves, the rogues, the nonconformists. But as the benefits of collaboration become clearer, individuals are sometimes at a disadvantage. In other words, these days, innovation is a team sport.

“There’s more and more to know in the world, and you can only have so much in your head,” explains Ben Jones, a Kellogg strategy professor. “So, the share of stuff you know as an individual is declining in any field.” This makes it critical to collaborate with others in order to push a project into new territory—whether that project is cutting-edge science or innovative customer service. But what does a collaborative workplace look like in practice? And how can leaders get there? Here’s what Kellogg faculty have to say.

1. Design a Collaborative Workplace

   Want more collaboration? Encourage people to work together—as in, quite literally, the same physical spaces. Perhaps you’ve heard about how companies like Pixar have designed their headquarters to encourage chance encounters, such as making bathrooms centrally located.

   “They were very intentional about wanting people who are artists and animators, and the coders, and the music people, and the screen writers to be constantly bumping into each other in random ways to spark ideas,” says Jones. He explains that not every interaction is going to lead to a home run. But that’s okay. “It creates the greater probability of creating some interactions where you’re like, ‘Hey, wait a second, we should talk.’”

   Don’t have millions to spend on a new office complex? Worry not. A regular bagel breakfast or afternoon happy hour can accomplish much the same thing.

2. Build the Right Teams

   Of course, not all collaboration emerges from spontaneous conversations over bagels. Often managers deliberately assign specific team members to a certain project. Should you find yourself in this position, here are a few important insights about teams to keep in mind:

   For one, know that bigger and smaller teams each have their pros and cons. Bigger teams are great for projects that build upon earlier work. That’s because these projects tend to require a lot of expertise, manpower and political oomph to gain traction. But smaller, more agile teams are better equipped to come up with novel or experimental ideas. For instance, if you wanted to make a drastic change to your company’s operations, you might put a small team in charge of this change. “Then, if it actually works, you can spread it to the entire company,” says Dashun Wang, an associate professor of management and organizations.

   Second, don’t make the all-too-common mistake of undervaluing your specialists. We have a natural tendency to compare people against one another—putting specialists, who excel in one area but might perform poorly in others, at a disadvantage. Think of it this way: Do you want five competent generalists on your team, or four competent generalists and one mediocre worker who absolutely excels in a niche area? On average, that fifth generalist might be the better employee. But as a team, you may be stronger with the specialist.

   Finally, consider unusual pairings. Specifically, you may want to pair someone with a very unique or unusual background with someone else whose background is more conventionally aligned with a project. This can create that perfect blend of novelty and conventionality that Jones and Brian Uzzi, a professor of management and organizations, call a “virtuous mix.” Says Uzzi, “People who bring together expertise from different domains may be an essential feature of progress.”

3. Set Some Ground Rules for Collaboration

   So you’ve got your team in place. How will you structure your time together to get the most benefits? “One of the biggest mistakes that leaders of new teams make is that they say something like, ‘our rule is that we have no rules,’” says Leigh Thompson, a professor of management and organizations. She explains that this approach tends to backfire. Rather than giving teams autonomy, it creates paralysis, as everyone waits for everyone else to take charge.

   Thompson suggests creating a charter—a document that identifies, ideally in just a sentence, the team’s goals and who is responsible for what. “Teams that develop a charter end up being nimbler, having more proactive behavior, and achieving their goals more than teams that don’t bother,” she says.

4. Reward Consistent Contributors

   Effective collaboration requires cooperation. And people who cooperate most effectively with each other have one thing in common: a consistent contributor. “The consistent contributor looks for the collective good first and personal good second,” said the late Keith Murnighan, a longtime Kellogg professor of management and organizations. These are the people who tend to initiate cooperation, leading the way for others to follow suit.

   Research by Murnighan finds that the actions of a consistent contributor can alter the dynamics of the entire group, making everyone more cooperative. The research also finds that consistent contributors seem to know when their contributions will have the most impact—and offer more when the stakes are highest.

   When everyone is suspicious of everyone else, assuming they will hoard resources or put their own business unit first, it can become a self-fulfilling prophesy. But “in a larger group, if someone consistently acts as a friend, it’s easier for others to act as friends and everyone benefits,” as Murnighan put it. So should you find yourself in a collaborative workplace that has no consistent contributor, consider playing that role yourself.

5. Know Which Tasks Could Benefit from Collaboration

   Of course, it is important to keep in mind that sometimes there is a downside to collaboration, such as a loss in productivity. This was the finding in research from operations professor Jan Van Mieghem and then–Ph.D. student Lu Wang. Their study investigated collaboration among medical professionals—specifically, what happens when the doctors in charge of a patient (hospitalists) confer with specialists. They find that these consultations—regardless of how medically necessary—slow hospitalists’ productivity by about 20%. “It’s not that any of these physicians are just sitting back and being on Facebook or reading the newspaper. They’re continuously busy,” says Van Mieghem. “But being busy may increase interruptions. At the end of the day, being busy may not equal being productive.”

   It is important for managers to understand the potential costs of collaboration when deciding whether a given task should be distributed among many employees, or whether an individual really should keep it in her purview.

Reprinted with permission by Kellogg Insight.