April 13, 2023

Speculation of the U.S. dollar’s decline has stemmed from recent news of China’s shift to yuan in commodity trades with several other countries on board. Many argue the demand for dollars will plummet, causing value to drop as well—but economists believe the dollar going from the most dominant global currency to being worth little-to-no value is unlikely.

This comes as tension between the two countries mount. “Recently, China has quarreled with the United States, claiming several times that a U.S. destroyer has operated in its territorial waters around the South China Sea,” reads an article from Reuters. “The United States and Philippines are also currently holding their largest joint military drills over shared concerns about China's assertiveness in the Asia-Pacific region.”

Here’s a history lesson for context: In 1979, the U.S. and China began trade relations creating a massive boom in trade over the next four decades to come, worth billions of dollars annually. In fact, the U.S. imports from China more than any other country, with China being one of the largest export markets for U.S. goods and services. The value of U.S. goods rose from nearly $100 billion in 2001 to $500 billion in 2021, largely due to China’s presence in global supply chains.

What is the impact? The dollar’s reserve currency status gives the U.S. economic and political strength on a global scale. China’s gross domestic product of $1.77 trillion is second to the U.S., and is the third largest trading nation in the world—right behind the U.S., per Bloomberg News. Last year, leaders in China announced they wanted to boost the renminbi and yuan’s status up to a reserve currency—and now need other foreign central bankers to transition to the yuan in order to put their plan in motion.

“If you look at global trade now, only 2% is dealt in yuan, which is very little,” said Fred Dons, director and head of CTF flow Netherlands at Deutsche Bank (Amsterdam, NL). “Russia is trading in Chinese renminbi (RMB) and yuan with China because they have to and there’s no alternative.”

One of Dons’ treasurers in Moscow said the yuan is indeed his biggest currency trade that is currently dealt with, but on a global scale. “It’s still so little and most of the trading parties don’t want to deal with yuan because you can only spend it in China,” Dons added. “The dollar is very stable as a global currency. Historically, there have been successful attempts switching to renminbi, but that success only lasted for a year in terms of percentages before fading away because of its limits in most markets.”

With the U.S. economy being the largest in the world, most major commodities are traded in dollars. And foreign exchange markets come into play from a perspective of needing to pay local workers in their prospective countries. They have to be paid in their local currency, as each country has their own central bank. “When you talk about de-dollarization it’s not as simple as flipping a switch and moving to another currency,” said Gabe DiGiorgio, vice president of global trade services at U.S. Bank (Overland Park, KS). “I think it depends on how transparent the particular currency is in terms of being able to build a sense of trust behind how the currency is managed.”

From a credit perspective, most companies will be affected through their receivables. For example, if your sales department decides to sell with a foreign currency, they must have a general idea or strategy around repatriating that money into their local currency and making additional profit on the sale. Otherwise, your company could potentially lose profit on that sale due to the exchange rate. “There’s ways to hedge these kinds of risks,” said DiGiorgio. “You must have a strategy around how you manage that from a credit perspective. If you are in a treasury department of a large multinational company, you must have a strategy around how you’re managing your cash around the world, the currencies it’s in and how you bring all of that together.”

Join DiGiorgio on April 25 to learn more about international banking. Register now and reserve your spot!

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Bankruptcies are on the rise again, a trend tracing back from December of last year. In March, new bankruptcy filings registered year-over-year increases across all major filing categories in the U.S. for the third month in a row, according to data from Epiq Bankruptcy. In fact, 42,368 new bankruptcies were filed in March, up 17% from the 36,068 filings registered in March 2022, marking the highest number of monthly filings since April 2021.

Most notably for trade credit professionals, year-over-year commercial filings were up 24%. Chapter 11 cases (including Subchapter V) surged 79% compared to March 2022. Of the total commercial Chapter 11 filings, the 140 Subchapter V filings in March represented a 12% increase from the 125 filings in March 2022, per Epiq Bankruptcy.

“The increase in bankruptcy filings in the first quarter of the year demonstrates the growing debt burdens of both consumers and businesses,” said ABI Executive Director Amy Quackenboss. “As inflationary prices have increased in tandem with the cost of borrowing, struggling companies and households have access to a financial reprieve through the bankruptcy process.”

The rise in private bankruptcies has been around eight per week, which indicates that there’s a “rising stress in small- to mid-size enterprises (SME) relative to your large bold-bracket firms,” Matthew Mish, UBS, told CNBC. This is an indicator for future credit stress because SMEs no longer have fiscal policy support and have substantial floating-rate debt from high interest rates and less funding options.

Why It Matters

The surge in commercial bankruptcies is largely the result of the Fed’s rate-hike campaign, per Axios. “When money gets more expensive and lenders get pickier, the number of companies cut off from rescue capital soon rises,” reads the article. “Another measure of corporate distress—default rates—rose to 2% of outstanding U.S. leveraged debt in February (the most recent available), according to S&P Global.”

How to Protect Yourself as a Trade Creditor

One way to guard your company against additional risk from bankruptcies is by joining a creditor's committee if your customer actually files. The Bankruptcy Code authorizes the U.S. Trustee to appoint an official committee of creditors with large unsecured claims to pursue and protect the interests of unsecured creditors at large. Serving on the committee can be a highly valuable experience for a creditor, but must be undertaken with a clear understanding of the corresponding responsibilities.

But finding people to fill creditor's committees has become more difficult. “Trade creditors are not being active enough or joining committees because they don’t feel like they should be allocating resources into committee membership,” said George Angelich, partner at ArentFox Schiff LLP (New York, NY), who co-leads the creditor’s committee practice at his firm. “Instead, committees are being heavily tilted in favor of landlord interests.”

The different groups that may comprise a committee are trade creditors, landlords and employees, all with a common interest of getting paid as an unsecured creditor. However, some may have an interest in accessing and promoting the provisions of the Bankruptcy Code that might maximize payments for their constituency. “It’s important for there to be balance on committees in order to ensure that the rights of all groups, parties and constituencies within the general unsecured creditor’s class are protected and treated fairly,” said Justin Kesselman, partner at ArentFox Schiff LLP (Boston, MA).

The lack of participation in committees has resulted in administratively insolvent cases, which means that trade creditors are not only getting zero payment for their pre-petition claim but they are not getting paid in full for their post-petition products and services. “The thought that you’re assured to get paid your post-petition amounts, continuing to do business with the debtor can no longer be assumed,” Kesselman said. “If trade creditors not only join committees but are active and vigilant, then they can get far superior results not only for their pre-petition claim but also for protecting their rights post-petition.”

Join Angelich and Kesselman on May 23 for a webinar about serving on an official committee of unsecured creditors. Register now to reserve your spot!

Trigger words are terms and phrases in construction contracts that heighten risk during a B2B transaction. Credit professionals must pay close attention to these trigger words to avoid additional costs, payment delays or nonpayment on a project.

#1 Mandatory Arbitration Clause

Litigation is a lengthy process that often delays payment, which is how mandatory arbitration clauses came to be. Mandatory arbitration declares that the parties will not litigate if a dispute occurs, such as a breach of contract or business dispute. Instead, the parties agree to arbitration to resolve the dispute but can be costly to creditors.

“You have to abide by the arbitrator’s hourly rate and hours of operation,” said Emory Potter, partner at Hays & Potter, LLP (Peachtree Corners, GA). “If the arbitration isn’t taking place at one of the lawyer’s offices, you have to pay for the other location and hourly by room.”

To save time and money, creditors should include a mandatory mediation clause, where both parties agree to mediate a dispute before resorting to litigation. Mediation does not require counsel, court fees or enforce strict deadlines. Or, they can add a voluntary arbitration clause, where both parties agree to go to arbitration, and creditors can set their own terms and hire their own arbitrators.

#2 Pay-if-Paid (PIP) and Pay-When-Paid Clauses

A term that is well known in construction, pay-if-paid clauses, state that the general or prime contractor’s payment obligation to pay downstream subcontractor claims are triggered only, if and after the receipt of payment in full from a higher-tiered contractor or owner for the lower-tiered subcontractor’s work. This means if the debtor is not paid, the creditor isn’t either. This can cause payment delays and lead to litigation, which is costly in itself.

Similarly, pay-when-paid clauses allow a general contractor or a subcontractor to pay lower-tier subcontractors and suppliers only after payment is received from the party with whom they are contracting. “Pay-when-paid clauses can impede prompt payment through no fault of a subcontractor or supplier,” said Steven Hopkins, CCE, CCRA, regional credit manager at North Coast Electric Company (Seattle, WA). “It can be viewed favorably by the general contractor, but lower-tier contractors may find this clause to be a hindrance to prompt payment.”

#3 Reasonable Time for Payment

Reasonable time for payment (RTP) is the timeframe for when a debtor is obligated to pay the creditor in the absence of agreed payment terms. For example, pay-if-paid is allowed under the Texas Contingent Payment Law, but can be voided under certain circumstances. In this case, the contractual terms of pay-if-paid are no longer enforceable and the general contractor (GC) is obligated to pay the subcontractor within a reasonable time (default new payment terms).

But the problem arises because a specific timeframe is not identified in the statute. In many contracts, RTP is defined as when the GC has exhausted all remedy in pursuing payment with the project owner, which could take years.

#4 Damages to Work

The costs of consequential damages and liquidated damages could be excessive through no fault of the creditor. Consequential damages result from performance or completion delays on a construction project, which eventually lead to a breach of contract. This means that if a project is not completed on time, the property owner can lose revenue. In this case, the property owner could file a lawsuit against the construction company in an attempt to recoup their losses.

Liquidated damages are a type of consequential damage that refers to the sum of cash that a party must pay if they breach a contract. The owner can include a provision that lets them obtain a specific amount of money if the construction company violates the contract and bails on them.

These damages impede on what is called the critical path in a construction contract, “the longest path (in time) from start to finish; it indicates the minimum time necessary to complete the entire project,” per Harvard Business Review. If the critical path is disrupted, creditors are left recouping what’s been lost through those damages. Thus, creditors should limit consequential and liquidated damage clauses to the value of the contract to save money.

#5 Lien Rights/Unconditional Lien Waivers Prior to Payment

A mechanic’s lien is a guarantee of payment to builders, contractors and construction firms that build or repair structures. Lien rights also extend to material suppliers and subcontractors and cover building repairs. The lien ensures that workers are paid before anyone else in the event of a liquidation. But many states don’t allow creditors to waive their lien rights before a construction job.

Lien waivers are documents that waive or release the right to lien, usually in exchange for payment. They are legally enforceable, so it is important that creditors know what they mean before they sign them. Unconditional lien waivers are provided by contractors or suppliers after they’ve been paid, so signing one prior to payment heightens risk of nonpayment.

“A lot of times, you’ll have a contract that says you waive your lien rights and you want to fight about it,” Potter said. “My recommendation is to talk to a lawyer in the state to find out if that’s applicable at all because why fight over something that is utterly unenforceable?”

#6 Back Charges

A back charge occurs when a general contractor or project owner identifies certain deficiencies in the work or costly damage attributable to a subcontractor or supplier. The cost of the error or neglect is calculated to a dollar amount and then subtracted from payment to the party at fault.

In a federal project, like a highway, mandatory back charges are put in place if the project gets delayed. “They don’t want the road closed any longer than it has to be,” said Ty Knox, ICCE, director of credit and risk at EFCO Corp (Des Moines, IA). “The responsible party can be back charged as much as thousands of dollars each day they’re running behind.” It's important contractors keep an eye on this trigger word to avoid costliness.

#7 Indemnity for Active or Gross Negligence

The purpose of indemnity clauses is to protect a party from third-party claims where the indemnified party is required to pay. Indemnity can protect active or gross negligence, an act showing a severe and reckless disregard for the lives or safety of another person. “It doesn’t matter if you agreed to it or indemnified them,” Potter said. “It’s an intentional tort and you can’t consent to it.”

#8 Extended Warranty

An extended warranty extends beyond completion of the project where the owner makes a claim against the surety for a latent defect, constituting a breach of warranty surviving completion of the project. “You want to make sure that in any contract you sign, the warranty does not give more rights than usual,” Potter said. “If a contract seeks to extend warranty, this may increase risk.”

#9 One-Sided Attorney Fees

One sided-attorney fees are just as they sound, one-sided. One party recovers attorney's fees in the event of litigation but the disadvantaged party is unable to recover them. “These are viewed as a valuable legal resource by some in the construction industry,” Hopkins said. “But an equal number may find it completely non-beneficial or an actual impediment to projects.”

One-sided attorney fees are disallowed in many courts but can be enforced “if only the other party can sue for fees,” Potter said. “It is not a fair contract.”

#10 Design Responsibility

Design responsibility in construction contracts should be discussed between employers to minimize the potential for disputes. If not, contractors run the risk of being uninsured for the design responsibility where the standard for assessing their performance under the contract is in excess of reasonable skill and care.

Creditors must make an explicit reference to the plans in the beginning of the documentation. “I look at the first three pages of the blue prints,” Potter said. “You want to make sure you’re relying on the general representations and not the specific representations.” The general requirements an architect imposes in the beginning can be very different from what they draw later in specific areas of the plan.

Are you a construction credit expert looking to network with others in your industry? Sign up for NACM’s virtual Construction Thought Leaders Discussion groups. The next meeting is scheduled for April 18.

Last month’s collapse of Silicon Valley Bank (SVB) saw the first real test of the new bankruptcy procedures put in place for financial institutions under Dodd Frank igniting a new debate on whether the system is working and potentially opening the door for renewed conversation on broader bankruptcy reform.

The Federal Reserve is currently conducting a holistic review of how this was allowed to happen, which they will release on May 1, but here is what we know now:

November 2021: The San Francisco Federal Reserve issued six warnings to SVB, identifying several areas of concern that they needed to address. This is typically the first step before the Fed takes escalating enforcement action against a bank.

May 2022: The Fed issues another three warnings, identifying issues with the management of the bank as well as inadequacies in their internal stress testing processes.

Summer 2022: The Fed lowered the bank’s rating to "fair," limiting its ability to grow through acquisitions.

November 2022: The Fed issued another warning, specifically citing SVB’s interest rate stress tests as inaccurate.

February 2023: Prior to the Fed raising interest rates to further combat inflation, the risks to institutions including SVB were explicitly reviewed and provided to Board members.

In hindsight, SVB’s rapid growth and reliance on riskier uninsured deposits should have and in fact did present red flags for regulators. Despite these indicators, the precipitous and unchecked failure of SVB forced the FDIC to take SVB into receivership under Title II of Dodd Frank to prevent further systemic risk to the nation’s banking system.

Within a week of SVB’s collapse, SVB Financial, the parent holding company under which SVB was an asset, filed for bankruptcy in New York in order to protect its remaining assets from FDIC clawback. In a series of hearings in both the Senate and the House on March 28 and 29, lawmakers on both sides of the aisle largely agreed that both bank management and bank regulators are at least partially to blame for the failure of SVB. Where they diverged was frequently on the question of whether new regulations were necessary or if regulators needed to make greater use of the tools already at their disposal.

After SVB Financial declared bankruptcy, President Biden issued a statement calling on Congress to increase regulations and stress testing for banks the size of SVB and provide new authority for the FDIC to clawback bonuses, salaries and stock buy-back funds from the executives of failed banks.

While somewhat unique to the banking industry, the concept of clawbacks is well known in bankruptcy. The question remains whether this issue will remain firmly in the financial services industry or if it will gain traction more broadly. Notably, SVB Financial filed for bankruptcy in New York, potentially limiting the ability for impacted Californians to be heard and increasing calls for bankruptcy venue reform.

The Federal Reserve is set to finalize its report on the collapse of SVB on May 1, 2023 and consensus has yet to be reached on what needs to be done to prevent similar situations in the future. Still, it has opened the proverbial can of worms and with Members of Congress jockeying for political space to legislation on the topic. We could see new proposals in the both Chapter 11 and Chapter 13 bankruptcy space based on SVB’s situation.