May 11, 2023

Bankruptcies remain top of mind as commercial Chapter 11 and Subchapter V filings have increased significantly over the past few months. Small business Subchapter V’s increased 81% year-over-year in April and commercial Chapter 11 filings were up 32%, per Epiq Bankruptcy.

“The substantial year-over-year increase in Subchapter V elections reflects statutory developments that took place last year,” the article reads. “The $7.5 million debt eligibility limit established by the CARES Act of 2020 (and renewed annually by subsequent laws) sunset in late March 2022 back to the $2,725,625 level established by the Small Business Reorganization Act of 2019, which led to a drop in Subchapter V elections in April and May 2022.”

And the rebound in business insolvencies is picking up speed, according to a report from Allianz Trade. The Global Insolvency Index is expected to jump by +21% in 2023. “In the U.S., we expect an increase of +49% in 2023 as a result of tighter credit conditions and the sharp slowdown, which will mean a return to 20,000+ insolvencies per year,” the report reads. “Even without a major financial crisis, a credit crunch of the magnitude seen in the early 2000s during the tech bubble burst would lead to 12,900 and 95,300 additional insolvencies over 2023 and 2024, respectively.”

The number of U.S. companies that have gone bankrupt so far in 2023 is higher than the first four months of any year since 2010, data from S&P Global Market Intelligence showed. A recent eNews poll revealed that 40% of credit professionals have seen an increase in the number of customers filing for bankruptcy in the last year.

“We’ve seen some slowdowns and there’s been some talk they’re reviewing credit limits to see if they need to be reduced for slower paying customers,” said Kimberly Howard, senior manager of credit services at Seafax, Inc. (Portland, ME). “For smaller companies struggling to begin with, the monetary tightening might be the final straw.”

Credit professionals must remain vigilant as bankruptcy filings are expected to continue increasing. “As a credit manager, we must be cognizant of where we would be if our customer was unable to pay their obligation,” said Jeff Gregory, CCE, credit manager at Helena Agri-Enterprises, LLC (Collierville, TN), who has seen an increase in Chapter 12 and Chapter 7 filings. “It is important to get an idea of their assessable net worth and their ability to convert assets to cash quickly to pay their obligations. We must recognize that bankruptcy is a real possibility if there is no assessable net worth available.”

Struggling companies have resorted to pulling from their cash reserves, but those have dwindled as pandemic-era stimulus ended. “Last summer and early fall, we started to see tremors in the economy and cash reserves dwindling,” said Justin Kesselman, partner at ArentFox Schiff LLP (Boston, MA). “There was a buildup of cash during the stimulus period and reduced cost incurrences during the pandemic that a lot of companies were able to reserve cash. But with interest rate hikes, we started to see more aggressive lender positions and less willingness to finance ongoing losses.”

Other professionals believe the increase in bankruptcies will continue but not as vigorously as the recession of ’08. They continue at a larger rate than we saw in 2021 and 2022, said Brian Jackiw, partner at Tucker Ellis LLP (Chicago, IL). “It’s not a tidal wave by any means, but the increases in bankruptcies will continue.”

The retail industry has been highly impacted by bankruptcies with large, well-known companies such as Party City, Mall of America and Bed Bath & Beyond filing recently. But according to a report by Allianz Trade retail isn’t the only sector hurting.

Macroeconomic factors such as the recent interest rate hike to 5.25% and rising cost of food are adding financial distress to companies. The CPI for all food increased 0.1% from February 2023 to March 2023 and food prices were 8.5% higher than in March 2022, per USDA. In the restaurant industry, food costs have gone up substantially. But unless businesses are able to maintain those costs and gain more foot traffic, revenue and margins may decline.

Not to mention the banking crisis that has tightened the banking sector, making it more difficult for companies to get loans. The looming potential of a debt-ceiling issue and debt default by the U.S. government adds a more wide-ranging impact on businesses that are already in financial distress.

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

Cash flow is the backbone of every business. Supply chain financing is just one tool available to companies to get paid faster in a volatile economy.  

Supply chain financing, also referred to as reverse factoring, supplier finance or buyer-driven receivables finance, is a financial arrangement that helps optimize the cash flow in a supply chain by providing early payment to suppliers. It is a collaborative solution involving the buyer, supplier and a financial institution.

In a typical supply chain financing arrangement, the buyer (often a large company) partners with a financial institution (such as a bank) to offer its suppliers the option to receive early payment for their outstanding invoices. Instead of waiting for the agreed-upon payment term, suppliers can choose to sell their invoices to the financial institution at a discount. The financial institution then pays the supplier the discounted amount, providing them with immediate working capital.

Costs are based on the credit standing and finance rates of the buyer rather than the borrowing rates of the seller. The process aims for both buyers and sellers to have control over cash flow and sense of collaboration rather than negotiation.

How Does It Work? If a supplier needs cash quickly, they can request an immediate payment at a discounted rate from a company’s bank. If the request is accepted, the bank will issue a payment to the supplier—extending the payment period for the company for an additional 30 days. Supply chain financing can give a buyer the opportunity to ask the supplier for extended credit terms without an increase in its total financial costs.

What Are the Benefits? Supply chain financing can help accelerate the flow of payments. From a credit perspective, it can be a useful tool to improve overall DSO and can lower disputes, said Shaun Papperman, CCE, CCRA, CICP, director, order fulfillment at Baltimore Aircoil Company, Inc. (Jessup, MD). “From a vendor’s perspective, inserting a third party means additional transaction costs,” Papperman added. “Generally, we found when we wanted to move our vendor base to supply chain finance, it costs more but was also a great way to extend days payable outstanding. Depending on what your goals are, there is a tradeoff between profitability and capital.”

Potential Downsides. Many large corporations have moved to 90- or even 120-day terms. The alternative is to accept a supply chain finance program to get paid sooner, said Janet Elliott, financial services manager at Werner Electric Supply Company (Appleton, WI). “Of course, you don’t want to accept 120-day terms,” Elliottt said. “As a distributor, we are stock our inventory in bulk, which cuts into our cash flow because we don't get paid for it right away. By the time we create a sale and sell it, that cash flow could be a total of six months you’re tying up with the company’s cash resource.”

Supply chain financing is usually based on market-variable rates—which can challenge some companies to reduce their sales discounts. “You could be paying anywhere from 1-2% to take an early payment program through supply chain financing,” said Elliott. “If my goal is to try to reduce sale discount, it is difficult to do while using supply chain finance and figure out the best option for my company.”

What Creditors Should Consider. If a seller uses its accounts receivable as collateral for financing, a release from its existing lender may be required to participate in a supply finance program. The release removes all value of the receivable from the collateral of the seller—which can potentially reduce its borrowing availability.

Many banks have started to restrict credits, said Dev Strischek, principal of Devon Risk Advisory Group, LLC. “Some suppliers are finding they’ve got less credit which impacts their ability to finance sales of goods to their customers,” said Strischek. “Both suppliers and purchasers rely on bank financing to the extent that banks are getting stingier. The impact is very high because your suppliers can only finance with as much credit they have.”

Although banks are not the only source of credit, it can become more of a challenge for suppliers and customers to find the credit they need in order to enter a supply chain financing agreement. Creditors should be aware if they are the primary, secondary or tertiary supplier, said Strischek. “One of the problems of supply chain finance is when customers have either choice, it depends on the supplier’s ability to get there on time,” he added. “The risk of running out of inventory is much higher.”

And considering some of the largest banks have failed this year, it is important for credit professionals to make sure they understand all transaction costs on the front end, said Papperman. “Keep an eye on how interest rates are calculated, how often they change and how invoices are submitted and approved,” Papperman added. “Do due diligence on the front end and it will save a lot of surprises.”

To learn more about supply chain financing, be sure to sign up for NACM’s Global Thought Leaders discussion on Wednesday, May 17.

Automation and development of Artificial Intelligence (AI) have started to integrate into day-to-day processes of credit and collections—modernizing the profession. It is not the complete replacement of a human, but rather a tool to help ease manual labor. What we know so far is that AI can cut down manual processes from hours to minutes.

Despite the many benefits of AI, a recent eNews poll revealed more than half of credit departments (56%) are not likely to implement AI into their credit and collections processes compared to only 6% that are currently leveraging AI.

Ways Creditor Professionals Implement AI

On one hand, AI has transitioned seamlessly into the credit and collections process. In fact, AI can be integrated into several credit processes such as:

• Credit hold releases and holds on accounts
• Customer collection priority queues
• Demand letters
• Scorecards in credit applications
• Invoice copy requests
• Cash applications
• Terms and conditions
• Customer identification and payment portals

A recent case study from Atlas Credit showed loan approval rates nearly doubled while decreasing risk losses up to 20% using AI machine learning models, per Experian. Any tasks done manually can become more flexible in terms of how much labor is put into the task. AI can also provide a wider range of comprehension of all data gathered on a regular basis. For example, automatic reminder notices to customers before invoices are due, or using new data gathered based on credit ratings.

“We as creditors are always asked to do more with less,” said Scott Chase, CCE, CICP, global director of credit at Gibson Brands, Inc. (Carthage, NC). “The time-saving process AI can provide is the number one item in a credit function to be able to take away the extras of daily compiling and other tasks that eat up your time in a given day.”

Some companies are just starting to leverage AI into their credit processes. Natalie Pearson, regional credit analyst II at TTI, Inc. (Fort Worth, TX) said she’s not sure how AI will progress, but customer responses is the main use of the technology. “We sort customer responses to assigned categories to better manage our time and tailor our responses to customers,” Pearson said. “I think there’s an element of risk but if credit professionals can partner with AI using it as a tool rather than relying on it for everything, it would be the best way to use it.”

Concerns of AI potentially replacing jobs has increased mainly in tech-based industries. The most recent example is IBM’s CEO, who plans to replace nearly 7,800 job positions with AI over a five-year period, per Axios.

But luckily for the credit industry, human interaction is highly depended on, said Jason Torf, Esq., partner at Tucker Ellis LLP (Chicago, IL). The gut feeling of a creditor cannot be programmed into software. “AI is largely dependent on computer programming and algorithms rather than what a human can do,” said Torf. “The human element of decision-making is instinctual. It is especially important when it comes to emotional intelligence needed to maintain personal relationships with customers.”

Could AI Test Legal Boundaries?

As AI becomes increasingly advanced, businesses must clearly define what processes can and cannot use AI-assistance. From a legal perspective, AI could potentially have a negative impact in the credit industry because customers may be at a higher risk of defaulting, said Torf. “Bad credit decisions could be made due to relying on AI rather than manual work due to the process not being as robust.”

For example, issues with terms and conditions gathered for a credit application can occur due to using AI to gather accurate information. This can impact the legal landscape because it will become more difficult to collect. “If AI algorithms aren’t programmed quite right, you run the risk of missing key parts that a human would be able to detect in order to allow you to collect more easily down the road if a customer defaults,” Torf said. “It impacts a company’s ability to recover and collect if there’s a customer default due to faulty terms and conditions that could be avoided if done from a human mind.”

Not only could AI impact credit policies, terms and conditions, but companies could inadvertently violate laws and regulations related to credit and debt collections. For example, discrimination in credit-granting decisions can go undetected in an AI system. If you base your credit decisions on an AI algorithm, a company could inadvertently walk itself into violating laws and regulations.

For creditors, the future is shaped around how to use AI technology to be more efficient and productive at our job, said Jonathan Chandler, CBA, CICP, senior credit analyst at Wonderful Pistachios Almonds (Bakersfield, CA). “You need human help to prompt AI technologies in order to tailor your company’s needs,” Chandler said. “Asking the right questions and programming the system will help us better generate reports, avoid any mistakes and process information a lot faster.”

Join NACM’s virtual Technology Thought Leaders discussion to learn more about technology in the commercial credit space.

Over the past decade, lien waivers have evolved from a half-page, fill-in-the-blank form, to a lengthy legal document. But now, creditors have more trouble tracking what's been waived per project and some lien waivers are misleading and demand concessions. This, along with changes in statutory state laws, makes it all the more important that creditors refine the lien waiver process to ensure payment can be made once the work is complete.

A Quick Refresher

A lien waiver is a document provided to the owner of a property stating the creditor has received all payment and gives up the right to impose a lien on the property. Lien waivers are used as a payment affirmation conduit for all parties in the ladder of supply beginning at a title company, a property owner, a general contractor (GC), a subcontractor and ends at a material supplier. A lien waiver is similar to a receipt and can prevent a mechanic's lien from being filed. As stated earlier, however, varying state laws and other circumstances can affect lien waivers.

Changes in Statutory State Laws

Over the past few years, lien waivers have become statutory forms with specific required verbiage extracted from the state's mechanic's lien statute; forms you must be able to produce. There have been recent statute changes in states like Texas, Georgia and California in which they’ve added statutory language requiring specific lien waiver forms designed to protect suppliers and laborers. But failing to produce lien waivers that are statutorily compliant can lead to litigation and delay payment. Often, paying parties don't want to cut a check until a lien waiver has been signed. The sooner a lien waiver enters the business relationship, the faster payment can be made once the work is complete. 

How Can Creditors Keep Up?

To solve this problem and to assist with the management of lien waivers, NACM's Secured Transaction Services division has created a Lien Waiver Manager. This online tool is free for NACM members to produce a lien waiver that’s statutorily compliant to their state and manage the waiver process altogether.

From the STS Lien Waiver Manager, you'll be able to create, print and manage all these state specific statutory Lien Waivers, merging project data from the STS system, on a national basis. Users will be able to load project information in the MLBS system, then merge, print or reprint statutorily compliant partial, final, conditional and unconditional waivers.

It’s separate from maintaining and enforcing your lien rights, it’s a component of it, said Chris Ring of NACM’s Secured Transaction Services. “But when somebody is presented with some of these lien waivers or they need to produce a waiver, they just need to ensure they’re statutorily compliant.”

The Lien Waiver Manager is very user-friendly. “I love that it is extremely easy to use, auto-populates and is to the point concerning legal language,” said Jean David, credit manager at Conklin Metal Industries (Atlanta, GA). “You also can type in information directly onto the form and print it out. All you have to do is sign and get it notarized.” It also saves creditors time when a customer waits until the last minute to request a lien waiver.