In the News

September 26, 2019

High-Margin Firms Benefit from Trade Credit

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New Bankruptcy Law to Change Chapter 11 Filing for Small Businesses

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SMB Creditors at Risk for Data Breaches If Not PCI Compliant

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California Subcontractor Loses Case for Prematurely Recording Mechanic’s Lien

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High-Margin Firms Benefit from Trade Credit

Business-to-business (B2B) payments can often be delayed with no repercussions for the buyer if they pay beyond the originally agreed upon invoice date. The B2B world is similar but different than the consumer world, where, if a credit card or mortgage payment is missed, the consequences are harsh.

According to the “SMB Receivables Gap Playbook: The Business Impacts of Trade Credit” from PYMNTS and Fundbox released earlier this month, there’s $3.1 trillion suspended in accounts payable and accounts receivable in the U.S. alone. “Long payment periods and late payments have thus become systemic parts of the economy,” stated the Playbook, which organized companies by how long they have been in business and margins to analyze trade credit and its impacts on businesses. The study used more than a thousand completed responses of the nearly 5,000 total responses collected.

One of the main findings was high-margin firms (25% to 75% margin) benefit most in regard to trade credit and payments. These businesses are able to extend credit more readily, and by doing so, can better manage cash flow as well as attract new customers and keep current ones. High-margin businesses are also more generous in offering terms, resulting in taking on higher risk. A majority of both high-margin and low-margin firms (losing money–25% margin) state trade credit is a challenge due to the risk of late payment and the amount of money that is locked up in accounts receivable.

“[D]elayed payment on a single, large contract could have catastrophic consequences for smaller and younger companies … missing payroll or being unable to purchase critical supplies,” the study stated.

Established (in business 11-plus years), high-margin firms extend payment terms of just north of 40 days on average and receive payment terms of more than 32 days. On the other end, early-stage (one to five years in business), low-margin firms extend payment terms of more than 25 days; however, they are only offered terms just shy of 24 days, resulting in a very small window for error or late payments. Established, low-margin firms have the most time (10 days) between average terms extended and received.

Intermediate (in business six to 10 years), high-margin firms are the most affected by late payments, nearly four in 10 reported customers paying late. Early-stage, low-margin firms were the least impacted by late payments, with less than a quarter of respondents mentioning the issue.

High-margin firms value acquiring new customers by extending trade credit. They also use trade credit to increase volume order and encourage repeat customers. Meanwhile, low-margin firms believe the greatest benefit of extending trade credit is staying competitive.

The biggest challenge for businesses was the time and complexity to operate the credit program—54% of high-margin firms reported the negative impact. The risks of late/nonpayment and the amount of money locked up in AR were also issues. Day-to-day operations were the most affected specific business aspects impacted by trade credit. Also named were employment, purchasing and capital expenditure.

“[High-margin firms] offering credit to B2B customers allows them to expand their clientele and production,” the Playbook stated. While these firms often reap the benefits of offering trade credit, they are also vulnerable to higher risks and late payments.

—Michael Miller, managing editor

New Bankruptcy Law to Change Chapter 11 Filing for Small Businesses

Chapter 11 bankruptcy is frequently referred to as a “reorganization” bankruptcy that usually involves “a corporation or partnership.” In other words, companies are given a second chance to stay in business by reorganizing to repay creditors over a set timeframe. For small businesses, the Chapter 11 process becomes tricky because of certain hurdles that have made it more difficult for small business debtors to successfully reorganize. These hurdles include the complexity and expense of the Chapter 11 process and other hurdles that discourage small business debtors from filing Chapter 11. However, on Aug. 23, the U.S. government came one step closer to easing the process for small businesses.

After its introduction in late 2018, the Small Business Reorganization Act of 2019 (SBRA; H.R. 3311) was signed into law by President Donald Trump in August and will take effect Feb. 19, 2020. The Wall Street Journal previously reported the law was introduced to “make the Chapter 11 bankruptcy process cheaper and faster for companies that file for protection with about $2.5 million or less in debt.”

According to the American Bankruptcy Institute (ABI), a supporter of SBRA, the new Subchapter V is expected to “reduce liquidations, save jobs and increase recoveries to creditors while recognizing the value provided by the entrepreneur.”

“SBRA ensures that small businesses will be able to reorganize and rehabilitate their financial affairs effectively under the Bankruptcy Code,” ABI Executive Director Samuel J. Gerdano said in a press release. “With proper planning and execution, the Small Business Reorganization Act enables financially troubled small businesses to emerge from bankruptcy within months following a court-approved plan of reorganization.”

Small businesses make up a significant portion of overall business bankruptcy filings—80% to 90%, according to an article in Bloomberg Law. Small business status would be available to debtors with liquidated and noncontingent secured and unsecured claims totaling not more than $2,725,625. Under SBRA, each case will be handled by a trustee with powers similar to the powers enjoyed by Chapter 12 and 13 trustees. No creditors’ committees will be appointed in small business cases, but there will be additional fees and expenses.

SBRA also changes the treatment of administrative expense claims, such as post-petition trade credit. Unlike other Chapter 11s where all unpaid administrative expense claims must be paid when due or on the effective date of a Chapter 11 plan, in small business cases, the debtor can stretch out payment of administrative expenses over the term of the Chapter 11 plan. SBRA streamlines the Chapter 11 process for small business debtors by requiring the debtor to file a plan within 90 days of the filing (deadline can be extended by the bankruptcy court), dispensing with the requirement for approval of a separate disclosure statement and voting on the plan as part of the Chapter 11 plan process.

Finally, SBRA eliminates the absolute priority rule that applies in other Chapter 11 cases, which would otherwise preclude the debtor’s principal from continuing to own the business where unsecured creditors vote to reject a Chapter 11 plan that provides for less than full payment of their claims and the owner fails to put up sufficient new value to retain ownership. SBRA replaces this requirement with the more lenient requirement that the small business debtor’s Chapter 11 plan must provide for the debtor’s distribution to unsecured creditors of all projected disposable income earned over the three- to five-year period following court approval of the plan.

SBRA provides for changes to the preference statute that may benefit trade creditors. A trustee bringing a preference action must, as part of his or her burden of proof, show that the trustee has conducted “reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under Section 547(c).” This change will hopefully discourage the practice of trustees basing their preference claim on payments indicated in the debtor’s check or other payment records. SBRA increases from $13,650 to $25,000 the minimum amount of claims where a trustee must commence a lawsuit against non-insider creditors in the venue where the defendant “resides” and not where the bankruptcy case is pending. This could apply to preference and other avoidance claims and will hopefully discourage the commencement of lawsuits to collect small preference claims.

Bruce S. Nathan, Esq., contributed to this article. Bruce is a partner in the New York office of the law firm of Lowenstein Sandler, LLP, practices in the firm’s Bankruptcy, Financial Reorganization and Creditors’ Rights Group, and is a recognized expert in trade creditors’ rights and the representation of creditors in bankruptcy and other legal matters.

—Andrew Michaels, editorial associate

SMB Creditors at Risk for Data Breaches If Not PCI Compliant

As technology advances and fraudsters adapt to changing security measures, the more difficult it becomes for creditors to combat any attempts at security breaches. Small- to medium-sized businesses (SMBs) remain at an arguably higher risk: They have less access to resources and were the victims of 43% of online security incidents in 2018, according to PYMTS. The credit department directly interacts with procuring payments, making creditors a main line of defense against data breaches.

Last year, 42,000 online security incidents took place—according to PYMNTS—despite the awareness that already exists about phishing and fraud methodology. Cybersecurity company AppRiver said the average cost of a data breach for an SMB sits at $149,000, even though most SMBs estimate a breach costing as little as $10,000.

“Cybercriminals continue to be creative in their attacks, turning their attention to industries such as manufacturing to retail, and using cloud technology and software like common mobile apps to their advantage,” said President Nathan Stallings of Matrix Integration in a statement. “All these threats mean that businesses need to cast a wide net and use a variety of tools to keep their businesses and their customers safe.”

Cyberthreats in businesses manifest themselves across different avenues, but infiltrating digital payments remains a popular method. Cutting down on risk can mean changing passwords for accounts often, being highly critical of emails from customers and avoiding the use of public Wi-Fi for business affairs, but it can also mean being aware of the nuances of PCI compliance.

NACM’s recent webinar titled “PCI Compliance and What Your Company Needs to Do to Get There” looked into the specifics of PCI compliance, breaking down any misconceptions and providing context for how to get companies to be the most efficient and PCI compliant as possible in order to mitigate cyberthreats. 

If a company accepts credit cards, it must be PCI compliant. PCI compliance consists of a set of standards and rules created to ensure credit card companies secure data correctly and consistently across their customer base. This also translates to the actions of staff. For instance, should a creditor jot down credit card information manually on a notepad, the creditor is responsible for destroying the paper. Leaving the number out poses a risk for the customer, which may lead to a breach.

According to a recent survey by Logically, 60% of SMBs would rather forfeit half of their revenue than lose half of their data to a breach. Two-thirds of survey respondents said their companies do not keep up with IT infrastructure to mitigate the risk of data breaches. While it may be difficult for SMBs to invest in IT, working with the IT department and making staff aware of the importance of PCI compliance can help mitigate cyberthreats.

Creditors at SMBs having a strong relationship with customers can also help. Asking customers to never email credit card numbers or leave sensitive information in a voicemail can protect both the customer and the SMB.

—Christie Citranglo, editorial associate

California Subcontractor Loses Case for Prematurely Recording Mechanic’s Lien

California provides three statutorily recognized construction payment remedies: mechanic’s liens; stop payment notices; and payment bond claims. Each is intended to provide payment protections for those who furnish labor, materials and services on a construction project. However, each is different in important ways.

One of those differences has to do with timing. Specifically, when the statutory payment remedy may be used by a claimant. Stop payment notices can be served at any time during a project even before a claimant has completed its work. However, mechanic’s liens may only be recorded and payment bond claims may only be made after a claimant has completed or ceased performing its work.

In Precision Framing Systems, Inc. v. Luzuriaga, Case No. E069158 (August 29, 2019), the Fourth District Court of Appeal examined whether a subcontractor had prematurely recorded a mechanic’s lien and, thereby, was prevented from filing a lawsuit to foreclose on its mechanic’s lien.

Precision Framing Systems, Inc. v. Luzuriaga

Precision Framing Systems, Inc. was a framing subcontractor on a veterinary hospital project in Wildomar, California. Precision’s scope of work was to supply and install trusses on the project. Precision hired Inland Empire Truss, Inc. for the fabrication of the trusses.

In late July 2013, Precision started working on the framing. Later that month, Inland delivered the trusses to the site. And by the beginning of August, Precision began installing the trusses. Shortly after the trusses were installed, the city issued a correction notice stating that “[t]russ bearing points are not per plan.” Precision notified Inland and Inland carried out some repairs.

In early December 2013, the city issued a second correction notice. A walk through of the project was conducted between Precision and the general contractor, and the general contractor found that Precision’s work was complete and fully in compliance with the plans and specifications. The city later approved the framing work.

However, Precision never received full payment for its work. The project owner, Deborah Luzuriaga told the president of Precision that “she was not interested in paying Precision and told [him] to sue her.” He did.

On January 2, 2014, Precision recorded a mechanic’s lien in the amount of $53,268.16. That same month, the Luzuriagas changed the locks on the building, locking all contractors out. Precision later met with project architect and building inspector and, at this meeting, learned for the first time of additional correction notices.

Luzuriaga took the position that Precision’s mechanic’s lien was premature because it had not yet completed its scope of work and, in particular, had not corrected its work as required by the outstanding correction notices. A site inspection was conducted and, in mid-February 2014, Inland performed additional repairs. The repairs took two to three hours.

Precision later filed suit to foreclose on its mechanic’s lien. During pendency of the case, the Luzuriagas moved for summary judgment on the ground that Precision’s mechanic’s lien was prematurely recorded because it was recorded before it had ceased its work in February 2014. The trial court agreed and Precision appealed.

The Court of Appeal Decision

The Court of Appeals began by citing the mechanic’s lien statute, specifically, Civil Code Section 8414 which provides:

“A [mechanic’s lien] claimant other than a direct contractor may not enforce a lien unless the claimant records a claim of lien within the following times: (a) After the claimant ceases to provide work; (b) Before the earlier of the following times: (1) Ninety days after completion of the work of improvement, or (2) Thirty days after the owner records a notice of completion or cessation.”

The Court of Appeals, noting that Precision’s subcontract required that Precision supply and install “trusses … necessary to complete the … project,” held that the repairs performed in February 2014 were part of Precision’s “work” and that because Precision had recorded its mechanic’s lien in January 2014, it had done so prematurely.

The Court of Appeals also explained that the fact that the general contractor deemed Precision’s work to be complete is irrelevant, since the scope of Precision’s work was established by its contract not by “the factually unsupported legal opinion of two witnesses.”

Finally, explained the Court of Appeal, while “it may seem unfair to hold that [Precision] recorded its claim prematurely” when “it did not know that it had any work left to do” that the Court had “not found any case law suggesting that a claimant’s subjective knowledge or belief as to whether it has ceased to provide work is relevant” and further that “nothing in the Mechanic’s Lien law prohibited [Precision] from recording its claim again after the repairs were prepared.”

Conclusion

Timing issues related to mechanic’s liens typically arise as to whether a mechanic’s lien was timely recorded rather than whether a mechanic’s lien was prematurely recorded. Precision Framing is a cautionary tale for contractors, subcontractors, suppliers and equipment lessors that they can get caught not only by mechanic’s lien deadlines, but also by the premature recording of a mechanic’s lien.

The case does raise some concerns though, as the earliest time a mechanic’s lien can be recorded and the deadline by which a mechanic’s lien can be recorded are both based on the date of completion or cessation of labor. They are, in short, part of a larger whole, and can’t be viewed in isolation. Most lien claimants, in order to not get caught having recorded a mechanic’s lien past the statutory deadline, view completion as not including repair or punchlist work.

Reprinted with permission.

Garret Murai. Esq., is a partner and construction attorney at Wendel Rosen LLP in Oakland, California. He is the chair of the firm’s Construction Practice Group and editor of the firm’s California Construction Law Blog which can be found at www.calconstructionlawblog.com.