In the News

November 7, 2019

 

The back-and-forth protectionist actions of the U.S. and China have a multitude of impacts on buyers and sellers of all different shapes and sizes. While much of the narrative is how the tariffs and trade war will affect consumers, businesses must also keep a close eye on what each administration is proposing and implementing. The U.S. hardwood industry is one of the many sectors being impacted by the previously announced tariffs.

“My job is made more difficult because of the economic impact in China, caused partially by the tariffs and trade war,” said Andrea Wolfe-Turosik, Director of Credit and Accounts Receivable with Northwest Hardwoods, referring to her position within the credit and hardwood industries. The tariffs have hurt her department, her company and the hardwood industry as a whole. “It’s a trickle-down effect,” she said. “Sales are down, causing receivables to be down, impacting cash receipts, employees, and it just keeps going.” As far as trying to collect, there is a definite change in the way we are doing our day-to-day jobs. The stability of companies in China has changed from what we previously knew. There is higher risk, customers are holding on to their money longer, devaluation of the dollar—making it more difficult for customers to bring lumber in off the docks because funds are limited.”

Companies are concerned and have started buying in smaller volumes, resulting in price drops, increased inventory levels and plant closures—impacting supply and demand. “[Tariffs are] impacting collections across the board. Sales are down because customers are afraid to buy, nervous as to the unknown with the tariffs,” Wolfe-Turosik said. Northwest Hardwoods has recently shut down two U.S. mills, and they’re not the only business impacted. “Hardwood suppliers across the U.S. are pushing higher inventory volumes into the domestic market, just as we are, impacting domestic customers’ cash flow, inventory volumes, etc. With lower sales volumes in China, the impacts to the industry segments such as cabinets, furniture, etc., it makes it difficult for them to generate sales, creating cash flow impacting their ability to pay their suppliers for previous orders.”

U.S. hardwood exports are down nearly $500 million in 2019 compared to the same time period in 2018, according to the mid-year Hardwood Export Report from the American Hardwood Export Council (AHEC). Exports to China are down roughly 40% during the first half of 2019 compared to 2018. “In the 12 months since tariffs on U.S. hardwood were announced (July ’18 to June ’19), lumber exports to China are down $615 million,” according to the report.

Wolfe-Turosik mentioned the trickle-down affect again stating the impact to the markets for “coal, soybean, transportation, shipping lines, foresters, loggers. It’s everywhere.” Finding a place for the product, if it’s not going to China, is the top priority. “Now you have nowhere to put your product; companies are moving to different countries, opening up plants to sidestep tariffs.” One of those countries alleviating some pressure for hardwood manufacturers is Vietnam, which has a market share about a tenth the size of China. Vietnam has seen 14% growth, states the AHEC Report.

While businesses and industries are just trying to find ways to keep their heads above water, credit departments keep churning.

“Credit departments are facing many challenges from tariffs—with fewer orders being placed for China, credit begins looking for other ways to help facilitate the sale and move inventory elsewhere. Domestic markets are being pushed to take more volume, impacting credit limits, exposure, collections. You must really think about putting that product on the water and what will happen when it reaches the receiving port,” Wolfe-Turosik said.

“When you’re selling customers on documentary collection terms such as Cash Against Documents (CAD) or deposits, you have to be prepared for the potential delay in cash receipts due to product sitting at the port longer now,” she added.

Owning and operating a small- to medium-sized business (SMB) comes with its fair share of struggles. Just as one issue is put to bed, another rises up to take its place, often requiring the full attention of the SMB’s accounts receivable and accounts payable departments. As 2019’s third quarter closes, experts are saying some of the most impactful challenges to U.S. SMBs may not only continue in the final quarter, but also show signs of carrying over into 2020.

No. 1: Tough to Get Credit

In September, Pepperdine University’s Graziadio School of Business and Management and Dun & Bradstreet released results for their quarterly survey of SMBs, which saw SMBs having increased difficultly obtaining credit. While the second quarter’s survey showed 56% of respondents struggling for debt financing, recent findings revealed 59% of the 752 respondents had a tough time with financing in the third quarter. The survey also analyzed small businesses separately from midsize businesses, both of which were less successful in obtaining bank loans.

“Twenty-eight percent of small businesses reported success in getting bank loans during the previous three months, down from 31.6% in the second quarter. Midsize companies also had a tougher time, with 75% reporting they could get bank loans, down from nearly 90%,” The Boston Herald reported. “Businesses had more trouble getting bank loans, a sign that financial institutions may be getting cautious amid an economy that has weakened since the start of the year.”

The study suggested banks’ hesitance to lend may be attributed to SMBs low revenue expectations. Despite quarter one and quarter two predictions of revenue gains by 7.5% and 7.3%, respectively, expectations fell shy of 7%.

No. 2: Politics Increase Costs of Business

Since the start of the U.S.-China trade war in early 2018 under the Trump administration, tariff implementation has weighed heavily on U.S. businesses, most recently, “the financial hit U.S. small businesses are suffering as a result of unraveling supply chains,” CNBC reported earlier this month. Out of more than 1,700 small-business owners surveyed by online business-for-sale marketplace BizBuySell, more than one-third said the tariffs are increasing costs of business and 46% admitted to customer loss.

With no end in sight, some small businesses are assessing their options, including 64% saying they would raise prices and 65% saying they would find suppliers elsewhere. CEO Brad Howard, of premier marketplace retailer Trend Nation, told CNBC his company’s costs rose from $800,000 to $1.6 million because of the tariffs. To combat growing costs, the company’s director of product development and global sourcing Joe Haddock added Trend Nation is adopting a “cost-reduction strategy.”

“We have to tell our factory partners that they’re sharing the burden of this with us,” Haddock told CNBC. “We can’t swallow this alone; we’re not able to do that.”

The Federal Reserve cut interest rates for the third time in 2019, now at a range between 1.5% and 1.75%. The rates remain at the lowest since the 2008 recession, where they approached nearly 0%. For creditors, those in manufacturing continue to feel the brunt of the interest rate cuts more than those in retail or other service industries.

The October Credit Managers’ Index (CMI) saw a slight uptick compared to September, but much of the positive news came from the service sector as opposed to the manufacturing sector. NACM Economist Chris Kuehl, Ph.D., said the dip in manufacturing was not “catastrophic,” but it does remain indicative of some slowdown—especially with the looming holiday season, global economic turmoil and the U.S.-China trade war.

“The area that saw the decline [in October’s CMI] was in manufacturing, which is going to be the most sensitive because that’s where people are making decisions about buying machinery and that kind of stuff, and rate cuts would matter more,” Kuehl said. “The fact that they’re already so low is already a factor because nobody is really waiting around for a break when it comes to rates.”

The rate cuts have mostly undone the increases from 2018, according to a recent New York Times article. The national economy remains relatively stable—unemployment sits under 4% and the U.S. dollar “is strong,” Kuehl said, and the most recent job report boasted better than expected numbers given the General Motors strike—meaning the decision to cut rates likely comes from the global economy’s health.

Fed Chair Jerome Powell warned “there’s still plenty of risk” in a statement, referencing challenges related to the U.S.-China trade war, Brexit and national rate cuts in other countries.

These recent cuts have formed a sense of camaraderie among the Fed, according to a recent article in Reuters. The Fed agreed there likely will not be any more cuts in 2019, bringing together formerly opposing sides on the matter. Some members of the Fed remain skeptical—including Boston Fed President Eric Rosengren and Kansas City Fed President Esther George—but a sense of agreement will likely make for a healthier economy for credit managers moving into 2020.

Despite the cuts, the biggest challenge for those in manufacturing rests on the U.S.-China trade war. A “phase one” agreement is being drafted, but until a proper agreement is reached, creditors in manufacturing will continue to be on edge.

“The main thing with the rate cuts is we’re doing it with everyone else,” Kuehl said. “... But if you really want to see the economy recover, knock off the trade war.”

The Michigan Court of Appeals held that an arbitrator’s decision to award a contractor consequential damages on a construction lien claim warranted reversal even under the extremely narrow standard of review for arbitration awards. In reaching its decision, the court made the definitive ruling that a contractor may not assert a construction lien for consequential damages beyond the monetary value of the parties’ contract.

In TSP Services, Inc. v. National-Standard, LLC, the contractor’s scope of work included asbestos abatement, demolition of steel structures and disposal of scrap steel as well as other site restoration work for an abandoned industrial facility. The parties’ contract required payment in installments with an aggregate contract price of $414,950, due upon completion of the asbestos abatement. Notably, the contract did not mention the sale of scrap steel or TSP’s potential profits therefrom as compensation under the contract. This fact was significant in the eyes of the appeals court because the arbitration proceeding focused on the profits from the sale of scrap steel as a major component of the contractor’s scope of work.

Because the project experienced significant delays in permitting, the contractor was unable to begin the steel reclamation work. During the delay, the market price for steel declined dramatically and as a result, the value of the contract was diminished significantly. In response to the declining steel prices, the contractor requested an equitable adjustment to the parties’ contract. At the time the contractor requested the equitable adjustment, only 9% of the available steel had been removed from the project site. When the parties could not reach an agreement to adjust the contract price, the owner terminated the contractor for cause.

However, the arbitrator ultimately concluded that the owner improperly terminated the parties’ contract and committed the first material breach of the parties’ contract. The arbitrator awarded the contractor a construction lien for $782,496.05 and broke that amount out as follows:

• $141,083 on the unpaid invoices under the contract
• $46,557.39 for interest and unpaid invoices
• $391,809 for lost profits on steel inventory
• $33,793 for interest on those profits
• $169,226 in attorneys’ fees

The arbitrator determined that the contractor’s construction lien was valid, and was enforceable against the entire award, including the award for consequential damages for lost profits on steel inventory. Notably, the arbitrator awarded the contractor the full value of all the steel even though the contractor never actually removed the steel from the project site.

Despite the extremely narrow standard of review for arbitration awards under Michigan law, the Michigan Court of Appeals reversed the arbitrator’s award of consequential damages in connection with the lien claim because the value of the lien was nearly double the value of the parties’ contract. In reaching this decision, the appeals court emphasized that under the Michigan Construction Lien Act, the amount of any construction lien cannot exceed the remaining unpaid balance under the contract. See MCL 570.1103(4).

Because the arbitrator approved a construction lien well in excess of the contract value, the award violated the Construction Lien Act. Specifically, the arbitrator approved a lien for $782,469, which is $641,386 greater than the unpaid balance under the contract. According to the appeals court, the arbitrator’s award constituted a clear legal error that would reduce the value of the lien by over $500,000.

In reversing the arbitration award, the appeals court relied upon the Michigan Supreme Court’s decision in Detroit Auto Inter-Insurance Exch v. Gavin, which held that judicial interference with an arbitration award is appropriate where the arbitration award contains a clear error of law that if corrected would substantially change the award. The Michigan Court of Appeals granted interlocutory relief because further proceedings on the lien claim would have only further complicated the issues and lead to multifarious litigation.

In summary, the decision in TSP Services, Inc v. National-Standard makes it clear that consequential damages are not available under the Michigan Construction Lien Act when they exceed the balance of the parties’ contract.

Reprinted with permission.

Scott R. Murphy, Esq., is a partner in the Grand Rapids, Michigan, office of Barnes & Thornburg LLP, where he serves as vice chair of the firm’s Construction Law Practice Group. He is also a member of the firm’s Commercial Litigation practice group, where he concentrates his practice on business torts, contract disputes and securities fraud as well as shareholder oppression claims.