In the News

May 28, 2020

 

There is always some sort of risk for credit professionals when a credit application comes in or the salesperson knocks on the door with a new customer. The risk of nonpayment for goods and services rendered is always at the back of a creditor’s mind no matter how nice and clean a transaction looks on paper. Even cash in advance can get tricky if there happens to be a bankruptcy. So, in the world of credit, nothing is 100%. The only permanence this year as in previous years, according to Benjamin Franklin, will be death and taxes.

COVID-19 has taken all that would previously have been called a sure thing and turned it upside down. The light at the end of the tunnel is approaching for some, as states begin easing regulations and reopening. However, that does not mean the coronavirus is gone. While some businesses will be able to rebound quickly, others will take years to recover, if at all.

No matter the industry, credit professionals are in the business of being paid for the extension of whatever it may be that is offered on credit terms. Some industries, because of their nature, have relatively short payment terms, e.g., food, but some sectors such as construction are known for having delays in payment. And, COVID-19 is only making the delays worse.

With every cause, there is an effect and with every action there is a reaction. When a raindrop or a rock breaks the surface of a pond, there are ripples that impact the ecosystem. The same goes for payments in the construction industry. One item out of place can cause a ripple effect, growing in magnitude as it expands.

In NACM’s recent webinar, “Life After COVID-19: Contract and Practical Considerations,” presented by Seth Robbins, Esq., of Robbins Law Group, PLLC, he spoke of problems and solutions. New to the vocabulary for many during the last several months, social distancing is causing quite a stir for construction projects. Social distancing wasn’t given much thought prior to COVID-19 by credit professionals, or anyone for that matter, but it has infiltrated projects on a grand scale. The new reality is that there are additional costs to manage projects—cleaning, quarantining, social distancing, said Robbins. The workforce and deliveries are among the biggest impacted by social distancing policies.

Making a change to the contract is a way to combat the rising unforeseen costs moving forward and to help mitigate risks. Changing or adding contract language can help if certain disclaimers, provisions and clauses are used correctly. Working in price acceleration and escalation clauses as well as bid disclaimers can help credit professionals better prepare for uncertainty as well.

It’s also important to continue to do due diligence up front when signing new contracts to get as much information as possible. This is done most of the time regardless, but “it’s now even more valuable,” Robbins said. Projects and products must be managed and monitored more closely than ever.

Robbins also noted mechanic’s lien and bond claim rights should not be ignored. “Don’t give up on lien and bond rights. Mechanic’s lien rights are extremely important … [since] you may not be collecting as soon as you thought.” Just because credit terms are extended or additional credit lines are given, doesn’t mean credit departments are going to get paid. “You need to make sure you’re protected downstream. Projects are going to deal with bankruptcies. You’re in a much better position if you have a lien in place … [going] from a general unsecured creditor to … hopefully getting paid out of contract proceeds for that project.”

 

 

It has been more than three months since COVID-19 appeared in the U.S., and the challenges are never-ending. Many schools are transitioning to online learning, thousands of businesses remain closed, and a lot of the workforce is working from home. Some sectors, such as construction, operate in a gray area as projects are either moving forward, postponed or canceled. This requires material suppliers to stay on their feet to help their customers, while also maintaining their own operations.

Unlike the Great Recession of 2008, recovery from COVID-19 will be quite different for the nonresidential construction industry, said Associated Builders and Contractors (ABC) Chief Economist Anirban Basu in Construction Executive magazine. Although certain businesses, particularly in the medical field, will see increased activity, others, like construction, will see a decline.

“Complete recovery from the recession will likely take years,” Basu said in Construction Executive. “One of the reasons for this is that state and local government budgets are now under severe pressure. With retail sales, hotel and income tax revenues declining, many state and local governments are now experiencing the emergence of massive gaps in their budgets; budgets that must be balanced each fiscal year. There will also be many empty storefronts, fewer occupied apartments and office suites, and a diminished tally of employers available to jobseekers once the pandemic has passed.”

Bob Majerus, vice president and general counsel for Hensel Phelps, told Construction Dive that even after the pandemic passes, projects will still take longer to complete. Instead, he noted, “there will be a ramp up” as well as “new safety regulations, new [personal protection equipment] and new safety orientations.”

In a chain reaction, material suppliers are most likely to see sales decrease and payments trickle in due to project delays and cancelations. Beth Roush, a credit manager in the construction industry, said her company has experienced slower customer sales but has created incentives to get current customers to take material now rather than later—a benefit to both the customer and material supplier.

“Only a few of my customers have asked for extended terms or have tried delaying payment,” Roush said. “Each time, we have managed to get them back online within our terms. What I feel will change [post-coronavirus] is maybe not accepting some new customers and not increasing credit limits with current customers.”

When asked about any advice she would offer fellow construction credit professionals, Roush summed it up in one word: monitor.

“Try and give your customers notification ahead of time that they will be going past due and on hold,” she said. “It’s been working here. Make sure if you have multiple divisions that you’re all treating past due customers the same way. Show a united front and we will get through this.”

 

 

As business shutdowns related to the COVID-19 crisis continue to wreak havoc on supply chains across the globe, companies responding to supply chain disruptions will find that their obligations, rights and remedies largely depend on specific language in their contracts. A carefully crafted (or renegotiated) contract and an appropriate, timely response when issues arise can help you avoid or mitigate insolvency issues within your supply chain. Here are some considerations.

What does the contract say about when and how you can terminate it?

Critical in responding to disruptions caused by a crisis is understanding the contract terms between you and your suppliers and customers. You must first identify key provisions that may be relevant during a crisis, particularly the termination rights governing who may terminate the contract, when and why.

Most contracts contain one of two types of termination rights: for cause or for convenience. Termination for convenience (without cause) gives you the ability to terminate a contract at will, effectively creating an option to end the contract for any or no reason. Termination for convenience clauses are rare because they create uncertainty and are more likely to be invalidated by a court if illusory or without consideration. Far more common are termination for cause provisions, in which termination is triggered by specifically identified events or circumstances that harm the terminating party or alter the transaction’s nature. Termination for cause provisions usually apply equally to both parties.

Review contracts for clauses that create a right to terminate for COVID-19-related issues. A termination clause may provide you with the right to terminate if your customer fails to buy goods at an agreed quantity or if your supplier fails to timely deliver conforming raw materials. However, your right to terminate is not necessarily automatic. Depending on the contract, you may be required to provide the customer or supplier with notice and an opportunity to cure.

The contract may also specify which remedies and damages are available to you. For example, an exclusive supplier agreement may enable you to enter into a relationship with another supplier if the breaching supplier fails to satisfy minimum purchase/supply quantities.

Can you negotiate or adjust payment or credit terms?

If you have entered into long-term contracts, consider developing strategies to protect yourself against the risk that a customer or supplier may face financial difficulties and file for bankruptcy. You can build terms into contracts that will protect you if a customer or supplier faces pre-bankruptcy financial strain.

One to consider is tightening credit terms. You may require collateral, third-party guaranties and/or letters of credit. To be even more cautious, you may monitor the customer’s or supplier’s financial condition and even require periodic credit opinions.

You can also establish a cash-on-delivery (COD) payment arrangement, also known as “cash on demand” or “collect on delivery.” In this arrangement, a customer agrees to pay for the goods at the time of delivery. The contract can specify that a COD arrangement is triggered if the customer fails to comply with the negotiated payment terms.

Another type of protection is requiring payment in advance of amounts due or payment of additional fees. Advance payment terms can be mandatory or optional, either requiring or permitting a party to pay some or all amounts due prior to the other party’s performance or before their due date. Naturally, advance payment provisions can be an effective way to reduce the risk of nonpayment.

If you are concerned that a customer is experiencing financial difficulties, what can you do?

Once a customer files for bankruptcy, you lose your right to issue invoices for shipments and collect debts that pre-date the bankruptcy filing. Fortunately, the Uniform Commercial Code (UCC) provides some protections before a customer files for bankruptcy. For example, under UCC § 2-609 you may be able to demand adequate assurance in writing that a buyer can perform under the contract, such as a letter of credit or other document demonstrating the customer’s ability to pay or perform. You may also be able to suspend your performance until you receive the assurance you request, which can allow you to review and amend your contract and potentially reconsider the credit line extended to the buyer. Review your contracts before a customer becomes insolvent or declares bankruptcy so you can determine how best to mitigate potential damages before they occur.

Does the contract require you, a supplier or a customer to maintain insurance or provide indemnification?

Review contracts with suppliers and customers for insurance requirements and indemnity clauses. Many customers and suppliers carry insurance policies that might apply to mitigate financial losses you suffer due to their COVID-19-related breaches or performance issues. In fact, the contract may require that they maintain insurance coverage. The types and levels of contractually required insurance coverage generally depend on the nature of the parties and the contract itself. While some insurance covenants are general and require only “sufficient insurance coverage,” others might specify types and levels of coverage, such as commercial general liability, workers’ compensation or an umbrella policy. Likewise, the contract might obligate a supplier or customer to indemnify you if their breach causes you to breach your obligations to third parties.

If you believe you may be entitled to insurance coverage or indemnification for crisis-related risks from supply chain partners, you should request and review copies of the relevant policies—not just certificates of insurance—and assess potential coverage. Of course, you must also ensure that carriers are on notice for claims under any even potentially applicable policies or agreements.

Similarly, evaluate your own potential contractual insurance-related obligations to provide insurance coverage or indemnification to supply chain partners for risks related to the COVID-19 crisis. Carefully identify and review insurance policies that may provide coverage for slowdowns and stoppages of your business or your suppliers’ or customers’ businesses or liability to third parties

As COVID-19 continues to negatively impact supply chains, parties should carefully review their contracts and consult with counsel about any uncertainties.

Reprinted with permission from Thompson Hine, a full-service business law firm.