Disaster #4 - Customer Bankruptcy
Part 4 of a series: Avoiding Disastrous Debt Interactions
All-business-class airline: great concept, lovely client…until they filed Chapter 11
On June 18, the New York Times reported that "A Tidal Wave of Bankruptcies is Coming." Here's my own experience in dealing with a customer bankruptcy during the last financial crisis:
In 2007, my marketing agency, Customer Growth, took on a new client: an all-business-class airline called Eos, flying between NY and London on Boeing 757s fitted with just 48 seating/sleeping compartments. It was a great concept, and a lovely client, but was, as we say in advertising, “a limited time offer.”
Eos declared bankruptcy on April 26, 2008 and ceased operations just hours later – with no warning to passengers, most staff…or vendors like me. This is fairly common for a private equity owned firm not required to disclose finances to the public.
Eos owed us about $15,000, and I was not expecting to ever see any of it; vendors being low on the bankruptcy totem pole. But to my shock, a couple of weeks later I received a demand from the court appointed administrator to pay back about $50,000 we’d already received over the previous three months.
My attorney explained this was due to something called a “preference period” in bankruptcy law: the administrator can clawback payments made in a 90-day window prior to the filing (1 year for creditors who are also company insiders) for redistribution to the entire pool of creditors.
This is intended to promote fairness, i.e. to prevent collusion between a debtor and a favored creditor, but it can be abused by bankruptcy administrators, because – you see – the more cash they can clawback, they more they have in the pot to siphon off for their fees.
My lawyer explained the defense is to demonstrate the payments were made contemporaneously to product or service delivery during the normal course of business. In other words, I wasn’t cutting in line before another creditor to collect a legacy debt.
I had a good case here: the prior fees were for work done in designated 30-day billing periods documented in our contract and supported by timesheets. But, my attorney explained, fighting this in court would lead to legal fees that could be nearly as high as the amount being demanded by the administrator. Better to negotiate a settlement with the administrator, he advised
And here’s when I got one of the best pieces of legal advice ever: “You should call the bankruptcy administrator yourself. As your attorney, I’m only allowed to negotiate through their attorney. That’s a more roundabout approach, and, of course, I’d have to charge you for it.”
So, I promptly called the administrator. Or at least I tried to. Each time, I received a recording that the phone was not accepting calls. That made me mad! I Googled this guy. Turns out he was currently the president of a bankruptcy administrator trade association, and the association’s website had email addresses, while the bankruptcy court documents, at the time, did not.
I emailed him along with chairman of the association, explaining that I did not think it was good practice for a court appointed administrator to be blocking calls from the very creditors they were supposed to protect.
Within 3 minutes the administrator called me back, and within 45 more minutes we agreed to a deal in which he would cancel the $50,000 clawback demand, in return for my cancelling the claim for $15,000 owed me. All with zero legal fees and no time wasted in court.
As we can expect business bankruptcies to spike in the coming months, here are some good rules to follow:
Prevent payment problems before they occur: Avoid risky credit terms, and if possible automatically draft money from a customer’s account upon shipment or service provision. Stay in close touch with customers to get early warning about problems. Be especially careful with troubled industries, such as retail, restaurant and travel…including airlines!
Don’t be on the hook for 3rd party suppliers. In our industry, we used to pass through 3rd party services like printing and media on our client bills, putting us at risk if a client defaults. Today we’re careful to have clients sign contracts directly with those suppliers, and have clients pay them directly.
Document that payments are contemporaneous with value delivered. Review your contracts, bills, timesheets etc. with your lawyer to be sure you have a good case against bankruptcy preference period clawbacks.
Have a good, and reasonable, business lawyer. Reasonable meaning not just the fees they charge, but their willingness to tell you when you might be better served by making that call yourself.