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Ask The Attorney: Warning Signs From a Distressed Customer

By Bruce S. Nathan and Scott Cargilll – Lowenstein Sandler
August 2022

 

Q: With an expected recession, what are the trends you are seeing?  What to watch for and where?

The last few years witnessed the unprecedented flow of trillions of dollars in direct federal and state stimulus programs; rent and student loan debt moratoriums; U.S. Federal Reserve-backed monetary liquidity programs; and historically low interest rates — all designed to blunt the financial impacts of the Covid-19 worldwide pandemic. As the worst of the pandemic recedes, the new reality of global financial markets in transition and the risk of an upcoming recession have created unique challenges for all business sectors.

Among the most pressing economic headwinds are the U.S. Federal Reserve’s plan to aggressively hike interest rates to tame consumer price inflation levels that have not been seen in decades. This new higher interest rate environment, coupled with continued supply chain disruptions, reduced government stimulus and debt relief programs, high energy and other commodity prices, and a material slowdown in the real estate market, have injected significant uncertainty into the U.S. economy and have added to the economic challenges exacerbated by the ongoing Ukraine war and the tensions between China and Taiwan. With little historical precedent, credit professionals across a broad swath of industries are attempting to utilize this confusing and often contradictory geopolitical and macroeconomic data to navigate complex credit decisions in order to protect against taking on unreasonable credit risk for their businesses.

It is, therefore, very important for credit professionals to diligently look for “warning signs” that their buyers/customers may be exhibiting as they endure a period of anticipated financial distress. While all situations are unique, below are some of the typical red flags to look for:

  • The buyer is incurring huge losses and is experiencing liquidity constraints.
  • The buyer is consistently taking longer to pay invoices than their stated credit terms, with the length of payment delays increasing, and/or the buyer formally requesting that you extend payment terms. In extreme cases, banks dishonor the buyer’s checks for insufficient funds, or the buyer begins post-dating payment checks.
  • The buyer is also late in making payments to its other vendors.
  • The buyer’s purchasing department has increased employee turnover and it is increasingly difficult to communicate with the buyer’s financial team.
  • There are delays, or refusals, to provide financial performance data that the buyer had previously routinely released.
  • The buyer is downgraded by rating agencies and/or industry financial observers place the buyer on a credit watch; the buyer has an upcoming principal or interest bond payment, a bond maturity date; and/or the buyer’s credit facility with its lender is about to expire.
  • The buyer’s secured and unsecured bond prices and stock prices are on a downward trend.
  • Credit insurance coverage for the buyer is restricted and/or has ended.
  • The resignation of the buyer’s Chief Executive Officer, Chief Financial Officer, and/or other key officers.
  • The buyer replaces members of its Board of Directors with new board members that have insolvency and restructuring backgrounds.
  • Public court dockets, lien filings, and financial reports show an increased level of collection lawsuits, judgment liens, tax liens, and the granting of security interests in the buyer’s assets and consignments in favor of other creditors.
  • Industry rumors swirl that there will be a sale of the buyer’s business and/or a bankruptcy filing; the buyer retains restructuring professionals; an ad hoc committee of creditors is formed to address the buyer’s late payments; you receive an increased number of credit reference requests about buyer from other suppliers.

It is imperative to closely and regularly monitor buyers exhibiting one or more of the above warnings signs. The most important action you can take to manage risk is to ASK QUESTIONS. A customer’s slide into default or bankruptcy is often a gradual process. Staying informed by consistent account monitoring, demanding real-time information from the buyer and actively participating in your industry credit group are invaluable for making well-informed credit decisions to limit credit exposure before it is too late.

For any questions, please feel free to reach out to Lowenstein’s Scott Cargill ([email protected]) or Bruce Nathan ([email protected]).