Working Through Your Key Customer's Financial Difficulties

Bettering Your Position For Payment On The Delinquent Account
By Scott Blakeley

You are a sole-source supplier with a long term contract with a customer. The supply contract provides for 30 day credit terms. The customer accounts for a significant percentage of the vendor's sales, which are on credit. With the downturn in the economy, the customer loses business, resulting in significant cash flow problems. However, your research indicates that the customer's financial problems are temporary, and may remain a significant source of business over the long term. The customer has problems paying its lender, who has a security interest in all of the assets, as well as its vendors. Your account is past due.

You consider alternatives for repayment of the delinquent account, yet still have the customer remain a significant source of business. One alternative, the customer solicits your company to invest in it to continue to operate during the shortterm downturn. Your company does not want to lose the significant revenue generated by the customer, but obviously does not want to increase its credit exposure.

Creditor instead of investor: to retain the significant source of business, the vendor may consider a short term loan to assist the customer's cash flow. Creditor status gives the vendor priority in the event the customer fails to repay, as opposed to investing in the customer.

Guarantying some of the customer's debt: the vendor may consider serving as a guarantor of certain of the customer's debts. The upside is that it may not require an immediate infusion of cash. However, the risk is that the vendor may have to pay on the guarantee if the customer fails to pay the guaranteed debts. The guarantee may calm creditors and allow the customer to continue to operate. Working with the customer's lender: the customer's lender has a security interest in all of the customer's assets including accounts receivable, inventory and cash. The vendor may be able to calm the lender's anxiety with the customer's financial performance by committing to guarantee certain of the customer's accounts receivable, or guarantee a floor for the lender's collateral should it be forced to foreclose on the customer.

Personal and affiliate guarantees to protect the vendor: the vendor may insist that the owner of the customer (if it is a closely held company) provide a personal guarantee to the vendor to protect it for its financing. The guaranty creates a contract of secondary liability. The owner may provide the guarantee to the vendor given the alternative that the customer's lender may foreclose on the business. Likewise, the customer may have an affiliate business with value that may furnish a guarantee to the vendor.

Purchasing the customer: in certain situations, the vendor may determine that the economics are such that buying the customer may be the most effective way to maximize the value of the relationship. This is the ultimate equity investment.

The vendor has to be careful with its approach to financially assist the customer. The vendor cannot misstep with its strategy to reduce its credit exposure but open the door as a target for litigation from other creditors, including its lender.

Reprinted by permission from The Trade Vendor Quarterly Blakeley & Blakeley LLP Fall 02