Dealing with Troubled Customers and Suppliers

The news has been full of stories about financial problems in the manufacturing industry lately, especially those related to companies that are involved in the automotive industry. The Obama administration has recently announced programs designed to help some of these companies, but government help is slow, cumbersome and often comes with strings attached. Even if your company is strong enough to make it through the recession without government help, the bankruptcy of a key customer or supplier can create troublesome collection, cash flow and supply issues. In many cases, by the time you know about the problem, it is too late to do anything about it.

Nevertheless, there are things you can do to reduce the risk that customers' and suppliers' financial problems will have an adverse impact on your business. Here are a few steps that every careful manufacturer should take in this economy:

Customers

Every company with significant receivables should be ordering Dun and Bradstreet reports for its major customers (including those that have a good payment history), monitoring changes in payment practices, and asking (polite) questions about customers' financial status. If a customer with financial problems offers to pay you in full and you suspect that it may not be able to pay its other suppliers, be aware that in a bankruptcy proceeding, you may have to give the money back (to be redistributed among all creditors), even if the amount you received was legitimately owed to you. Current bankruptcy law does not allow a supplier to cancel a supply agreement with a customer merely because the customer is involved in a bankruptcy proceeding (even if your contract says you can), but you can refuse to accept new orders and minimize your losses.

Suppliers

With suppliers, the risk has less to do with getting paid than it does with getting control of important tooling and ensuring a steady supply of raw materials if the supplier stops producing. A breached three year supply agreement doesn't do you any good if the supplier goes out of business and there is no one to sue for the breach.

If you own tools, dies, inventory, drawings or other items that a supplier has in its custody, make sure that everyone knows they are yours, so that you do not have to fight about ownership in a bankruptcy proceeding. Get a bailment agreement in place with the supplier (pursuant to which the supplier acknowledges that these items belong to you and are not available as collateral for lenders or to satisfy claims by other creditors), mark your property ("Property of X") as indelibly as you can, write a letter to the supplier's lender(s), and put the rest of the world on notice that your property is yours by filing a Uniform Commercial Code notice filing with the appropriate secretary of state office(s).

To avoid running out of raw materials, build up some inventory and start looking for alternative suppliers early--especially if you need to budget some time for a testing or approval process (like U.S. Food and Drug Administration or Production Part Approval Process approval) before you can start using a new supplier's products. If a supplier calls and asks for accelerated payment terms to "keep them from shutting down," ask for something in return, such as guaranteed supply through a certain date, an agreement to sign the bailment agreement that you should have had in place already, an assurance that your supply needs will get priority, or an agreement that the supplier won’t hold you in breach of an open purchase order or supply agreement if you move production to another supplier.

Terms and Conditions

Finally, no matter who you are dealing with, having good terms and conditions in place greatly improves your negotiating position. Get good agreements and terms and conditions in place--and use them--before you have a problem.

For more information, contact Dale Stackhouse or Ben Caughey.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice.  The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.