What suppliers need to know about retailer bankruptcies

The rise of e-commerce has made life increasingly difficult for shopkeepers of every size and shape. The continuing shift to online shopping, and the failure of many retailers to adapt, has pushed many retail chains into bankruptcy. Radio Shack, Wet Seal and Deb Shops are just a few once-popular merchants that have declared Chapter 11 in recent years.

But for retailers in particular, Chapter 11 does not always mean a true reorganization, with inventory sell off, lease terminations and dividend payments to creditors. Traditional reorgs have become too expensive for many retail debtors, and banks often prefer to sell off the inventory, suffer their losses and move on quickly rather than slog through a Chapter 11.

Still, if you’re supplying a company that is at risk of going bankrupt, it’s important that your company takes certain step to protect itself. Don’t assume that there’s a court-ordered payment down the line that will help make your company whole. Instead, insulate yourself against potential losses before your customer goes belly-up.

The 20-day Rule: When suppliers line up to collect on goods delivered but not paid for, the bankruptcy code gives priority to those who made deliveries within the 20 days preceding the date of bankruptcy Those debts are supposed to be paid “off the top,” right after the payment of secured claims. So when you begin to doubt a customer’s solvency, start demanding payment within 20 days of delivery.

Reclamation: This is when a seller of goods demands return of the goods upon learning of the buyer’s insolvency. Outside of Bankruptcy Court, return of the goods probably requires seeking the help of a State court. Sending out your reclamation letter quickly is important because goods that the buyer has already sold when the reclamation letter is received can’t be reclaimed. The bankruptcy law also has deadlines by which to file reclamation claims. And, a vendor’s reclamation claim is junior to a bank’s secured claim.

Aggressive repayments: The best way to avoid an outstanding balance with a customer sinking into bankruptcy is to avoid letting the balance become outstanding in the first place. The best time to be aggressive in a looming bankruptcy is while it’s still looming. Demand payment on past-due balances and consider switching to cash-upfront terms for current shipments. You may lose part of those payments if they’re made within 90 days of the bankruptcy filing (this is called a “preference” payment). But you’re better off fighting to keep what’s in your bank account than fighting over Chapter 11 scraps. Don’t worry about preferences.

Buy a put: If you’re really concerned about your customer declaring bankruptcy, consider purchasing a put on your claim. Basically, this will give you the right to demand that the seller purchase your bankruptcy claim at a certain price within a predetermined period. Puts usually expire after 90 days. So if your customer goes bankrupt within those 90 days, you’ll be able to convert your claim to cash immediately. Puts can be expensive but often the sellers know more about the financial health of your customer than you will, so even negotiating one can provide valuable information.

Credit insurance: Credit insurance is common among companies that manufacture things like paper, apparel and textiles. It’s less common for other manufacturers, though that seems to be changing. If you’re shopping for credit insurance, consider insuring healthy accounts along with problem accounts, which will help you reduce the cost. Credit insurers can also be another great source of information about the financial health of your customer.

Adjust the terms:The contract with your distressed customers probably specifies the credit terms. Normally you can’t unilaterally change those terms. But the law makes an exception when your customer is known to be under duress. In that situation you can declare yourself insecure and demand assurances of payment —payment on past-due balances, collateral or a letter of credit, for instance —in order to continue extending credit.

Finally, do your homework. Learn as much as you can about your customers. The Internet might be killing the brick-and-mortar retailers, but it’s a great resource for information. You can use it to look for lawsuits and liens that might have been filed against your customers. If a company is public, you can look up details of its financial health through documents on file with the Securities and Exchange Commission. Sites like CapitalIQ, Debtwire and Reorg Research are good sources if the company is private.

Kenneth A. Rosen is chair of Lowenstein Sandler's Bankruptcy, Financial Reorganization & Creditors' Rights Department. He focuses on Chapter 11 reorganization, out-of-court workouts, financial reorganization, and litigation.