Always avoid clients who are in a shaky financial position. They are prime candidates for bankruptcy. This advice may sound obvious, but few companies do anything about it until it is too late. This article presents strategies to detect and avoid potential client bankruptcies. But before proceeding, I offer a disclaimer. I am not an attorney, and this article is not offering legal advice. If you need legal advice, seek qualified counsel.
Bankruptcies can be worse than most owners think. Many assume that the worst result of a client bankruptcy is that they will lose outstanding payments and some future revenues. It can actually be worse.
A company that enters a Chapter 11 bankruptcy gets a bankruptcy trustee to help manage its affairs. The bankruptcy trustee can ask another company to return any payments made to them within the last 90 days. They often execute this ability to “claw back past payments.”
This step is taken to ensure all creditors are treated fairly. It neutralizes rash payments/collections made prior to the bankruptcy. It also takes revenues away from another company.
In some cases, an owner may have to honor any contracts he or she had with the client prior to the bankruptcy. This obligation includes honoring 30- to 60-day credit terms, and it means the owner may have to continue to do business and offer credit to a client undergoing restructuring. There are exceptions to this rule. However, seek legal counsel to use these exceptions.
The bankruptcy of an important client can entangle a business in many ways. Fortunately, there are ways to protect a company.
First, do necessary due diligence. Companies tend to let their guard down when things are going well. The economy has been growing for nearly a decade. No one has the possibility of major bankruptcies on their radar. But, if we learned one thing from the 2008 downturn, it is that things can turn badly quickly.
Before signing any client, check their commercial credit report. The four main providers of commercial credit reports are Dun & Bradstreet, Ansonia, Experian Commercial and Cortera.
If the client is small, a single report should be enough. If it's a large project, consider getting comprehensive reports from multiple credit bureaus to give you a more balanced view.
Review the report’s credit determinations, payment history and litigation history. Provide term credit only to clients who have a good payment history and decent credit.
After a company becomes a client, take additional steps if they will become a long-term client. These steps will help catch many problems before they become emergencies.
1. Review payment history regularly. Examine the collection history with the client. Have they requested longer-than-customary payment terms? For example, 30- to 60-day payments are customary. A client who requests 90 or 120 days to pay may have cash flow problems. Cash flow problems may be temporary—everyone has them—or they can lead to bankruptcies.
Has the client started paying late? Are 30-day invoices paid in 45 or 60 days? Are they paying late regularly? This delay also indicates potential cash flow problems.
2. Watch for unusually large orders. By itself, getting a large order from a client doesn’t mean much. It can be a very good thing. However, some clients have been known to place large orders just before declaring bankruptcy. They place large orders to have stock during the restructuring. Keep an eye out for this activity, especially if it’s coupled with a long history of delayed payments.
3. Check credit profiles every 3 to 4 months. Check the credit report of important clients every couple of months. Some bureaus also offer services that allow regular monitoring of clients. Within the reports, analyze payment trends and litigation history. Declining payment trends across all vendors is always a sign that things are not going well. Likewise, be careful if any new litigation or judgements arise.
4. Look at the big picture. A single negative indicator doesn’t always mean much. Examine trends and clusters of indicators. Assess the whole picture before making a decision. If an owner spots a problem with a client, be proactive and use best judgement. Have these clients pay in advance. If things become too problematic, consider letting the client go.
5. Get credit insurance.
Consider getting credit insurance coverage for large, important projects. While this insurance adds to costs, it also offers important protections.
The obvious protection is that it covers invoices in event of a client bankruptcy. This coverage can be important if a company is taking on a very large project. Credit insurance also provides coverage if the client goes out of business without declaring bankruptcy.
However, credit insurance has another important use. An owner can use the insurance company as a credit bureau. He or she can run a potential client by them for review. If the review fails, they can advise the client of this outcome and negotiate different payment terms.