Minimizing Exposure to Client Bankruptcy

by Rick Gould, CPA, J.D.

Visualize this hypothetical:

• You won your largest account against several top PR firms. You have invested time and key staff in servicing this Fortune 500 client.

• The high-profile client instantly elevated your brand recognition. Their fee is $125,000 per month, representing 41% of your net revenue and generating 25% profitability.

• You are very liberal in allowing your bills to be paid in 75-90 days. You’re sure they are good for it.

• You maxed out your line of credit to cover the receivable. You have no access to additional credit lines or capital.

• You then receive an email informing you that your largest client is filing for Chapter 11 protection and you are just one of several hundred creditors waiting in line.

We read daily about the rise in bankruptcies. Numerous solid companies, previously profitable, have filed for Chapter 11. As their credit lines dry up, as suppliers press hard for payment, as professional costs increase in restructuring debt, as operating costs increase and as retaining expensive turnaround firms add to the bleak mix, bankruptcy protection will continue to be used as a tool in this economic downturn.

Additionally, you may have exposure to outside vendors and suppliers with whom you have entered into agreements on behalf of clients. The vendors/suppliers/freelancers have the agreement with “you”. They perform the service or provide materials for an event. They bill your agency; you bill your client. Your client ends up in financial distress or files for Chapter 11. The vendor/supplier/freelancer is entitled to get paid. You now are on the hook for both the amount due to the third party, as well as for your fees for PR services rendered to your client.

How do you ultimately protect yourself from this kind of situation?

Our distinguished colleagues at PR specialist law firm Davis & Gilbert published a February 3 report in their “Insolvency & Bankruptcy Alert” titled “A Guide for Dealing with Advertisers and Vendors in Bankruptcy.” Although mainly geared to the Ad Agency industry, the advice is equally valuable to PR firms.

Following the advice of Davis & Gilbert could save you substantial dollars and stress if you get caught as a creditor in a bankruptcy filing.

Davis & Gilbert outline the following critical legal protection points:

• Review forms of client-agency agreements and other contracts.
• Consider including provisions that would give your agency more flexibility to terminate the contract or change the terms in the event certain early warning triggers are tripped, i.e. consider inserting a provision that allows you to modify payment terms if your client’s financial condition deteriorates.
• Minimize the risk of a preference action by requiring advance payment from any client in financial distress. Advance payments fall outside the definition of a preference and are less vulnerable to attack. A preference is a payment made by your client to you on a “past due” account or within 90 days prior to the bankruptcy filings. If any payment to you by your client is considered a preferential transfer (preference) you may have to pay it back to the trustee in bankruptcy.
• Formalize agreements with vendors and subcontractors to limit any authority of such entities to legally bind your agency.
• Once a bankruptcy petition is filed, your client is bound by the automatic stay which stops all actions of creditors against the debtor. Violators are held in contempt of court.
• Your client may, at their discretion, elect to assume or reject your contract. If your client assumes the contract, it must make good on all past due balances. The choice, however, is the debtors and the client may not be able to terminate the underlying contract
• As a reward for providing your continued services to your client in Chapter 11, you may be considered an administrative expense for the services provided after the bankruptcy filing. This will put you higher up in the payment priority ranking, but is not a total guarantee for payment. If ultimately a full liquidation (Chapter 7) ensues, even administrative expenses may be foregone.

Conclusion

Legal analysis is required to assess your exposure and resolve any preference attack. It is imperative to have this conversation with your attorney to mitigate the risk of getting caught up in a client’s bankruptcy filing.

For additional information, please contact:
Michael Lasky, Partner at Davis & Gilbert – 212-468-4849 or [email protected]

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