Managing Relations with Insolvent Customers

How to get paid and keep the money


Shock waves from the implosion on Wall Street have spread to Main Street, and the economy is now in a recession. The fallout for suppliers of goods and services will very likely be an upsurge in customer bankruptcies.

Customers' bankruptcies don't necessarily mean a total loss of receivables due from those customers. Suppliers can avoid, or at least minimize, such losses by using a wide array of tools to obtain payments from insolvent or bankrupt customers and keep those payments if a bankruptcy trustee demands their return. Here is a summary of strategies and tactics that can help.

Sellers' Remedies When Customers Become Insolvent or File for Bankruptcy

A person is insolvent when he is not paying his debts as they mature or when his liabilities exceed his assets at a fair valuation. The Uniform Commercial Code (UCC), enacted in all states, provides a variety of remedies to suppliers who discover or suspect that a customer has become insolvent. Knowing when and how to rely on these remedies is crucial. 

1. Refuse delivery unless payment is in cash. First, upon discovering that a customer is insolvent, a seller has the right to refuse to deliver goods unless the customer agrees to pay for the goods – and possibly for all goods previously delivered – in cash. This right covers not only goods for which the title has already passed to the buyer, but also goods in the possession of a bailee (such as a warehouse) that has not yet acknowledged the buyer's ownership of the goods. 

2. Stop goods in-transit. Discovery of a customer's insolvency also gives the seller the right to stop delivery of any goods in the possession of a carrier or other bailee. However, the seller must exercise this right before one of the following occurs: (1) the buyer receives the goods; (2) a bailee of the goods (other than a carrier) acknowledges that the bailee holds the goods for the buyer; (3) a carrier acknowledges that it holds the goods for the buyer (by reshipping the goods or by entering into a separate contract with the buyer to act as a warehouse); or (4) any negotiable document of title covering the goods is negotiated to the buyer. For the purposes of exercising the right to stop delivery, the term "buyer" includes any designated representative of the buyer or any entity to which the carrier has been directed to drop ship the goods.

3. Reclamation. In some circumstances, a seller may have the right to reclaim goods already delivered to a buyer. This right arises when the seller discovers that the buyer has received goods on credit while insolvent, and it permits the seller to demand return of those goods within 10 days after the buyer's receipt of them. The 10-day period does not apply if the buyer has made a written misrepresentation of its solvency within three months prior to delivery of the goods.

Reclamation demands should be made as soon as possible after a supplier learns of a customer's insolvency; if the buyer commingles fungible goods or sells the goods, the seller's right of reclamation will be lost.

4. Adequate assurance of future performance. While it is not necessarily a right triggered by discovery of a buyer's insolvency, a buyer's right to demand adequate assurance of due performance from a customer is still a powerful weapon in the seller's arsenal.

Under Section 2-609 of the UCC, once either party to a contract has reasonable grounds for insecurity with respect to the other party's performance, the insecure party may demand in writing adequate assurance of due performance from the other party. Until it has received the requested assurance, the requesting party may, if commercially reasonable, suspend any further performance as long as it has not already received the agreed-upon return performance. 

5. Recoupment and setoff. Suppliers often purchase goods from their own customers, thereby creating "contras." If the supplier owes a customer money for such goods while simultaneously holding a receivable from the customer, the supplier will have either a right of recoupment or a right to set off its payable against its receivable.

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