Anticipating Credit Defaults in the COVID-19 Era: Strategies to Maximize Creditor Recovery

As the COVID-19 pandemic continues to erode the global economy, most economists predict a wave of corporate defaults and bankruptcies for the foreseeable future. Regardless of whether additional economic stimulus enters the pipeline, creditors would be well advised to implement strategies to address defaults or payment delays.

Strategic planning is not solely the province of secured lenders and financial institutions. Developing a comprehensive default strategy is particularly important for unsecured creditors such as trade creditors, vendors and service providers who do not have the benefit of security provisions or collateral to secure payment. While unsecured creditors undoubtedly have less leverage than their secured counterparts, an attentive and aggressive unsecured creditor may still pursue a number of options to maximize recovery or gain an advantage over other similarly situated creditors. If the account debtor is in significant financial distress, these strategies may be the difference between recovery and write off.

An unsecured creditor’s success in implementing protective measures will depend upon a multitude of factors. Like most business transactions, leverage is critical. An unsecured creditor supplying a good or service that is critical to the continuation of the customer’s business stands a far better chance of success. Similarly, customers will be more inclined to capitulate to those creditors with a reputation for aggressive pursuit of delinquent accounts.

Pre-Default Measures

Slow or late payments may be a harbinger of future defaults. Creditors should explore incremental protections at an earlier stage to ensure that the unpaid receivables do not accumulate beyond acceptable levels. Examples of such protections may include:

• COD Payments: A creditor concerned with a customer’s creditworthiness may ask that any future deliveries be made on a cash on delivery (COD) basis or request at least a partial payment when the goods are delivered.
• Collateral: A creditor could also request that its customer provide collateral to secure future extensions of credit. Collateral may consist of a lien on an unencumbered asset, a guaranty from a principal or a letter of credit.
• Amended Credit Terms: Tightening credit terms such as a reduction in the total amount of open receivables or reducing payment terms will also be an effective way to reduce exposure.

Post-Default Measures

Following a default, additional measures will enhance the likelihood of repayment. Examples of post-default strategies include the following:

• Forbearance Agreement. Creditors can demand that a defaulting customer enter into a forbearance agreement or repayment plan providing additional protections. Such agreements will enable creditors to strengthen their position while affording the customer time to repay the outstanding indebtedness. Agreements should include terms that would enhance the creditor’s position, including:

• Payment of entire debt over a fixed period, with interest: Spreading payments over a longer term will afford the customer time to strengthen operations and cash flow while reducing the outstanding indebtedness;
• Stipulate to amount owed without defense, counterclaim or setoff: A stipulation that all amounts are due and owing, without defense, will streamline the creditor’s case if a lawsuit is filed;
• Release of claims and defenses: Similarly, the creditor may secure a release of any claims or defenses relating to performance, quality or other issues;
• Debt secured by escrowed consent judgment/confession of judgment: Creditors may be able to enter an immediate judgment, and avoid protracted litigation, through a stipulated judgment;
• Consent to jurisdiction/choice of law: Provisions may be included to ensure that any lawsuit proceeds in the creditor’s preferred venue;
• Documentation issues: The original contract may have some deficiencies that can be remedied in the forbearance agreement.

For more information, please contact John Kilgannon or reach out to the Stevens & Lee attorney with whom you regularly work.

This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.