Service Area: Collection Services

Is it a Bird? Is it a Rule? It’s a Cardinal Change Order!

Posted on March 8, 2019 by - In Other Commercial Credit News, Mechanic's Liens & Bond Claims

Is it a Bird? Is it a Rule? It’s a Cardinal Change Order!

Change orders. Everyone’s got ‘em! But, what’s the difference between a change order and a cardinal change order? Read on to find out!

Boring Ol’ Change Orders

A change order is a change to the original contract. “I need more material” is a common trigger for a change order. Some construction projects encounter hundreds of change orders – verbal and written (written, of course, is preferred, though surprisingly difficult to obtain).

Generally, a “boring ol’ change order” isn’t for terribly significant changes or changes that would change the entire scope of a project. As I mentioned above, a change order is likely a request for additional material because an estimation was wrong, or the material sent needs altering.

I should mention, although it may not be a significant change it may be substantial enough to change your last furnishing date.

I know…“Can open. Worms everywhere.”

Cardinal Change Orders

When you think of cardinal change orders, think specifically about the word cardinal. Not the red bird, but rather the idea that something is essential, fundamental or vital (thank you Merriam-Webster).

Joseph R. Young with SmithCurrie provides an excellent definition in his article Changes and Extra Work – Is There a Limit?

“A “cardinal change” is a change or the culmination of changes ordered by the owner that are beyond the scope of the contract and that may constitute a material breach of contract.” 

Young goes on to explain that these cardinal changes are “beyond the reasonable expectation of the original undertaking and have significant planning, scheduling, and cost implications…”

How Do I Know the Difference?

Construction contracts and, of course, mechanic’s lien statutes are never black and white. Within the text there are inferences, assumptions and text is always open to interpretation. So, how do you know if the change order(s) is a cardinal change order?

In true construction-related fashion, the answer is: it depends.

Young reinforces this answer:

“There is no bright line rule about what could be considered a cardinal change or what was reasonably contemplated by the parties in the original contract. Unless the contract expressly limits the owner’s right to issue changes, reliance on the cardinal change doctrine is a risky basis to refuse additional or changed work. Clear contract language addressing the scope and magnitude of permissible changes is the most reliable source of addressing significant changes.”

There is a chance that a change may be drastic enough to be an obvious cardinal change, such as changing plans for the construction of a 1200 sq ft single family residence to a 200,000 sq ft commercial shopping center. But, the likelihood of something that obvious is slim at best.

Best defense? Young recommends including verbiage within the contract.

“The contract should address some limitations on the extent of changes or place restrictions on material changes in the use of the project or the contractor’s work. The contract should also address when the contractor may refuse to perform changed or additional work. By clearly defining the limitations of the changes clause, parties can minimize the disputes about ambiguities over the legal concept of “cardinal changes”, and the parties can eliminate the risk of an unnecessary dispute as to whether there has been a cardinal change. The best course of action for all parties is to incorporate the cardinal change concept into the contract and follow the terms of the contract in managing and addressing changes.”

My Advice

If you are drafting a contract, have a contract lawyer review the document. If you are in the middle of a dispute, consult an attorney – don’t try and navigate the possible breach of contract claims on your own.

Time for Preparation, There’s No Rest Post-Recession

Posted on February 22, 2019 by - Credit Risk Management, In Other Commercial Credit News

Use this Time as Preparation, There’s No Rest Post-Recession!

FMI has released its 2019 U.S. and Canada Construction Outlooks. The report contains a considerable amount of valuable information, but one topic is forefront: be prepared for the next recession. Today I’ll touch on steps outlined by FMI as well as NCS best practices you can implement to ensure you are prepared for the next economic downturn.

Awesome T-Shirt: “Keep Calm, Stay Focused and Get Ahead of the Next Downturn”

I’m going to emboss it & stick it to my computer as a reminder! The introduction to FMI’s outlook article is titled “Keep Calm, Stay Focused and Get Ahead of the Next Downturn.” Yes, I think it would be a great t-shirt, but more importantly, it’s a reminder that you have an opportunity to ensure you have the working capital and business model to make it through the next downturn.

What did we learn during the Great Recession? Hopefully you learned the value in proactively securing receivables! During the Great Recession, you likely experienced supply chain disruptions, slow pay/no pay customers, depleted liquidity or cash flow issues, and even customer insolvency. What have you done to prevent these experiences going forward?

FMI recommends addressing these 7 hurdles now:

1. Evaluate underperforming departments and employees. If you have been dragging your feet on eliminating a low performing division or a poor performing employee, now is the time to have the conversations. You don’t want this hanging over the business during tough economic times. FMI says, “During the last recession, these types of issues plagued E&C companies for far too long. Leadership that is slow to react and respond can make or break a company.”

2. Be selective in new projects. Select projects within your core competencies. FMI has a saying: “Contractors don’t starve to death; they die from gluttony. They get too much work, too fast, with inadequate resources, and then they get into financial trouble and run out of cash.”

3. Look at the big picture and have a strategy in place. “Living in a reactive mode and not being proactive and taking charge of shaping your own destiny and future can become your biggest detriments.”

I will come back to 4 & 5. Let’s jump to 6 & 7: get your sales game on!

6. & 7. Strengthen existing client relationships, build new relationships, and get your sales folks prepared.

“…educate your people on “how to behave in a recession”—estimators with project selection, field managers with scope management, PMs with cash management, etc. Client interaction across all company levels will increase your presence with clients, give you an inside track and improve collaboration among future leaders.”

4. Know your costs and plan accordingly. “Understanding the total costs for each project and how these costs break down is the first step in knowing where and how you can improve profit margins.”

5. Cash is King! “Conduct a risk analysis on all existing projects slated to complete more than six months out. Identify high-risk projects and how each will be staffed to take to project completion. Leverage and utilize a multiskilled workforce: In-house, self-perform capabilities can mean a difference on margins, time and manpower, while all-around adaptability can make a firm indispensable to satisfied clients.”

And this is where the NCS best practice fits in: implement a UCC and Mechanic’s Lien process.

Supply goods? Renting equipment?

File a UCC, even if it’s “a good, longtime customer” because absolutely no one is safe from insolvency. A properly perfected security interest affords you crucial leverage if your customer defaults, plus, it puts you at the front of the payment line in the event of bankruptcy.

Furnishing to a construction project?

Serve a preliminary notice. Every. Time. The notice is critical when pursuing a mechanic’s lien or bond claim. Many states require the service of a notice in order to proceed with a lien or bond claim. If you fail to serve a notice and you can’t file a lien, you have lost the leverage the law affords – is that a risk you want to take?

Ensuring the process is in place now helps to normalize the process for your internal customers (sales & credit) and your external customers. This is big: NORMALIZE.

UCCs and mechanic’s liens are not to be feared. It is a business practice used by millions and it can be vital to your working capital and subsequent business survival.

Implementing the process now, when economic times are great, helps put a positive spin on UCCs and mechanic’s liens.

It gives you an opportunity to demonstrate to your customers that there is no harm in either process, because everyone is getting paid & happy. Then, when the next downturn comes around, you will spend less time scrambling to secure these rights and battling upset customers – “Why did you send me this prelien notice?!?!” – and more time increasing your sales and, in turn, your working capital.

There’s No Ice Cream in Bankruptcy. Wait, What?!

Posted on February 18, 2019 by - Credit Risk Management, UCC Financing Statements

There’s No Ice Cream in Bankruptcy. Wait, What?!

In bankruptcy, we frequently hear terms like preference payment, claw back, and new value. What do these terms mean? Further, what do these terms have to do with ice cream?

Let me tell you a little story about an ice cream truck and its weekly deliveries to a now insolvent grocery store.

The Ice Cream Truck – Music to My Ears!

Blue Bell Creameries, Inc. (Blue Bell) supplies ice cream and related items to a variety of businesses, including a grocery store chain, Bruno’s Supermarkets, LLC (Bruno’s). Each week, Blue Bell would deliver ice cream to Bruno’s and twice a week Bruno’s would remit payment to Blue Bell.

Soon, Bruno’s payments dropped from twice a week to once a week. Blue Bell continued its routine deliveries, after all, Bruno’s wasn’t paying twice a week, but Bruno’s was still paying within terms. Then Blue Bell began hearing rumors about Bruno’s cash flow problems, even the possibility that Bruno’s was preparing for bankruptcy. Technically, Blue Bell was still receiving timely payment from Bruno’s — what should Blue Bell do?

Blue Bell decided to continue supplying to Bruno’s, all the way to the date of bankruptcy. Soon after Bruno’s bankruptcy filing, Blue Bell found itself scooped into a lawsuit: the bankruptcy trustee wanted to recover ALL payments Blue Bell received from Bruno’s during the 90 days prior to the bankruptcy filing, to the tune of over $500,000.

Ice Cream Break

This period, the 90 days prior to the date of the bankruptcy filing, is also known as the preference period. Payments made during the preference period are often referred to as preference payments. The court opinion defines preference as

“… as defined by § 547(b), a preference occurs when an insolvent debtor transfers money to pay a creditor for a prior debt within 90 days before filing a bankruptcy petition.”

Claw backs and Happy Tracks. One of these is a term for the bankruptcy trustee obtaining preference payments from creditors and the other is a delicious ice cream treat. You guessed it, the act of obtaining these payments is known as claw back. “The trustee will claw back payments from the creditor.” A defense against preference or to alleviate claw backs? New value.

bankruptcy and new value

Back to Blue Bell

Blue Bell recognized and admitted based on 547(b) of the bankruptcy code the trustee could claw back the money Bruno’s paid Blue Bell. (It’s the “ordinary course of business” defense)

But this story wouldn’t be as sweet if it stopped now. Blue Bell argued the payments it received from Bruno’s provided “new value” which is in line with 547(c).

I like the bankruptcy court’s explanation of new value for this case

“… lots of ice cream products that [Bruno’s] was able to sell to its customer in its efforts to remain financially afloat.”

If the court agreed with the new value defense, the trustee couldn’t go after those payments. But the court didn’t agree, stating the new value defense requires the new value to remain unpaid.

There is a confusion related to the idea of remaining unpaid. I’m not going to create a brain freeze by explaining too much about it, but here’s a high level look:

Essentially, Blue Bell wouldn’t have been permitted to use the new value defense because Bruno’s actually paid them for the goods Bruno’s received from Blue Bell — Blue Bell could have used the new value defense if it continued supplying to Bruno’s and Bruno’s didn’t pay them.

Fortunately for Blue Bell, the Court of Appeals determined Blue Bell could use the new value defense, despite payments received from Bruno’s. Why?

In part, it’s because the “one of the ‘principal policy objectives underlying the preference provisions of the Bankruptcy Code’ is ‘to encourage creditors to continue extending credit to financially troubled entities while discouraging a panic-stricken race to the courthouse.’” Despite the rumors, and subsequent realities of Bruno’s fiscal situation, Blue Bell continued to supply its delicious treats.

You can view the Court of Appeals case here: Kaye v. Blue Bell Creameries, Inc.

UCC the Proverbial Sundae Topper

Could a properly perfected security interest have saved Blue Bell from this melty mess? Quite possibly. A properly perfected UCC provides an additional defense against preference payments.

We’ve previously discussed the higher risks of supplying to foodservice, beverage and hospitality industries. This is no different. Never assume, no matter how large your customer is, your customer is immune to insolvency. File UCCs and ensure you are in the best possible position to get paid.

Arkansas: You Can’t Lien a Property You Didn’t Improve

Posted on February 15, 2019 by - In Other Commercial Credit News, Mechanic's Liens & Bond Claims

Arkansas Mechanic’s Liens: You Can’t Lien a Property You Didn’t Improve

Turns out, if you want to secure a mechanic’s lien in Arkansas, the lien must be filed against property you improved. Kind of feels like a face-palm moment, right?

I know what you are thinking “Kristin, of course I can’t file a lien against a property if I didn’t furnish to the property.” So, let me clarify, if the property owner has multiple parcels of land, you need to specify which parcel is related to the improvement. Identifying the wrong parcel, as one supplier has learned, can result in an invalid lien.

Steps to Securing Lien Rights in Arkansas

Commercial projects and residential projects are treated differently in Arkansas.

Residential Notice:

  • Include notice in contract or serve residential notice upon the owner before first furnishing materials or services. (The notice may be served after furnishing, but the lien, when later filed, will only be effective from the date the notice was served.)
  • A residential contractor who fails to give the notice may be fined up to $1,000.00, and is barred from bringing an action to enforce any provision of the residential contract.
  • No residential notice is required when:
    • the notice is incorporated within your contract,
    • the prime contractor or another lien claimant has served the notice upon the owner,
    • the prime contractor furnishes a payment and performance bond, or
    • you contract directly with the owner, to provide materials or services, but you are not a home improvement contractor or a residential building contractor.

Commercial and Residential (with more than 4 units):

  • Serve notice of non-payment upon the owner and prime contractor after last furnishing materials or services, but within 75 days from last furnishing materials or services.
  • The 75-day notice is not required of prime contractors contracting directly with the owner.

In Arkansas, the mechanic’s lien for commercial and residential projects is a two part process: notice of intent followed by the filing of the lien.

  • Serve a notice of intent upon the owner at least 10 days prior to filing the lien.
  • File the lien after last furnishing materials or services, but within 120 days from last furnishing materials or services.
  • Serve a copy of the lien upon the owner.
  • If the notice of intent cannot be served within the 10-Day time frame, file the lien and suit to enforce the lien within 120 days from last furnishing materials or services, requesting both the lien and foreclosure.

This Is for the Birds, or Is It?

According to the court opinion, the property owner had at least 5 parcels of land. The owner’s home & a barn were on one of the parcels, and the subsequent parcels held several poultry houses.  [The home & barn were at 20190 Garman Road and the poultry houses were at 20178 Garman Road.]

The HVAC materials furnished by the supplier were for the improvement of two poultry houses. When the supplier filed its lien, the supplier included a legal description of the property. But the legal description was for the parcel that held the house & barn [20190 Garman Road], not the parcel with the two poultry houses [20178 Garman Road].

Arkansas statute specifically states “the lien shall contain a correct description of the property to be charged with the lien.” A.C.A. § 18-44-117 In this case, the supplier clearly identified the wrong property in its lien.

In his article Construction Law in Arkansas: Construction Lien Filings and Property Descriptions – Sometimes Less Is More, author Larry Watkins leaves us with great advice:

“… if you provide a detailed real property description, make sure it describes the construction site where the materials or labor were provided. Remember that for describing property for lien filing purposes, general may be better than specific, and, sometimes, less is more.”

Need help securing your mechanic’s lien rights in Arkansas? Contact us today!

Approve More Small Businesses for Larger Sales

Posted on February 11, 2019 by - Credit Risk Management

Approve More Small Businesses for Larger Sales

By: Pam Ogden President, Business Credit Reports

As originally published in the Credit Research Foundation 3Q 2018 CRF News

Small businesses are a critical component of the American economic engine, contributing about half of the gross domestic product of the US. Companies that undervalue this all-important segment are leaving money on the table.

In any credit deal, you want to extend as much credit as possible without exceeding acceptable risk levels to generate the biggest sales possible. This principle is not limited to only large, well- established companies with dozens or hundreds of tradelines. The same applies to smaller, growing companies that may have more limited credit records. The challenge is in collecting enough information on the smaller company to establish a certain level of comfort on the risk front. The more information, the better, of course.

Smaller Companies Have Thinner Credit Records

Companies that issue credit are not required to report their payment data to all of the credit bureaus. In fact, they are generally not required to report payment activity at all. The credit bureaus all have data acquisition teams whose sole job is to get lenders, manufacturers, distributors, utilities and other companies to send them their account data to build and update the credit bureau’s database.

So, if there is nothing forcing companies to report their payment data to the credit bureaus, what is the result? We get disparate credit records across the various credit bureaus. Each credit bureau has a different perspective on a company. Nobody has the complete picture. This problem is amplified in the case of a small business that doesn’t have many credit relationships to begin with. Each credit relationship makes up a greater share of the complete credit picture. Missing even one or two of these can dramatically change the risk profile of a small company.

Credit managers know that less data on a prospective customer frequently means more risk. Credit policies are written to reduce credit offered when there is less information on a company. This puts smaller companies at a disadvantage in terms of obtaining the credit that they need to grow their business. It also means the company issuing credit to the small business is granting less credit, thereby limiting the revenue opportunity.

Combining Multiple Credit Data Sources is the Key

The problem of incomplete credit records on small businesses is solved by leveraging multiple credit bureaus in the credit granting process. If each credit bureau has a piece of the complete picture, putting them all together delivers a full 360-degree view of the company. With three major credit bureaus and several others with strength in particular industries, the only way to get a complete credit picture of a small company is to pull them together.

Many credit managers employ a first-pull/second-pull practice whereby they check one credit bureau first, and then cascade to additional bureaus for additional information as needed. The drawback with this approach is you are paying for multiple reports to multiple providers and those reports are separate reports. Also, a hit on the first pull may result in a credit approval without proceeding to the second pull, which may indicate a higher credit limit.

A more efficient and economical approach is to utilize a business credit information provider that combines the data and analytics from multiple credit bureaus into one report. This means only one report needs to be pulled by the credit analyst and only one credit vendor relationship needs to be maintained by the credit manager. Also, the total price of a blended business credit report is frequently lower than the total price of multiple credit reports.

Higher Hit Rates

Often, small businesses are declined for credit because no record could be found in the queried database. This is a lost opportunity for the small business applicant and could also be a lost opportunity for the company that is considering issuing credit.

Pulling the data of multiple business credit bureaus into one report results in higher hit rates on small businesses. While one credit bureau may not have any information on a small company, another one might. Checking the databases of two, three or four credit bureaus increases the likelihood of finding a credit record on a small company.

While it may not be practical to query two, three or four credit bureaus separately, using a credit information provider or tool that connects to all of the bureaus gets the job done in one search. This results in higher hit rates and more approvals.

Bigger Sales

Bigger sales require higher credit limits. Higher credit limits require more information on a company that supports the case to grant credit. By pulling together data from multiple credit bureaus, you build a thicker, more complete credit record. With a more complete credit record, credit managers are able to approve higher credit lines which accommodate larger sales.

Credit managers that are able to approve larger credit lines without increasing risk are heroes to their companies. Sales people are happy because Credit granted them room to negotiate a large deal. Management is happy because more revenue is flowing in.

More Prospects for Growth

Today’s small businesses are tomorrow’s medium and large companies. Once a budding company has established a relationship with a vendor, it’s unlikely they will change as long as the provider continues to deliver as needed.

Establishing relationships with companies early in their life cycle enables suppliers to grow their own business and increases the prospects of a long, mutually-beneficial relationship.

In fact, one of the main reasons growing companies switch providers is because another provider is willing to grant more credit than the incumbent. Using a multi-bureau credit solution or tool can establish the relationship on the right foot with larger credit lines and keep it that way as credit lines are extended over the life of the relationship.

More Information Means Less Risk

We’ve covered how pulling together data from multiple credit bureaus into one solution increases revenue, but we’d be remiss if we didn’t also mention the fact that having more information on small businesses helps mitigate risk.

Because the credit bureaus frequently don’t have the full picture on small businesses, the credit bureau used in a single-bureau model may paint a rosy picture of a company while missing a key piece of derogatory information. Pulling together multiple credit bureaus’ data into one report reduces the chances of missing a key negative factor.

The Key Takeaway

Don’t leave money on the table as a result of no-hits and thin credit records on small businesses! Access credit reports that pull all the credit bureaus together into one search and one report for stronger hit rates and a more complete credit picture. With a comprehensive picture, you can issue higher credit limits and minimize your risk.

Would you like access to comprehensive credit reports without the hassle of contracts?

Arbitration, Mediation, Lawsuit – What’s the Difference?

Posted on January 18, 2019 by - Credit Risk Management, In Other Commercial Credit News

Arbitration, Mediation, Lawsuit – What’s the Difference?

Over the holiday break, I spent some time reading articles I’ve (shamefully) had bookmarked for way too long. One of these articles reviewed the pros & cons of arbitration in construction disputes, although for me, it better explained the similarities and differences of arbitration and a lawsuit.

Construction Arbitration: The Pros and Cons by Jason Strickland of Ward and Smith, P.A.

Arbitration vs. Mediation vs. Lawsuit

I don’t think I have ever confused a lawsuit with arbitration or mediation, but I have certainly confused arbitration with mediation. Here are key features explained by Strickland:

“Mediation is a settlement conference in which the parties meet (typically in person) and use a third-party neutral to act as a settlement facilitator.  The third-party neutral is called the mediator.”

It’s important to note, the mediator can’t force a settlement – which I didn’t know. I assumed the mediator has the same powers that an arbitrator has.

“A lawsuit is conducted in a court of law and usually is initiated by a plaintiff filing a complaint, in which the plaintiff will ask for some form of relief from the defendant.”

In the NCS world, a lawsuit is often referred to as “suit to enforce…” a lien or bond claim.

Now, this explanation of arbitration is new to me, in part:

“Arbitration is essentially a lawsuit but without court involvement.”

Wow. “Arbitration is essentially a lawsuit but without court involvement.” Yes! That’s a great explanation. Why? Because arbitration is binding, just like a legal decision.

Mind. Blown.

“The parties agree… to submit their dispute to arbitration rather than to pursue a lawsuit in court.  The parties’ agreement gives the arbitrator the power to issue a decision as to the parties’ rights and obligations, and such decision will be legally binding on all parties. Thus, arbitration is very different from mediation because the third-party neutral provides a legally binding decision.  However, arbitration is not mutually exclusive with mediation.  In many cases, parties will have a dispute resolution provision in their contract that will allow, or require, the parties to mediate first, and if the mediation is unsuccessful, to then submit their dispute to arbitration.” – Jason Strickland

The Differences (Pros & Cons) Between Arbitration and Lawsuits

Strickland reviews several differences between arbitration and a lawsuit. Here’s a quick table to break down Strickland’s points.

So, who wins? Arbitration or Lawsuit?

Obviously, it will depend on your circumstances and contractual language, but both options have their pros & cons. A key benefit in arbitration is the efficiency; with a less formal environment and the rarity of appeal, it can prevent a case from dragging on. On the flip side, construction disputes typically involve a myriad of parties, which can be easier to accommodate within a court/lawsuit setting.

Mechanic’s Liens and Discharge Bonds

Posted on January 11, 2019 by - In Other Commercial Credit News, Mechanic's Liens & Bond Claims

Mechanic’s Liens and Discharge Bonds

We know mechanic’s liens can be bonded off, we’ve discussed it before. But it’s a topic that can be quite confusing, especially when each state treats the bonds a bit differently. I recently read an article from Surety Bond Quarterly, that I found not only entertaining, but quite educational on the perks and perils of a lien discharge bond – let’s dig in!

“Mechanics’ Lien Discharge Bonds — The Substitutes of the Surety World”

In this article, written by attorneys Mike F. Pipkin and Jacob L. McBride (collectively “authors”), authors compare a lien discharge bond to a substitute teacher.

First, let’s take a moment to relive “substitute days.” Most, if not all, of us know what it was like to have a substitute teacher in school.

Walking into class to see your regular teacher has been replaced by a new face often triggered a mini-party in your head, because it meant a break from the routine, a decreased likelihood of a test, an increased likelihood of the AV club wheeling in a projector (I may be showing my age), and if you were a procrastinator, it may have given you a little extra time to finish the homework from the night before.

OK, so how is a discharge bond like a substitute teacher? According to authors, “Mechanics’ lien discharge bonds… substitute for a previously filed mechanics’ or materialman’s lien, providing relief to owners and contractors alike from the onerous procedures, rules, and remedies that such liens carry with them. They may provide added time to negotiate a settlement by substituting their own statutes of limitations. While mechanics’ lien discharge bonds are not without their risks, they offer a satisfying alternative in that owners and other stakeholders can insulate their property interests from foreclosure, while contractors have a simpler alternative to recovery than foreclosure.”

Two substitute teacher & discharge bond commonalties that jump out? Both may provide relief/reduce pressure and they may provide additional time.

There’s Always a Risk of One Kid Spoiling It for the Group

You know the kid – the one who saw the line drawn in the sand and crushed it with rude comments, long trips to the bathroom and picking on other kids. The kid that put the whole class at risk of having “quiet time” or forcing the substitute to turn off the movie.

Just as there were risks in school, there are risks with discharge bonds. Specifically, according to authors, why a discharge bond was issued to begin with. It’s important to understand, a payment bond and a discharge bond are not the same.

“Unlike a typical payment bond, issued to protect against potential future circumstances, a lien discharge bond is born out of an existing dispute over nonpayment that resulted in a lien being filed on real property. In other words, a surety executing a lien discharge bond steps into a situation where the principal is already not paying the obligee(s).”

In other words, the discharge bond is issued because there is already a payment problem. Because they are issued based on a “known” issue, the scope of the discharge bond can be limited. Authors remind us the discharge bond is frequently issued for an amount that totals the value of filed mechanic’s liens, which means it is “[U]nlike a typical payment bond with its broad scope… the scope of a lien discharge bond is limited to specific, identified lien claimants with specific, limited lien values…”

The Savvy Substitute Reigns Supreme

As a kid, I remember the different feeling between seeing a new substitute versus a seasoned veteran. A seasoned veteran knew the rules, enforced the rules, and provided a bit of relief from schooling but we knew better than to push our luck. What’s the discharge bond equivalent? Rules still apply, deadlines must be met, and statute must be complied with — from authors:

“Like the wise substitute teacher who learns and enforces the class rules, the surety can assert the defenses of its principal. Because a lien discharge bond provides substitute security for the lien, most states require a claimant to have complied with the requirements of the lien statute to make a claim on the bond. The lien discharge surety can defend against a claim by identifying any defects in the lien claim, such as failure to meet standing requirements, failure to provide proper notice, and failure to perfect the lien claim, among others. The surety may also use any substantive defenses it has available to the validity of a claim as well as applicable affirmative defenses, such as statute of limitations and waiver.”

Be aware of & follow statute carefully. Earlier this year we reviewed a case in New York where the claimant failed to follow lien statute when its lien was discharged by a bond, and lost its rights.

As a best practice in liens & in school: assume the substitute has the same authority and follow the rules, otherwise, there will be consequences.

UCCs Have Priority Over 503(b)(9) Claims

Posted on December 17, 2018 by - Credit Risk Management, UCC Financing Statements

503(b)(9) Claims & Consignment Agreements are No Match for Properly Perfected UCCs

Businesses file for bankruptcy protection; it is an unfortunate and uncontrollable reality. Considering the likelihood of debtor default, some creditors take unnecessary and avoidable risks relying on reactive recovery. Secured creditors, however, wisely mitigate these risks through the proactive protection afforded to creditors under Article 9 of the Uniform Commercial Code (UCC).

Proactive Takes Priority

It’s true. In bankruptcy, a properly perfected security interest, in compliance with UCC Article 9, has priority over unsecured creditors, creditors with administrative claims, 503(b)(9) claims, and even consignment agreements. If you attended CRF’s Fall Forum, the Bankruptcy Judge Panel – Three Judges/One Verdict reinforced the priority UCC filings have over 503(b)(9) claims and consignment agreements.

The proof is in Sections 506 & 507 of the bankruptcy code. Section 506 defines what is considered a secured claim and Section 507 dictates the payout priority of claims.

Ultimately, the payout priority in a Chapter 11 filing is:

  1. Secured Creditors (e. creditors who have a perfected security interest)
  2. Administrative Expenses (e. costs associated with filing & processing the bankruptcy)
  3. Unsecured Creditors (e. creditors without a security interest)

Secured creditors are paid before all other claims, to the extent of the pledged collateral. After secured creditors have been paid, payments are made to creditors with administrative claims. The administrative claims may include costs associated with the management of the bankruptcy (i.e. attorneys), post-petition claims and 503(b)(9) claims. Among those paid last in a bankruptcy, if paid at all, are general unsecured creditors.

“Who Needs UCCs? We File 503(b)(9) Claims”

Yes, 503(b)(9) claims can be advantageous for an unsecured creditor. The bankruptcy code was amended in 2005 to include a new administrative claim: 503(b)(9). With the addition of 503(b)(9) claims, some creditors became complacent. The availability of a 503(b)(9) claim seemed to misleadingly allay creditor concerns, “Nah, I don’t need UCC filings. We just file a 503(b)(9) to get paid.” This somewhat false sense of security can easily cost creditors millions of dollars.

Under 503(b)(9), creditors may file a claim for “the value of any goods received by the debtor within the 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.”

As you can imagine, there are challenges with 503(b)(9) claims. High-profile cases are in heated debate over the definition of “received by” for the 20 day rule. And, of course, there is the question of what constitutes a “good” because services are not covered under these claims, and whether those goods have been sold in the ordinary course of business.

As an aside, a member of the panel at CRF’s Fall Forum, Judge Christopher S. Sontchi, Chief Judge of The United States Bankruptcy Court for the District of Delaware, has presided over several cases determining “goods” and “receipt.” Notably, in one case, Judge Sontchi looked to the UCC definition of goods and subsequently held that electricity is not a “good” under 503(b)(9).

To be clear, a UCC filing is not without potential obstacles. Your UCC must be properly perfected and there is a narrow margin for error. But, ensuring a UCC has been properly perfected is less cumbersome than proving goods are goods, defining date of receipt and verifying goods are sold during ordinary course of business.

We Sell on Consignment, No UCC Necessary

“Why would I file a UCC if I’m selling on consignment?” Because the law allows you to establish priority as a secured creditor! A simple consignment agreement is often viewed by the courts as a “secret lien” and may not be enough to protect you if your debtor defaults or files for bankruptcy protection, as there is no legal/recorded document identifying your title to the goods provided to the debtor.

If the debtor files for bankruptcy protection, the inventory the debtor has on hand is gathered up and sold off to pay creditors (secured creditors first and then the unsecured creditors). Without the UCC filing identifying you as a secured creditor and specifically identifying your goods, the inventory you supplied automatically becomes property of the estate.

Is a UCC required for consignment sales? No. Creditors are not required to file a UCC. In default or bankruptcy situations, when a creditor is selling on consignment, there is a chance the creditor could argue it is “commonly understood” the debtor engages in consignment sales. But making that argument seems shaky at best, not to mention inefficient – how much time would it take to successfully make that argument vs. filing the UCC and granting a security interest at the beginning of the relationship?

UCCs are Payment Priority

Please understand, UCCs are not a guarantee; there are no recovery guarantees in bankruptcy; after all, 100% of nothing is nothing. However, without a properly perfected UCC, you are just another unsecured creditor, wading in an overcrowded shallow pool for payment. With a properly perfected UCC, you are a payment priority.

Article was originally published in the Credit Research Foundation 4Q 2018 CRF News