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2018 Legal Seminar for Credit Professionals


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Kegler Brown’s 2018 half-day legal seminar with guest speakers Scott Goen of Cardinal Health and Rebekah Smith of GBQ Consulting, alongside our Creditors’ Rights + Bankruptcy team.

Topics Included:

Hot Topics in 2018:
Christy Prince, Director, Kegler Brown
Stephanie Union, Of Counsel, Kegler Brown

Identifying Warning Signs in Financial Statements:
Rebekah Smith, CPA, CVA, MAFF, CFF
Director of Forensic & Dispute Advisory Services, GBQ

Best Practices: Designing Credit Applications:
Larry McClatchey, Director, Kegler Brown
Scott Goen, Manager, Credit Underwriting Retail, Cardinal Health

Strategies to Optimize Financial Outcomes in Cross Border Transactions:
Luis Alcalde, Of Counsel, Kegler Brown

Published in: Business
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2018 Legal Seminar for Credit Professionals

  1. 1. z
  2. 2. z Presented by Christy Prince + Stephanie Union
  3. 3. z Receiverships1
  4. 4. z A state court way to liquidate or turn around a company Typically filed by creditors who have a large stake in seeing the debtor liquidated or rehabilitated
  5. 5. z
  6. 6. z THE RECEIVER is supposed to be a neutral, disinterested third party. However, generally the creditor selects the receiver so often there is a relationship between the two. THE CREDITOR has to give notice of the potential appointment to parties in interest so that they have the opportunity to object.
  7. 7. z THE CREDITOR often has a large say in dictating who is appointed as received, although the court has final approval over the appointment. THE PARTY SEEKING APPOINTMENT of a receiver typically suggests one. Although the appointment of that person is not binding on the court, consideration is given to that person.
  8. 8. z A hybrid between a state court action and a bankruptcy Filed in Common Pleas Court so state laws apply
  9. 9. z In Ohio, there are not a lot of laws relating to how, when and why a receivership can be filed In Bankruptcy, there are a lot of rules and a lot of caselaw discussing those rules
  10. 10. z It is generally much less costly to have a receiver appointed than to put a debtor into involuntary bankruptcy.
  11. 11. z Ohio Revised Code 2735.01
  12. 12. z Under ORC 2735.01, a receiver can be appointed in any of the following situations: (1) In an action by a vendor to vacate a fraudulent purchase of property, or by a creditor to subject property or a fund to the creditor's claim, or between partners or others jointly owning or interested in any property or fund, on the application of the plaintiff, or of a party whose right to or interest in the property or fund, or the proceeds of the property or fund, is probable, and when it is shown that the property or fund is in danger of being lost, removed, or materially injured; (2) In an action by a mortgagee, for the foreclosure of the mortgagee's mortgage and sale of the mortgaged property, when it appears that the mortgaged property is in danger of being lost, removed, materially injured, diminished in value, or squandered, or that the condition of the mortgage has not been performed, and either of the following applies: (a) The property is probably insufficient to discharge the mortgage debt. (b) The mortgagor has consented in writing to the appointment of a receiver. (3) To enforce a contractual assignment of rents and leases; (4) After judgment, to carry the judgment into effect; (5) After judgment, to dispose of the property according to the judgment, or to preserve it during the pendency of an appeal, or when an execution has been returned unsatisfied and the judgment debtor refuses to apply the property in satisfaction of the judgment; (6) When a corporation, limited liability company, partnership, limited partnership, or other entity has been dissolved, is insolvent, is in imminent danger of insolvency, or has forfeited its corporate, limited liability company, partnership, limited partnership, or other entity rights; (7) In all other cases in which receivers have been appointed by the usages of equity.
  13. 13. z THE RECEIVER has to swear to perform faithfully his duties and typically must post a bond, as directed by the court, to ensure he does so comply with his duties and the court’s orders. The receiver has fiduciary duties to the estate and the assets in it. THE RECEIVER will act similarly to a bankruptcy trustee, either running the business or liquidating it to benefit all creditors.
  14. 14. z Bring and defend actions in the receiver's own name as receiver Take and keep possession of real or personal property Collect rents and compromise demands; Enter into contracts Sell and make transfers of property Execute deeds, leases, or other documents of conveyance of property Open and maintain deposit accounts in the receiver's name Generally do any other acts that the court authorizes Ohio Revised Code 2735.04(B) Powers of Receivers
  15. 15. z
  16. 16. z Receivership Law Changes 2016 Allows for sale of property fee and clear of liens, subject to court approval Requires the court to establish a reasonable time to exercise that redemption Mortgager can consent in writing to the appointment of a receiver The receiver can hire his or her own counsel and both are paid upon application to the court from proceeds of running the business or liquidating it
  17. 17. z There are some code sections devoted to how and when a receiver can sell real property: 1 giving notice to other creditors with liens on it 2 setting forth the proposed procedures 3 after application to the court
  18. 18. z
  19. 19. z Demands for turnover of your accounts payable 2
  20. 20. z Your company owes money to its vendors Its vendors owe money to the vendor’s creditors Different from a sale or assignment of A/R
  21. 21. z Why Should You Care?
  22. 22. z Because if you receive a valid turnover demand and pay the wrong entity… YOU STILL OWE THE DEBT
  23. 23. z Because if you receive an invalid turnover demand and pay the wrong entity… YOU STILL OWE THE DEBT
  24. 24. z Is this a demand for turnover of money that your company owes to its vendor?
  25. 25. z
  26. 26. z It’s likely that you will not recognize the name of the creditor since it’s not your vendor
  27. 27. z A Demand Letter Indicating: Copy of Agreement Vendor Gave Creditor Copy of UCC-1 Financing Statement Sender is a creditor of your vendor Vendor gave creditor security interest in its A/R How much is owed to the creditor Who to contact if you have questions
  28. 28. z Steps to analyze a demand for turnover of accounts payable owed to a vendor based on a creditor’s security interest in the accounts
  29. 29. z Compare the named recipient with the name on the invoices from the customer 1
  30. 30. z Consider whether the recipient has an existing right of setoff against the funds 2
  31. 31. z Review the documents included with the demand to confirm the legitimacy of the request 3
  32. 32. z Consider whether specific exemptions apply 4
  33. 33. z Tell the vendor about the letter 5
  34. 34. z Continue to send future A/P to the creditor 6
  35. 35. z Cost Management in Litigation 3
  36. 36. z One of the best way to save future costs in litigation is to get more information up front At the start of a relationship, get all information available and ensure it is correct
  37. 37. z Another key is to keep after receivables while they are still fresh If you find yourself unable to collect, consider getting an attorney involved early Consider having a mediation or arbitration clause in your contract
  38. 38. z Confidential and non- binding Can be conducted by the court at no cost Parties usually agree to split costs when hiring private mediators Help parties see strengths + weakness of their case to reach an agreement Mediation
  39. 39. z Binding Usually a 3- member panel, all paid for their time Like a mini- trial, often done before extensive discovery Can be just as expensive as a trial Arbitration
  40. 40. z 90 %+ of all cases settle before they reach a verdict
  41. 41. z Engage an attorney that believes in settlement discussions early + often After discovery, it should be time to discuss settlement Often times, settlement discussions are more fruitful when all parties are present, in the same room
  42. 42. z Preference Update4
  43. 43. z Transfers or payments made by a bankruptcy debtor to its creditor within the 90 days prior to the debtor filing a bankruptcy petition Recover payments made to unsecured creditors right before the bankruptcy, then split those payments among all unsecured creditors It doesn’t matter if the creditor knew the debtor was on unstable financial ground when debtor made the payment
  44. 44. z Elements of a Preferential Transfer 5
  45. 45. z The transfer is made to or for the benefit of a creditor 1
  46. 46. z The transfer is made on account of a pre-existing debt owed by the debtor 2
  47. 47. z The debtor was insolvent at the time of the transfer 3
  48. 48. z Time span for preference period 4
  49. 49. z The transfer enables the creditor to receive more than the creditor would 5
  50. 50. z Status as a secured creditor – entitled to retain money to extent of collateral value Subsequent new value – creditor supplied new value after receiving the payment Contemporaneous exchange defense
  51. 51. z Ordinary Course of Business
  52. 52. z Debt incurred in the ordinary course of business between debtor + creditor Ordinary Course of BUSINESS Compare the preference period payment pattern to the historical payment pattern The more similar the historical conduct to the preference period conduct, the more likely payment is shielded by subjective OCB defense
  53. 53. z Much harder to use if the creditor and debtor do not have a long pre- bankruptcy course of dealing Possible Subjective OCB Defense PROBLEMS Creditor and bankruptcy trustee will probably disagree over how to measure similarities Look at any ultimatums, threats to cease shipping, reduction of existing credit terms, imposition of new charges and response to new of financial decline
  54. 54. z
  55. 55. z
  56. 56. z Christy Prince Director 614-462-5444 Stephanie Union Of Counsel 614-462-5487
  57. 57. Identifying Warning Signs in Financial Statements Presentation to the 2018 Legal Seminar For Credit Professionals June 14, 2018
  58. 58. Rebekah A. Smith, CPA, CFF, CVA, MAFF Director of Forensic and Dispute Advisory Services GBQ Consulting LLC 230 West Street Suite 700 Columbus, Ohio 43215 614.947.5300 Today’s Presenter 58
  59. 59. This seminar will cover the following topics: 1. What warning signs of financial distress can be found in a company’s financial statements? 2. What tools can be used to uncover these warning signs? Seminar Objectives 59
  60. 60. 60
  61. 61. Financial Statements – the “history books” of business • Three statements are most common: 1. Balance Sheet 2. Income Statement 3. Cash Flow Statement • Each statement has unique purpose but information is referenced between the three statements • Financial Statements tell the story of the company and its operations • What can the past tell us about the future? Understanding Financial Statements 61
  62. 62. Footnotes to Financial Statements • Typically more comprehensive for publicly traded companies • May provide additional information about financial risks and other potential liabilities • May describe company operations and business units • Discloses key accounting policies and significant management estimates • Discloses intercompany relationships (e.g., with subsidiary companies) • May provide financial results by business segment 62
  63. 63. Warning Signs and Tools to Identify Them
  64. 64. • If the auditor determines that the company is troubled enough that it might not last through the next 12 months, a paragraph will be added to the audit report: “The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note X to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note X. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.” Going Concern Opinion from Auditor 64
  65. 65. • Lenders often require that borrowers provide annual financial statements – often audited or reviewed financial statements • These statements are often required within a certain time after year end – 30 or 60 days • What might late financial statements indicate? • The reasons for late financial statements should be thoroughly explored with the company • and its accountant, if possible Late Financial Statements 65
  66. 66. • Debt covenants are designed to protect the lender and require specific actions by the borrower. For example: • Maintain certain earnings levels • Maintain a certain cash balance • Restrict distributions • Require certain financial ratios be met • Failure to meet these covenants indicate a level of financial distress and may result in an acceleration of debt maturity dates that will be reflected in the financial statements and notes. • Companies can obtain waivers of covenant violations that may not be reflected in the financial statements • A separate question to management may be needed Debt Covenant Violations or Waivers 66
  67. 67. • Will be reflected on Income Statement • Declining revenues may be the result of: • Waning demand for the company’s goods or services • The loss of a significant customer (customer concentrations are disclosed in the footnotes) • The entrance of a new competitor • A change in technology • A change in economic, industry or market conditions • A significant decrease in revenues from one year to the next should be explored with management • Management should have plan to respond or address the change in revenue levels • May take time to reduce fix costs Decreases in Revenues 67
  68. 68. • Will be reflected on Income Statement • Increases in sales returns and warranty allowances may indicate: • A decrease in the quality of manufacturing • A new supplier provider lower quality raw materials • Weakening demand for the company’s product • Financial statements including only “Net Revenues” will not detail returns and warranty allowances • Management will be able to provide both gross sales and deductions from gross sales to arrive at net sales Increases in Sales Returns and Warranty Expense 68
  69. 69. • Will be reflected on Income Statement • Reductions in payroll expense may indicate that the company has reduced its workforce • Financial statements may also reflect additional expenses to account for future severance payments • Changes in employee levels may be made in response to financial issues that the company is experiencing or knows are coming Reductions in Payroll Expense 69
  70. 70. • Will be reflected on Statement of Cash Flows and Balance Sheet • Will be reflected by declining (or even negative) cash balance on Balance Sheet • Companies can use more cash than they generate for short periods of time • However, negative cash flow cannot continue in the long-term • Additional equity will be needed • Additional borrowing will be needed Negative Cash Flow 70
  71. 71. • Calculated from Balance Sheet accounts • Working Capital = Current Assets less Current Liabilities • Most commonly used measure of liquidity • Indicates company’s ability to pay its short-term liabilities • Measured by calculating the Current Ratio • A current ratio of more than 1 is “better” • Can be compared to industry norms to determine adequacy for a given company Decreasing or Negative Working Capital 71 Current Ratio = Current Assets Current Liabilities
  72. 72. Increasing Inventory Levels 72 • Will be reflected on Balance Sheet and Statement of Cash Flows • Indicates that the company is producing more products than it is selling • May indicate that company’s sales are slowing Inventory Turns Total Net Sales Average Inventory Balance =
  73. 73. Increasing Accounts Receivable Balance 73 • Will be reflected on Balance Sheet and Statement of Cash Flows • Indicates that company is not receiving payments from its customers in as timely a fashion • May be caused by financial weakness of customer • May be caused by overall economic or market conditions • May indicate lack of customer satisfaction with company AR Turns Total Net Sales Average AR Balance =
  74. 74. Increasing Accounts Payable Balances 74 • Will be reflected on Balance Sheet and Statement of Cash Flows • Indicates that company is not paying its suppliers and vendors in a timely fashion • Company may be trying to retain cash • Creates risk of disruption in supply chain if vendors or suppliers require cash on delivery or change credit terms
  75. 75. Increasing or Flat Debt Balances 75 • Will be reflected on Balance Sheet and Statement of Cash Flows • Inability to make principal payments on loan balances will result in flat debt balances from period to period • Additional borrowings will result in increased debt balances from period to period • Company may be making interest only payments resulting in flat debt balances Debt to Equity Ratio Total Debt Equity =
  76. 76. Increasing Accrued Interest 76 • Will be reflected on Balance Sheet • May indicate that company is not making debt service payments in a timely fashion Interest Coverage Ratio EBIT Interest Exp. =
  77. 77. Increasing Loans from Shareholders 77 • Will be reflected on Balance Sheet and Statement of Cash Flows • In the absence of other funding sources, shareholders may have to provide additional funding • Why are shareholders making additional loans? • Are there terms (interest rate and payments, payback terms and period, etc.) to the loan similar to third party funding?
  78. 78. Decreasing Levels of Capital Expenditures 78 • Will be reflected on Statement of Cash Flows • Companies need to invest to maintain grow and maintain the assets used to generate their revenues • Lack of capital expenditures may indicate a lack of capital or funding to make needed purchases of fixed assets • Similar to “deferred maintenance” • May be acceptable over a short period of time but is not sustainable in the longer-term
  79. 79. Discontinued Operations on Income Statement 79 • Will be disclosed on Income Statement and Footnotes to the Financial Statements • Reflects operations that have been dis-continued: • A location • A division • A business line • Perhaps due to financial weakness • Accounts for all future costs estimated to be incurred related to the discontinued operation
  80. 80. Concentrations 80 • Will be disclosed in the Footnotes to Financial Statements • Customer Concentration – indicates a risk of revenue loss if one or more large customers stop buying • Supplier Concentration – indicates a risk of production interruptions or increased costs if supplier stops selling • Geographic Concentration – indicates a risk of revenue loss if a geographic region (e.g., a foreign country) becomes de-stabilized
  81. 81. Related Party Transactions 81 • Will be disclosed in the Footnotes to the Financial Statements • May indicate transactions that are not at “arms-length” • Related parties often own real estate and lease it to the company • Is the rent paid above or below market? • Financial strength of the related parties may also have to be assessed • If the related party provides financing for the company and it fails, where will the company obtain funding?
  82. 82. • Change in economic, industry or market conditions • Is the overall economy expanding or contracting • Is the company’s industry healthy • Change in competitive landscape • New competitors? • Failed competitors? • Change in business strategy or direction • May indicate a lack of confidence in current products or services Non Financial Statement Warning Signs 82
  83. 83. • Change in technology • “Big” floppy discs, “small” floppy discs, CDs, memory sticks, FTP portals and web transfer • Change in senior management • From an accounting perspective, particularly of the CFO or Controller • Change in accountants • May indicate a disagreement over accounting standards and their application Non Financial Statement Warning Signs 83
  84. 84. Questions and Wrap-Up Thank you!
  85. 85. z Presented by Scott Goen, Cardinal Health + Larry J. McClatchey, Kegler Brown BEST PRACTICES Designing Credit Applications
  86. 86. z CREDITis an important tool for business Accounts receivable may be your largest asset View as “loan application” Used to get information about prospective customer
  87. 87. z EVALUATE risk of credit and how much to allow for how long Can include terms and conditions that bind customer Should be reviewed periodically as a monitoring tool Useful as last resort in enforcement + collection
  88. 88. z WHO’S Asking?
  89. 89. z Correct name and/or trade name of customer Legal form in which business is conducted Tax identification number (EIN) for applicant Applicant email + website Industry and product or service supplied
  90. 90. z HOW Much?
  91. 91. z Applicant’s projected annual or monthly purchases Amount of credit requested
  92. 92. z CREDIT Worthiness?
  93. 93. z Approximate annual sales and years in business Numbers of employees Bank reference Trade references » Authorization to bank and trade to release account information » Retain right to receive and exchange information from other creditors » Obtain permission to do credit investigation, especially individuals » Retain discretionary right to revoke or modify credit terms
  94. 94. z BILLING + Payment Requirements
  95. 95. z Purchase order requirements of applicant Addresses to which goods will be delivered Phone and fax numbers Tax exemption certificate
  96. 96. z ASSURANCES From Applicant
  97. 97. z Signer verifies accuracy of information Applicant grants right to obtain new credit reports, as needed Signer’s authority to bind applicant Signer’s title + date of application Applicant required to notify of change in information provided Right to rely on information unless changed in writing
  98. 98. z AGREEMENT to Terms + Conditions
  99. 99. z AGREES to be bound by Terms and Conditions State or summarize terms and conditions of sale Use of website posting of terms Disclaim any oral modifications of credit terms
  100. 100. z MOST IMPORTANT Terms
  101. 101. z Reserve right to revoke or limit credit at any time State circumstances under which credit automatically revoked Include agreement to pay interest on past due accounts Include requirement that customer pay attorneys fees and court costs Have customer agree to place of filing suit to collect and applicable law Include Ohio and federal ECOA disclosures
  102. 102. z OTHER DESIRABLE Terms
  103. 103. z Policy on overdue invoices Discounts, authorized + unauthorized Agreement for arbitration rather than suit, if desired Special address to which disputes over billing should be sent
  104. 104. z Require notification of changes in address, ownership, etc. State when new application will be required Provide that your successors can rely on and enforce terms Recite business use of credit and disclaim consumer transaction Consider inactivity fee or abandonment of credit balances
  105. 105. z PERSONAL Guarantees
  106. 106. z Consult credit policy on when to use – be objective and consistent Guarantee is not needed for proprietors or general partnerships Should be used with limited partnerships and LLCs Guaranty MUST be in writing to be enforced
  107. 107. z Should guarantee prompt performance by customer of ALL terms, not just prompt payment Should be continuing and irrevocable as long as credit line is open Guarantor not given right to revoke Guarantee unaffected by credit decisions made regarding customer
  108. 108. z Unaffected by changes of name or location of customer Require guarantor to notify of any change in ownership Should cover any preferences that must be returned Include authorization to run consumer credit report from time to time
  109. 109. z Larry McClatchey Director, Kegler Brown 614-462-5463 Scott Goen Manager, Credit Underwriting Retail Cardinal Health
  110. 110. z STRATEGIES to Optimize Financial Outcomes in Cross-Border Transactions Presented by Luis Manuel Alcalde
  111. 111. z What We Will Review Due Diligence Structuring the Transaction Contracts + Contract Clauses
  112. 112. z Due Diligence 1
  113. 113. z DUE DILIGENCE “The detailed examination of a company and its financial records, done before becoming involved in a business arrangement with it.”
  114. 114. z Due diligence needs to fit the circumstances Different Due diligence needed for: Deal with Caterpillar subsidiary in E.U. Deal with subsidiary of Sonogal in Angola Deal with a small company in Mexico
  115. 115. z Due diligence is not easy around the world U.S. information access is not the norm Data privacy strict in China Private investigators/investigations against Chinese law Dun & Bradstreet – SEC $9 million fine FCPA bribery charges to obtain China information General Data Protection Regulation (GDPR) will restrict information in EU
  116. 116. z Information from a Foreign Party Credit application/questionnaire Credit + banking references Identification of related parties and principal customers Waiver/consent to verify information and/or references Foreign government involvement requires FCPA due diligence to augment commercial due diligence
  117. 117. z Additional Risks in Cross-Border Credit Political risks that can affect payment Environmental risks + natural disasters Currency exchange rate fluctuations impact on debtor’s business and ability to pay Bilateral Investment Treaty
  118. 118. z Structuring the Transaction 2
  119. 119. z Structuring the transaction to optimize success Sales Price Reflective of Net Risks Front- Loaded Payment Terms Letters of Credit Escrow of Specified Funds Guarantees + Surety Bonds
  120. 120. z Types of Guarantees Payment Guarantee Collection Guarantee Limited vs. Unlimited Guarantee Absolute vs. Conditional Guarantee
  121. 121. z Political Risk Insurance Nationalization or Expropriation Currency Inconvertibility Political Violence Acts of Terrorism Host government breach
  122. 122. z Contracts + Contract Clauses 3
  123. 123. z Addressing risk mitigation strategies Front- Loaded Payment Terms Commercial Letter of Credit Escrow of Specified Funds Security Interest in Obligor’s Properties Guarantees + Surety Bonds
  124. 124. z Contract CLAUSES Termination Clauses for Non-Payment Termination Clauses Triggering Escrow, Guarantees, Sureties Liquidated Damages Clauses Stabilization Clauses
  125. 125. z Luis Alcalde Kegler Brown Hill + Ritter 614-462-5454
  126. 126. z