Should you sell on a secured or unsecured basis?
Successful businesses must prepare for potential problems and possible solutions related to selling to and buying from companies that are insolvent, or may become so. Here are some considerations in that regard.
An important business decision is whether to sell to customers on a secured or unsecured basis. If you are secured, you are more likely to get paid or you can retrieve your inventory or potentially receive adequate protection in a bankruptcy case. Alternatively, if you are unsecured and have no reclamation rights, you are less likely to get paid. You can ship on a COD basis for additional sales, but you will generally not collect prior outstanding balances. Of course, credit policy must be balanced against your overall profit, as a tighter credit policy may reduce sales. Additionally, your customers may have a secured lending arrangement with their primary lender, in which case your security interest in the products you sell may reduce your customer's credit availability with its primary lender.
To become secured, a valid security agreement, setting forth your customer's correct legal name and a description of your collateral, must be signed by your customer, and your security interest then must be properly perfected according to applicable law. Be sure to obtain and review copies of your customer's organizational documents and identify any other liens that may take priority over your interest. In most states, online searches are available. Once perfected, secured parties should create a tickler system to monitor expiring financing statements and notice periods for purchase-money security interests.
Additionally, consider proactively addressing potential disputes with other secured creditors before a problem arises. For example, if the goods in which you have a security interest are incorporated into other goods, disputes could arise over allocation of proceeds. Where certain disputes are foreseeable, consider entering into inter-creditor agreements. Also, identify goods that may be subject to a purchase-money security interest, and send notice of a purchase money security interest to any blanket lienholder. Moreover, analyze how your customer's credit practices may affect your collateral. For example, if your lien continues in identifiable cash proceeds, but not in receivables, consider whether your customer generates receivables. If so, is there a way to create a mechanism to segregate cash proceeds to be identifiable as proceeds from sales of your inventory?
On the other hand, when dealing with suppliers, consider whether you may be purchasing goods that are subject to liens in favor of your supplier's creditor. Generally, a sale of inventory in the ordinary course of business cuts off a lien granted by a supplier to its creditor, so a buyer in the ordinary course purchases free and clear of any security interest created by its seller. Also, if the goods you purchase have been “identified to the contract,” they probably will be safe from creditors of your supplier. Alternatively, if certain goods are not “identified to the contract,” and you have not received the goods, you may run the risk of creditors of your supplier retaining a lien, even if you have made substantial payments towards the purchase of those goods.
In summary, as with any contract, examine your contracts related to the sale or acquisition of goods carefully. If you are dealing with a sales contract, consider whether you are comfortable with your credit policy and options to obtain proper security. If you are dealing with a purchase agreement, consider whether the goods you are purchasing are sufficiently identified. If not, you may need to create better identification of those goods to the relevant contract, so you may receive the goods free and clear of any lien upon paying the final amount due under the contract.
J. Brian Hittinger, is a partner with the law firm of Krieg DeVault LLP and the executive partner of the firm's Northwest Indiana office. Patrick A. Brennan is an associate with the firm.
