Agencies could pay if they give certain clients too much credit

In today's economic climate, PR firms need to be increasingly careful about the clients with whom they choose to do business and even more careful about the credit terms under which they do so.

In today's economic climate, PR firms need to be increasingly careful about the clients with whom they choose to do business and even more careful about the credit terms under which they do so. Crisis communications, in particular, require rapid and intensive action. There is often little time to consider the potential exposure to the PR firm should its client present a serious credit risk or, worse yet, file for bankruptcy. 

PR firms, like other unsecured creditors, are often shocked to learn they might be forced to return money to their former client if and when that client files for bankruptcy. A debtor or a trustee of the debtor can seek the return of payments made to any vendor (including a PR firm) within the 90 days preceding the filing of bankruptcy.

In order to do this, these payments must be deemed “preferential” – that is, if the PR firm receives payment from its client of a greater percentage of its claim than it would otherwise have received in the distribution of the assets of the bankrupt estate. This is almost always the case when a company is approaching insolvency. Thus, it is vital for companies, including PR firms, doing business with an entity that might file for bankruptcy to take advantage of the simple preventive measures available to reduce, if not avoid altogether, this preference exposure. There are at least two simple ways to do so:

1. Minimize liability through contract. A payment can only be preferential if it is for what the bankruptcy law calls an “antecedent debt” (which is a past due account). One way to avoid preference liability, therefore, is to require contractually that payments for services be made in advance of performance

Just as important as the language in the agency-client contract, however, is ensuring its proper implementation. Even if advance payments are required by contract, payments will be considered preferential and subject to “claw back” or refund if services are performed before a payment clears. Therefore, PR firms should insist on wire transfers or immediately deposit money received, since the “clear” date and not the “date of receipt” is what courts use to determine whether a payment falls within the 90-day preference period.

2. Make sure payments are made in the “ordinary course of business.” The bankruptcy law provides various defenses that an unsecured creditor, such as a PR firm, may assert to avoid having to return money to a trustee in bankruptcy. One example is the “ordinary course of business” defense.

For this defense to apply, the transfer must be a payment of a debt that was incurred by the debtor in its ordinary course of business and made according to ordinary business terms. Thus, firms must keep in mind any sudden changes in the timing of payments and collections to make sure they can take advantage of the “ordinary course of business” defense.

Other factors to keep an eye on include:

Sudden changes in timing of payments. The “ordinary course of business” defense might not be accepted if an alleged preferential payment is made either more quickly, or is significantly delayed, compared to prior historical payments. As such, a PR firm that is owed money by a client that might become insolvent should be aware of the amount of time it typically takes a debtor to pay and should be wary of any drastic deviations from normal practice. This could mean a PR firm should consider either stopping work or altering payment terms to insist on advance payments going forward if a client shows signs of financial distress by a sudden change in its payment practices.

Collection methods. Courts evaluate the intensity of collection efforts during the 90-day preference period to determine whether they deviate from collection efforts made prior to the preference period. Collection efforts that precede preference payments that are more intense than the historical level of collection activity can result in courts finding the “ordinary course of business” defense to be inapplicable. 

A PR firm might determine that the benefit of continuing to do business with a client is worth the risk of potential preference exposure in the event the client files for bankruptcy. Conversely, that agency could decide to end that client relationship because it concludes that the benefits do not outweigh the risk.

At minimum, good business and legal practices suggest that the actions identified in this column will reduce the risk that a PR firm will be required to return a payment made by its client. While some level of risk is inevitable, the old adage “an ounce of prevention can be worth a pound of cure” is fully applicable to this situation.

Michael Lasky is a senior partner at the law firm of Davis & Gilbert LLP, where he heads the PR practice group and co-chairs the litigation department. He can be reached at mlasky@dglaw.com.

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