What’s Your Team’s DNA, Accommodative or Punitive? How to Rebuff the Terms Pushback Strategy

A payment trend affecting credit across all industries is customers disregarding vendor-set trade terms and unilaterally extending these terms to better fit their working capita] and cash flow needs, a trend known as the terms pushback strategy (TPS). According to Sageworks' 2013 Private Company Report, private US companies reported a 7.4-day increase in their average accounts receivable days (37.9-45.3 days) in the last year alone. This is despite the fact that customers are sitting on record cash holdings.

While pushing back on terms gives customers a lessexpensive financing option and improves their working capital (as well as a best practice according to the customer's finance team), the TPS negatively affects a vendor's DSO and cash flow. The credit team attempting to preserve a trade relationship has a balancing of interests where the customer (whether financially sound or strained) has pushed invoices past normal terms or threatens to do so with new orders. How can the credit team keep customers within normal terms when faced with a customer's TPS? The credit team's decision tree when responding to a TPS may be to consent to extended terms, negotiate incentives to keep the customer within terms (accommodative) or reject the TPS and create consequences for the customer breaking their payment promise (where invoices are outstanding) or with new orders. The decision tree branch the vendor ultimately adopts is one based on consultation with the credit and sales teams and management.

Formal TPS or Ad Hoc

TPS can be either formal or ad hoc. The formal TPS, or the Customer Payment-Term-Pushback Program (CPTPP), is rolled out to all of the customer's vendors. The ad hoc or informal TPS singles out certain vendors.

To ferret out whether the customer's TPS is ad hoc, the credit team can benefit from industry group member- ship as they may inquire of group members selling to the customer whether they have also received a TPS notice from the customer. With the privately-held customer attempting to roll out a TPS, the customer may say they have extended terms commitments with key suppliers. However, the industry group inquiry may show otherwise. Industry group inquiries as to whether the customer has requested extended terms from competitors is fine, but industry group members cannot agree to reject the TPS and keep the customer on normal terms, as that may violate the Sherman Act and the anticompetitive provisions.

The Accommodative Approach: The Vendor's Control over the Terms Relationship May Be Slipping (So Let's Create Some Incentives and Principled Responses to Keep the Customer within Normal Terms)

It may not be the credit team's sole decision to cut off credit when a customer adopts a TPS, especially if the vendor is a smaller company selling to a larger customer that is a significant source of revenue. That is a decision that may be reserved for management. To that end, the following "accommodative" responses to a customer's TPS may be in line with sales and management's position.

No Meaningful Competitive Advantage

Before responding to a customer's TPS, the vendor should consider its relationship with the customer and where they fit in the customer's supply chain. Are they a critical supplier, providing an indispensible product or service? Or are they just one of numerous competitors vying for the same customer's business and can therefore be easily replaced? Vendors who have a reputation for quality and service may have more leverage.

Principled Responses to Keep within Normal Terms Cannot Single Out Terms. The customer must appreciate that terms are but one component of the overall price of the product or service. The customer cannot single out terms alone through a TPS program as it upsets the entire pricing package the vendor has offered.

Two Price Lists. The vendor may have two price lists: one for normal credit terms and a second for extended terms. While the strategy of charging an increased price for extended terms might appear (from the customers point of view) to be more punitive than accommodative, the vendor is still acquiescing to extended terms and is accommodating the customer and its cash flow constraints. This compromise benefits both the customer and vendor. The customer may pay beyond normal terms for a fee, but is incentivized to pay within terms, while the vendor offsets the potential gaps in payment with a price increase for extended terms.

Invoking the Robinson-Patman Act. In response to a customer's TPS, the vendor may advise the customer that the Robinson-Patman Act (RPA) bars them from extending more favorable prices and/or terms to one customer without extending comparable prices and terms to similarly-situated customers. If another customer occupies the same functional level (i.e., wholesaler, retailer, etc.), does business in the same geographic region and buys the same type of product (i.e., grade and quality) as the customer requesting TPS, the vendor may respond that the extended terms may constitute discriminatory terms under the RPA. The credit team may respond to the customer's TPS with "We would like to accommodate extended terms, but the RPA prevents us. You are classed with customers who are granted normal terms." This attempts to bridge the gap between the customer's strategy to improve its cash flow and the vendor's detrimented DSO. The vendor may underscore to the customer that, under the RPA, allowing a customer to set extended terms (or other vendor concessions) is no different than the vendor setting extended terms as to compliance with the like-class rule. The extended terms are still the terms of the trade relationship and if they differ from the terms extended to another similarly-situated customer, the vendor has discriminated in favor of the customer setting terms.

Contract Controls. If the vendor and customer have negotiated a supply contract that provides for trade terms, the vendor may respond to the TPS by advising that the customer is bound by these terms for the duration of the contract. However, under a purchase order or invoice-based relationship, the customer is not bound to terms beyond the fulfillment of the P.O. or invoice. A larger question for the vendor is whether to use supply contracts preemptively to lock a customer into normal credit terms for a period of time, say a year or two. This preemptive strategy may be appropriate when a vendor's key customers are pushing for extended terms.

Loan Covenants. If a vendor receives financing from an assetbased lender, the loan covenants under that financing may bar receivables older than 60 days from qualifying for the loan's borrowing base. In this setting, the vendor can use its own financing arrangement as justification to deny a customer's TPS request.

Credit Insurance Limitations. If the vendor backstops the customer's credit risk with credit insurance, the credit insurer may have credit terms that the customer cannot exceed or the policy may not be enforced. The vendor can use the credit insurer's terms limitations as grounds to push back on the TPS.

Vendor-Sponsored Incentives to Keep within Normal Terms

Early-Pay Discount. To incentivize the customer to pay early or not later than normal terms, the vendor may offer an early pay discount, say 10 days from issuance of the invoice.

Annual Volume Rebate Award and Other Trade Concessions. To keep the customer within terms, the vendor may reward the customer with an annual rebate based on volume. However, the vendor can condition awarding the annual rebate based on compliance with the vendor's normal credit terms. Likewise, the vendor may consider other rewards, such as promotions, if the customer pays within normal terms.

Credit Cards. The vendor may propose a credit card payment agreement, as the customer receives additional time to pay when a card is used to pay an invoice. To cash-strapped customers, credit cards are a source of financing. To the vendor, cards mean immediate payment.

When the Customer Succeeds with Its Extended Terms Request

The customer may prevail on its request for extended terms. In this setting, the credit team should negotiate some benefits and protections.

Exclusive Supply Agreement in Exchange for Extended Terms. If the vendor is forced to negotiate extended terms, the vendor may condition extended terms on an exclusive supply contract. The exclusivity for the vendor provides volume and greater revenue.

Call in the Teams. The vendor should include its sales team and the customer's purchasing team in negotiations.

ACH Payment. The vendor should insist on ACH payment agreement as a condition to extended terms. The ACH should reduce the risk of "terms creep" and the "check is in the mail" excuse when the extended terms invoice is due.

Credit Enhancements and Credit Application Terms. If the vendors incentives are insufficient to keep the customer within normal terms because of the vendors competitive market niche and the risk of losing the customer's business, the vendor may consider credit enhancements to backstop the risk of loss tied to extended terms. With new orders and extended terms, the following may be negotiated:

Personal Guarantee. Future orders with a corporate customer are contingent on the principal of the customer personally guaranteeing the credit sale.

Cross-Corporate Guarantee. The customers corporate affiliate guarantees the debt of the customer.

Purchase Money Security Interest. A security agreement is negotiated where the goods covered in favor of the vendor are identified, and then a security interest is perfected by filing a UCC-1 financing statement with the appropriate filing office (i.e., Secretary of State).

Consignment. A security interest in inventory is created by executing an agreement with the customer, describing the trade relationship (vendor as consignor and customer as consignee) and the goods covered by the consignment agreement. The vendor then files a UCC-1 financing statement at the appropriate filing office.

Letter of Credit. A letter of credit is a promise by a bank, independent of the underlying supply contract, to pay the vendor when the customer defaults on the credit sale.

Credit Insurance. Credit insurance is purchased to protect against the customers bankruptcy, default or dispute. The vendor retains control of the accounts receivable, while the credit insurer covers a percentage of the insured account (say up to 90%).

Credit Application Terms. With extended terms, the vendor should contract around the excuses the customer may raise to delay payment beyond the extended terms by including conditions that reduce disputes, such as acknowledgment to pay within terms of sale; duty to inspect and complain about shortages and defects within a short period after receipt of the product and, if the customer fails to complain, the customer has waived its right to dispute payment of the invoice; and the applicant agrees to pay all cost of collection, including attorneys' fees and court costs.

The Punitive Approach: The Vendor Still Controls the Terms Relationship (So Customer Take Your Relationship Elsewhere If You Won't Pay within Normal Terms)

Some vendors may demand compliance with normal terms in response to a customers TPS, rather than consent to extended terms or offer the customer incentives to pay within terms. A vendor may use "punitive" measures to keep the customer within normal terms.

Key Supplier

If the vendor is providing a unique product or service that cannot be easily duplicated (think Google or Coca Cola), which is reflected in dominant market share, the vendor has greater leverage to play the punitive card. Although there are variations within the punitive model, the customer's take away is that the vendor is willing to cut off the customer and find a substitute customer. With this, the customer is pressed to find a replacement vendor who may agree to extended terms.

Credit Hold

If a customer continually pushes back on terms and seems unresponsive to both the agreed-upon terms as well as the vendor's payment demands, the vendor may withhold its product or service, pending payment of invoices. The halt (or its threat) in the customer's supply chain can prompt payment on past due invoices.

Report to Industry Group and Credit Bureaus

A vendor can report the customer to its industry group and to credit reporting companies.

Late Payment Penalty

This penalty incentivizes the customer to pay within terms. A best practice is for the payment penalty to be a term in the credit application.

Two Price Lists

As discussed in the accommodative section, the two price list strategy (one for invoices paid within terms and one for invoices paid on extended terms) may be considered punitive by the customer.

Right to Setoff

Where a vendor both sells to a customer on terms and buys from the customer on terms, the vendor may use offset rights to keep the customer within normal terms. For example, the vendor has an open invoice where normal terms were extended. The customer employs a TPS. The vendor also owes the customer for goods it purchased on terms. The vendor offsets the customer's invoice with what it's due.

Termination of Credit Where There is No Default

The vendor has received a purchase order, has invoiced the customer on normal terms and, prior to shipping, the customer announces a TPS. The vendor may respond by converting the credit sale to cash terms, provided the vendor has a provision in its credit application that reserves the right to terminate credit terms (consider: "[Creditor] reserves the right to revoke credit to the Applicant at [Creditor]'s sole discretion and without notice"). This provision allows the vendor to move to cash terms even though the invoice is not past due.

Uniform Commercial Code Protections

Where a vendor has just shipped product and the customer announces a TPS, and the vendor has evidence that the TPS is prompted by the customers deteriorating financial condition, the vendor may look to the Uniform Commercial Code in order to push back.

Demand for Adequate Assurance. Where a vendor has sold goods to a customer on credit, but has grounds that the customer will not pay (i.e., "grounds for insecurity"), the vendor may demand assurance, such as advance payment. If the customer fails to provide assurance within a reasonable time (not to exceed 30 days), the contract is repudiated.

Stopping Goods in Transit. Where a vendor has shipped goods to a customer on credit, the vendor may stop their goods in transit. The vendor must give notice of stoppage to the bailees (carrier and/or warehouseman) as well as the customer. The vendor loses the right to stop goods once the customer has obtained possession of the goods or the bailees acknowledge that they are holding the goods in favor of the customer.

Reclamation. If the customer is insolvent, the vendor may make a reclamation demand to the insolvent customer within ten days after the customer received the goods.

Mechanic's Lien Rights. Mechanic's liens assist vendors supplying labor and/or materials that improve property in getting paid. States have specific notice and filing deadlines for vendors to qualify for lien protection. A lien notice may prompt the customer to pay.

Customer Divorce. In some cases, a vendor may decide they are devoting too much administrative time and expense in keeping a customer within normal terms. Rather than accept the customers TPS request and shrinking profit margins, the vendor might opt for a customer divorce. By cutting trade terms with the high maintenance customer, the vendor may redirect its resources to customers who pay within normal terms.

Conclusion

Whether the TPS is a solvent customer's strategy to improve working capital, or a financially-distressed customer's attempt to preserve cash and continue operations, terms pushback is a topic seemingly all credit teams are confronted with. The vendor's response to a TPS may trigger an evaluation from all functions of the organization-credit, sales, finance and management. Given this collaborative approach by the vendor's teams, a best practice objective to TPS is to keep as many customers within normal terms as possible. The vendor's response will vary depending on the competitive niche and value of the customer. The vendors response to a customer's TPS not only affects that trade relationship, but also impacts the vendor's DSO, profit margin and trade relationship with other customers. Today's economy of low interest rates does not impact the vendor's profitability of extended terms, as would an economy with higher interest rates. But higher interest rates are on the horizon.

Before responding to a customer s TPS, the vendor should consider its relationship with the customer and where they fit in the customers supply chain.

NN 118(TM) CREDIT CONGRESS & EXPO

Join Scott for an interactive session when he co-presents:

23080. Customers Unilaterally Extending Credit Terms

If the vendor is providing a unique product or service that cannot be easily duplicated, which is reflected in dominant market share, the vendor has greater leverage to play the punitive card

Whether the TPS is a solvent customer's strategy to improve working capital, or a financially-distressed customer's attempt to preserve cash and continue operations, terms pushback is a topic seemingly all credit teams are confronted with.

SCOTT BLAKELEY, ESO.

Scott Blakeley, Esq. is a principal at Blakeley & Blakeley LLP, where he practices creditors' rights and bankruptcy. He can be reached at [email protected].