The COVID-19 crisis is wreaking havoc on the economy. It’s no longer a question of if there will be a global recession, but rather how deep and lasting it will be. Businesses, large and small, must take immediate steps to prepare for the downturn to limit downside risks.
On Wednesday, March 25 at 1 p.m. ET, The Dragich Law Firm is hosting a complimentary webinar to help you get your business ready for what is to come. Corporate restructuring professionals David Dragich and Gene Kohut will provide advice on the actions businesses should take to mitigate the effects of the economic slowdown, and will answer questions from the audience.
Webinar Hosts:
David Dragich—Corporate Restructuring Lawyer and Founder of The Dragich Law Firm PLLC
Gene Kohut—Managing Director with Conway MacKenzie, a part of Riveron, a global financial advisory firm
Topics to be Addressed:
The importance of increasing liquidity
Protecting supply chains
Reviewing the financial health of customers
Reviewing insurance policies and commercial contracts
Registration is limited to 100 participants. Click here to register.
At the time of this writing, there have been more than 200,000 confirmed cases of COVID-19 around the world. Governments are implementing lockdown procedures. Businesses are reeling. A global recession is almost a certainty. In fact, on March 17, economists from Morgan Stanley and Goldman Sachs, respectively, made the call that the world’s economy was already in recession.
Crain’s Detroit Business has reported that the recession is likely to hit Southeast Michigan particularly hard, citing the region’s heavy reliance on the automotive sector, which is expected to be badly affected by the crisis. On March 18, Ford Motor Company, General Motors, and Fiat Chrysler announced plans to close all U.S. factories, which will send shockwaves through the supply chain.
Our region, and our country, have been through difficult times before and emerged stronger from the experience. The Great Recession, precipitated by the 2008 financial crisis, was deep and painful, but in a few years’ time the economy regained its footing. In many ways, this one feels different. There’s no historic corollary, at least in most of our lifetimes, that serves as precedent to help anticipate what to expect next. But one thing is certain—businesses must take immediate steps to ensure they are prepared, as best as possible, to survive this crisis.
During the last 20 years of providing corporate restructuring counsel to distressed businesses, I’ve witnessed the differences in outcomes experienced by companies that take bold, aggressive steps to ensure their survival during a downturn and those that don’t. Here are some of the issues that your company should be focused on and steps it should be taking now.
Increase liquidity. Companies will need cash sufficient to survive, which means tapping credit lines before liquidity dries up, and divesting non-core assets to provide needed cash at prices higher than may be available in the coming weeks and months. In 2008, Ford put up all of its assets as collateral to raise funds, which enabled it to stay out of bankruptcy.
Protect your supply chain. Plan for certain of your suppliers of parts and services to fail, or at a minimum experience disruptions, moving forward. Assess and identify critical parts and services, particularly those that come from a single-source supplier, and make contingency plans to ensure continuity of your supply chain.
Review the financial health of your customers. In every economic downturn, one of the ways that companies try to conserve cash is by delaying payments beyond contract terms. Audit the financial health of your customers. Be diligent about enforcing payment terms. In some cases, amend payment terms to cash on delivery. To the extent your business is experiencing liquidity issues, consider approaching certain of your customers to determine whether they will pay you more quickly.
Review insurance policies. Determine whether your existing insurance coverage is sufficient to protect against downside risks. Coverage for business interruptions and supply chain issues is particularly important in this environment, although there are questions as to whether damages due to COVID-19 would count as a covered loss.
Review commercial contracts. From event cancellations to breaches of supply agreements, COVID-19 is forcing companies to make difficult decisions leading to terminations of business relationships. The long-term ramifications of those decisions will be sorted out in a rash of litigation in the future. For now, review your commercial contracts, especially “force majeure” clauses, to determine what flexibility you—and your counterparties to contracts—have regarding contract performance.
We are in uncharted waters. In times such as these, it’s critical for companies to be hyper-zealous in order to survive.
When developing contract documents that all seem relatively standard, businesses may be inclined to pay little attention to those sections that are “just boilerplate.” Many assume that boilerplate is synonymous with meaningless. But while boilerplate contract language may appear to be made up of stock phrases, those words have real impacts and shouldn’t be overlooked.
Just ask DoorDash, a national food delivery company, that got slapped with $12 million in arbitration fees because a group of drivers decided to call the company’s bluff and use its individual arbitration clause—classic standard boilerplate language—against it. Or ask Lease Finance Group, a California-based commercial equipment dealer whose standard forum selection and choice-of-law clauses were held by a Federal Court to be unenforceable since they deprived lessees of a jury trial, even though waivers of jury trials are lawful in New York, the state the company made their choice jurisdiction.
Anticipating Known Unknowns
Even the most carefully worded contract provisions can’t guarantee an end to all litigation, but businesses can protect themselves by thoroughly understanding their exposure under any agreement—not just the day they sign, but every day after. Laws change, circumstances change, and businesses change. There will always be the possibility of an incident a business couldn’t foresee, but companies that work to anticipate those eventualities will find themselves more often on the winning side of any contract disputes.
As Donald Rumsfeld famously said, “Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know.” Those “known unknowns” can sneak up on a business that isn’t actively focused on identifying potentially problematic situations.
Coronavirus Supply Chain Impacts
The outbreak of Covid-19, the recent novel coronavirus, is exactly the type of known unknown that could wreak havoc on a company’s supply chain. As of March 9, 99 countries had confirmed Covid-19 cases, with 35 U.S. states reporting cases. With China at the epicenter of the outbreak, global supply chain disruptions are inevitable. As existing inventory at plants runs out, companies that rely heavily on Chinese parts—like those in the automobile industry—may be forced to stop production and may not be able to provide necessary services, like car repairs. According to reports, General Motors was forced to airlift supplies for its North American truck production.
The repercussions of failures along various parts of the supply chain will be far-reaching. So who takes the hit? In most cases, it depends on boilerplate contract language, from what constitutes a breach to whether contracts have a force majeure provision.
Force Majeure Clauses
Force majeure—literally “superior force”—provisions in contracts relieve a party from liability for non-performance if the party’s failure to fulfill its obligations under the contract is the result of circumstances that are beyond their control. Language can vary significantly. Some provisions set out specific instances that would relieve liability, sometimes including epidemics and pandemics. Others provide more vague parameters, such as an “act of God” or “circumstances beyond the parties’ control.”
The burden lies on the party that has not performed to show that, but for the specific circumstance, they would have been able to perform. They must also show that there is no alternative means to perform under the contract—and performance being more costly than originally planned is not generally a sufficient reason for non-performance.
Viewing force majeure provisions in light of the coronavirus outbreak reveals potentially significant contract exposure for manufacturers and retailers throughout the world. In every place that has experienced Covid-19 cases, the impact on companies has been not just from the virus (loss of labor force) but also from government acts (forced quarantines and plant closures) to contain the virus.
A Tier 2 manufacturer that has been closed because of quarantines and outbreaks will argue that their breach is the result of circumstances beyond their control. The Tier 1 manufacturer will argue the same, suggesting that the domino effect of their supplier’s closure was beyond their control. Whether these arguments would succeed depends on a decision maker’s interpretation of the specific contract language that governs the relationship among those manufacturers and the original equipment manufacturer.
As manufacturers and retailers scramble to build war rooms, identify alternative suppliers, and create more diversity in their supply chains, they would be wise to review the boilerplate language in their existing contracts and in any contracts they plan to enter into in the future. Delays, breaches, and non-performance can cost companies millions of dollars, not just in lost revenue but also in litigation fees and demands for complete performance. Companies that anticipate the known unknowns—whether it’s coronavirus or some future unimagined event—will be less likely to bear the financial losses when the unforeseen occurs.
A state court receivership can be a viable and effective alternative to a federal bankruptcy proceeding which often costs more, takes longer, and involves more oversight than a receivership. However, because it is a state court proceeding—as opposed to a federal bankruptcy or receivership—a state court-appointed receiver must sometimes grapple with the extent of his or her power to act across jurisdictions.
In this article, we will explore a particular situation that often must be addressed during the course of a state court receivership proceeding: What issues must be considered and steps that should be taken to enforce a state court receivership order authorizing the sale of assets with regard to assets that lie outside of the state court’s jurisdiction.
State Court Receivership Overview
A receivership involves the court appointment of a receiver to oversee and, in most cases, operate and/or liquidate a business. A receiver is a neutral and independent third party appointed to act on behalf, and for the benefit, of all interested parties. Receiverships are often sought by secured lenders as a liquidation-alternative to bankruptcy.
A receiver’s duties and responsibilities, such as monetizing assets and distributing funds, are outlined in an order entered by the court overseeing the receivership.
Multi-State Issues
A state court receivership order typically authorizes a receiver to sell or otherwise liquidate assets for the benefit of creditors. It is not uncommon, however, for assets of the business subject to a receivership to be located in other states. Since one state’s courts don’t have jurisdiction over assets located within another state, the power of a receiver to enforce a receivership order by liquidating assets doesn’t automatically transfer across state lines.
This long standing legal principle was addressed by the U.S. Supreme Court in 1854 in the case of Booth v. Clark, in which the Court explained that a receiver “has no extra-territorial power of official action.” Further, the Court stated that a state court that appoints a receiver has no “authority to enable [the receiver] to go into a foreign jurisdiction to take possession of the debtor’s property.”
That doesn’t mean, however, that a receiver has no recourse. As a number of cases across jurisdictions have made clear, a receiver may seek to appear in another state’s courts to address assets located in that jurisdiction as a matter of comity. In other words, while a receiver may not be able to simply seize or sell assets located in another state, it can seek to work through that state’s court system to receive approval to do so based upon the power granted in a receivership order.
For example, in Wright v. Philips, a case decided by the California Court of Appeals, the court stated that:
“Receivers appointed under a jurisdiction other than that of the state forum may be permitted to sue in a stranger state as a matter of comity only. That this privilege of comity will be extended, wherever the rights of local or domestic creditors are not prejudiced, is now the general rule in the United States.”
A state court receiver who has to deal with assets in a different state must consider a number of issues. If a receiver is seeking to sell or otherwise take possession of assets located in another state, the receivership order, and any applicable sale order, should be domesticated in the state in which the asset is located. To the extent that an asset is subject to the claim of a creditor, such as a lien holder, notice of the receivership proceedings and any sale order should be provided to such creditor.
In some situations, it is advisable and/or necessary to seek the appointment of an ancillary receiver in another jurisdiction to deal with out-of-state issues. If this course of action is decided upon, the receiver should first seek approval from his or her appointing court before proceeding in the foreign state. In some cases, the primary receiver can also be appointed as the ancillary receiver, but the statutes and rules of the foreign state should be reviewed to determine whether appointing the same person (as opposed to an in-state resident) is permitted.
Finally, before a state court receivership is pursued, multi-state asset issues should be carefully considered. In situations involving assets located across many states, a federal court receivership may be the best option, provided that the requirements of federal court jurisdiction are met.
If you have any questions about these issues, or receiverships in general, please contact David Dragich at ddragich@dragichlaw.com or 313-886-4550.
It’s a new year, the time of fresh starts and big dreams, but the “retailpocalypse” doesn’t seem to have taken notice. Earlier this week, Pier 1 Imports announced plans to close up to 450 locations—nearly half of its 942 stores—conduct layoffs, and cut expenses. According to Bloomberg, Pier 1 is preparing for Chapter 11 bankruptcy.
If Pier 1 files for Chapter 11, it will become just the latest in a long string of retail restructurings and liquidations that have taken place over the last several years. At a time of growth in the overall economy, there were 23 major retail bankruptcies in 2019 (including brand names such as Gymboree, Barney’s New York, and Forever 21), compared with 17 in 2018, according to CB Insights.
Issues Impacting Retailers
There are many factors that have contributed to distress across the retail landscape. One of the most significant is the seismic shift in consumer behavior over the last decade. The rise of e-commerce, generally, and the dominance of Amazon, in particular, have wreaked havoc with the business models and balance sheets of traditional brick and mortar retailers.
Traditional retailers are parties to expensive leases in shopping malls and other retail centers that are seeing less foot traffic. On the other hand, Amazon and other online retailers are able to invest in warehousing, distribution, and logistics in order to cater to customers who increasingly prefer to shop from the comfort of their own homes.
Lower revenue and burdensome real estate expenses are contributing to the wave of retail bankruptcies, particularly for those retailers (and there are many of them) who are servicing large amounts of debts. Over the last two decades, a number of retailers were acquired through leveraged buyouts led by private equity firms. These transactions saddled retailers who were taken private with large, and, in many cases, unsustainable debt loads. For example, in 2005, Toys “R” Us was acquired by a syndicate of private equity firms in a leveraged buyout. Toys “R” Us had approximately $2 billion in debt pre-acquisition, and $5 billion in debt post-acquisition. In 2017, Toys “R” Us filed for bankruptcy.
Retail Restructuring Options
Chapter 11 bankruptcy offers a corporate debtor a “breathing spell” and opportunity to reorganize. For most retailers, one of the most important benefits of Chapter 11 is the opportunity to evaluate the business’ portfolio of real property leases and determine which ones to either assume or reject. Leases related to underperforming stores can be rejected and damages are treated as general unsecured claims. By eliminating underperforming stores and limiting the financial fallout from doing so, a retail business should be in a better position to reorganize and emerge from Chapter 11 as a leaner and more profitable business.
In reality, retailers have struggled to effectively reorganize in bankruptcy. According to a study conducted by Alix Partners in 2016, 55% of all retail bankruptcy cases result in liquidation. One of the reasons for high liquidation rates is that, following the 2005 amendments to the Bankruptcy Code, retailers have less time (210 days to be exact) to make the decision to assume or reject leases. As a result, lenders—who control the purse strings via DIP financing—often push debtors to decide whether to liquidate or reorganize quickly so that underperforming store liquidation sales can be conducted prior to the 210-day assume/reject deadline. The “decision” often equates to a lender mandate to pursue a path that results in liquidation. There is simply not enough time to fix the business if the senior lenders determine that liquidation can make them whole (or close to it).
For a struggling retailer, Chapter 11 is not the only option—another path is to pursue an assignment for the benefit of creditors (“ABC”). An ABC is an insolvency proceeding governed by state law rather than federal bankruptcy law. In some states, the right to pursue an ABC is rooted in the common law, in others it’s governed by statute. In Michigan, MCL § 600.5201 sets forth the procedural requirements for a company making, and an assignee accepting, an assignment for the benefit of creditors.
Generally speaking, in an ABC, a company (the assignor), transfers all of its rights, title, and interest in its assets to an independent fiduciary (the assignee). The assignee then liquidates the assets and distributes the net proceeds to the company’s creditors.
Unlike a federal bankruptcy proceeding, which can be time-consuming, expensive, and involves lots of oversight, a common law ABC allows for flexibility and quick action. While an ABC may not be appropriate for a massive retail case of the variety we’ve addressed previously in this article, under the right circumstances it can be an effective tool for a retail business. Case in point: We recently led an ABC process for a retail business in Michigan that concluded in a going-concern sale of the business.
There is no end in sight for the “retailpocalypse.” Accordingly, retailers, as well as their lenders, suppliers, and landlords need to be thinking about the options available to them should reorganization or liquidation become necessary.
If you have any questions, please contact David Dragich at ddragich@dragichlaw.com or 313.886.4550.
Companies experiencing financial distress have a number of options available to them. If a business has the potential to continue as a going-concern despite a heavy debt load, reorganizing or conducting a sale process in a Chapter 11 bankruptcy proceeding may be the best route. At the other end of the distress-spectrum is the option to simply shut down and dissolve, and leave it to creditors to sort out the mess and fight over the scraps. But that’s messy, and can often leave a company’s key stakeholders exposed to liability. A better approach for a business that must shut down but doesn’t want to do so in an ad-hoc manner, is to utilize a legal process that enables it to maximize the value of its assets and wrap up its affairs in a more organized way.
A Chapter 7 bankruptcy or sale or liquidation process overseen by a court-appointed receiver are both viable wind-down options. However, both of these processes involve a business and its principals relinquishing control of the business and its assets to a fiduciary.
In many states, another option is an assignment for the benefit of creditors (“ABC”). An ABC is an insolvency proceeding governed by state law rather than federal bankruptcy law. In some states, the right to pursue an ABC is rooted in the common law, in others it’s governed by statute. In Michigan, MCL § 600.5201 sets forth the procedural requirements for a company making, and an assignee accepting, an assignment for the benefit of creditors.
Generally speaking, in an ABC, a company (the assignor), transfers all of its rights, title, and interest in its assets to an independent fiduciary (the assignee). The assignee then liquidates the assets and distributes the net proceeds to the company’s creditors. While the process varies by state, in most jurisdictions board and shareholder approval are required to initiate an ABC.
So, why would a company pursue an ABC rather than another liquidation alternative? Some of the primary advantages of an ABC include:
Lower Cost: An ABC typically costs less than, for example, a Chapter 11 reorganization or Chapter 7 liquidation because there are far fewer administrative obligations involved and little to no court oversight.
Speed: One of the reasons ABCs cost less than other options is that the process can proceed much more quickly.
Flexibility: Unlike in a Chapter 7 bankruptcy or state court receivership proceeding, in an ABC the company/assignor gets to choose the fiduciary/assignee who oversees the liquidation of assets.
Expedited Sale Proceedings: In an ABC, there are no sale procedures equivalent to those found in Section 363 of the Bankruptcy Code, so assets can be sold quickly.
Less Oversight: The degree of court supervision in an ABC proceeding varies by jurisdiction (from none to some), but is always less than in bankruptcy.
While there are many advantages to ABC proceedings, they are not appropriate for every circumstance. One of the main disadvantages to ABCs is that, unlike in a bankruptcy proceeding, there is no automatic stay in place. In most receivership proceedings, the court order appointing a receiver also contains some form of automatic stay that limits litigation against the liquidating company. Accordingly, existing lawsuits may proceed and new ones may be filed against a company pursuing an ABC.
Determining the right path forward for an insolvent company depends on the specific facts and circumstances at issue, and such a determination should be made in consultation with legal counsel who understands the relative advantages and disadvantages of each liquidation alternative. For any company that is experiencing distress, an ABC can be an effective option to liquidate assets and wind-down affairs, particularly if speed is of the essence and less oversight of the process is desired. If you have any questions about the feasibility of the assignment for the benefit of creditors process for your business, please contact David Dragich at ddragich@dragichlaw.com or 313.886.4550.
At The Dragich Law Firm, we strive to deliver value and results for our clients. We are pleased to announce recent successful outcomes we have helped our clients achieve, and new matters our firm has been engaged to assist with.
Settlement Reached With Creditors in Receivership Case of Heritage Sportswear, Inc.
The Dragich Law Firm represents Gene R. Kohut, of Conway Mackenzie, Inc., as the court-appointed receiver over the assets of Heritage Sportswear, Inc. Heritage is a supplier of blank apparel in the promotional products industry, including items such as t-shirts, pullovers, hats and other athletic related items.
Heritage’s headquarters are in Hebron, Ohio, but the company had locations in multiple states. The receivership case is pending in the United States District Court, Northern District of Georgia, (Atlanta Division). On November 12, 2019, the Court entered an order approving a settlement among the Receiver, Cadence Bank, the plaintiff in the action, and Gildan Activewear SRL.
The settlement resolves months-long litigation among the parties and will enable the Receiver to distribute proceeds to creditors and work toward finalizing the case. “We were very pleased to reach an agreement with the principal creditors in the case. This will allow the Receiver to pay creditors and move the case forward,” said David Dragich, counsel to the Receiver.
The Dragich Law Firm Retained by Assignee of AT Group US, LLC
The Dragich Law Firm has been retained by Gene Kohut of Conway MacKenzie, Inc., as legal counsel in connection with Kohut’s role as the Assignee of AT Group US, LLC and related affiliates. This assignment for the benefit of creditors was filed in the Washtenaw County Circuit Court In the State of Michigan.
The Dragich Law Firm helps businesses navigate complex bankruptcy and corporate restructuring issues, particularly in the automotive industry. It also assists clients with commercial litigation matters and business transactions.To learn more about The Dragich Dragich Law Firm’s capabilities, please contact David Dragich at ddragich@dragichlaw.com or 313.886.4550.
The Detroit Chapter of the Turnaround Management Association is hosting its annual holiday party on December 4, 2019, from 6:00 – 8:30 p.m. at the Detroit Golf Club. The Detroit Chapter is not only celebrating the upcoming holiday season but also its 25th anniversary.
The festive evening will include hors d’oeuvres and cocktails, as well as networking opportunities with other TMA business professionals. Amanda Vintevoghel of The Dragich Law Firm will be in attendance as the current President of the Detroit Chapter of the Turnaround Management Association.
For more details about the event, visit the TMA event page.
The U.S. economy is in the midst of a record economic expansion but signs, from slowing manufacturing numbers to weakness in formerly high-flying housing markets, suggest we may be in the tail-end of growth. In times of distress, troubled companies and their secured lenders start to evaluate options. Chapter 11 bankruptcy reorganization, or Chapter 7 bankruptcy liquidation, are common processes that are used to address distressed business situations. An often overlooked solution is utilizing a state or federal court receivership.
State and federal court receiverships involve the court appointment of a receiver to oversee and, in most cases, operate a business. A receiver is a neutral and independent third party appointed to act on behalf, and for the benefit, of all interested parties. Receiverships are often sought by secured lenders as a bankruptcy alternative because it’s typically a faster and less costly process.
A receiver’s duties and responsibilities, such as monetizing assets and distributing funds, are outlined in an order entered by the court overseeing the receivership. Because receiverships typically involve a sale or a liquidation of the business, one of the issues that a receiver and its legal counsel must address is the reduction of the business’ workforce. And whenever a significant layoff of employees takes place, a key legal issue that must be considered is the potential implication of the Worker Adjustment and Retraining Notification (“WARN”) Act, 29 U.S.C. § 2101-2109.
A Brief Explanation of the WARN Act
The WARN Act, subject to certain exceptions, requires employers with 100 or more employees to provide employees, bargaining representatives of the employees (unions), and specific government agencies at least 60-days’ notice of any plant closing and mass layoff.
The notice procedures prescribed by the WARN Act are meant to give workers transition time to prepare for the loss of employment, to seek new work, and, if necessary, to seek training in a new skill or retraining in an existing skill that will allow them to obtain replacement work.
Failing to abide by the WARN Act can have serious consequences. The statute provides that an employer who orders a plant closing or mass layoff without providing WARN Act notice is liable to each unnotified employee for back pay and benefits for up to 60 days during which the employer is in violation of the WARN Act. In addition, if an employer fails to provide notice to the relevant local government, it can be liable for a civil penalty of up to $500 for each day the employer is in violation of notification requirements.
Does the WARN Act Apply in a Receivership?
One of the primary goals of most receivership proceedings is to move fast. After all, the longer a legal process such as a receivership proceeding takes, the more expensive it will be. A dragged out process may also negatively impact the value of receivership assets, leading to reduced creditor recoveries, and hamper the receiver’s ability to sell the business as a going concern. Accordingly, speed is paramount.
The WARN Act, however, is meant to slow employers down, at least when it comes to layoffs associated with the wind-down of a business. So, does a receiver have to abide by the WARN Act?
There is little case law on this issue. While it’s always hard to provide a definitive answer on an issue of statutory interpretation without clear court guidance, the short answer is: probably not.
At least that’s been our experience. For example, in a receivership case pending in the United States District Court for the Northern District of Georgia involving the assets of Heritage Sportswear, Inc., we recently filed a motion on behalf of the receiver requesting that the court authorize the receiver to reduce the company’s workforce without sending notice in accordance with the WARN Act. No objections were lodged and the court granted the motion.
While there’s not much in the way of case law that’s directly on-point, there is guidance that can be drawn from analogous court decisions—involving contexts slightly different than a traditional receivership— that suggest that receivers aren’t obligated to provide WARN Act notice. The key distinction that these courts identify is that in the case of a receivership-like proceeding, an entity other than an “employer,” such as a receiver, court, or the federal government, is ordering the layoffs and directing the wind-down. Therefore, because an “employer” is not in control, the WARN Act doesn’t apply.
For example, in a situation involving a failed bank and a government takeover of the bank’s assets, a court explained, “[W]hen the federal authorities take over the bank and shut it down, there is no employer to give notice. The former bank owners do not own the bank; nor did they close the bank. Moreover, the federal government is precisely not an employer if it is shutting the bank down.” Office & Professional Employees Int’l Union Local 2 v. FDIC, 138 F.R.D. 325 (D.D.C. 1991).
Conclusion
A receivership can be an excellent tool for a secured lender to maximize the value of its secured collateral while holding down costs relative to a Chapter 11 bankruptcy proceeding. One of a receivership’s primary advantages is that, unlike in many Chapter 11 cases involving a debtor-in-possession, the WARN Act doesn’t apply when layoffs are required. Labor costs are significant in most receivership cases, and avoiding 60-days’ notice in advance of a workforce reduction can have a meaningful impact on the funds ultimately available for distribution.
The Dragich Law Firm serves as legal counsel to receivers in cases throughout Michigan and across the country. To learn more about our receivership legal counsel services, please contact David Dragich at ddragich@dragichlaw.com.
Despite recent optimism that certain aspects of the United State’s trade war with China may soon be resolved, its effects will be long lasting in certain regions and industries. The automotive and manufacturing sectors in the Midwest have been particularly hard hit by tariffs imposed on steel and aluminum. According to the Federal Reserve, manufacturing output shrank over two straight quarters this year. The auto industry has been cutting jobs at a rate not seen since the “Great Recession.”
The recent tariff trouble began in March 2018, when President Donald Trump signed two proclamations placing tariffs on imported steel and aluminum. The tariffs are authorized under Section 232 of the Trade Expansion Act of 1962 on the grounds of national security. The president’s action imposed a 25% tariff on imported steel and 10% on imported aluminum.
From auto suppliers to makers of construction equipment, tariffs have had a significant impact on the bottom line. Most companies that operate in the automotive and manufacturing industries participate in supply chains, buying from lower tier suppliers and selling to higher tier customers.
Long-term, fixed price contracts typically govern customer and supplier relationships. And when it comes to tariffs, there’s the rub. Because tariffs have driven steel and aluminum prices significantly higher, companies that entered into long-term contracts at pricing levels that didn’t take into account the impact of a 25% tariff on steel—in other words, virtually all of them—are stuck with contracts that are unprofitable. Most companies are not, pursuant to the terms of their contracts, able to pass through price increases resulting from the tariffs.
There are, however, some strategies that automotive and manufacturing companies struggling with tariffs can seek to implement. The Department of Commerce and Bureau of Industry and Security have established a process whereby individual importers may request exclusions from the tariffs. Approximately one year following imposition of the tariffs, companies had filed 45,328 exclusion requests, and 21,464 had been granted.
Another option is to attempt to renegotiate unprofitable contracts in an effort to recoup increased costs of raw materials. While a customer may be under no contractual obligation to reopen negotiations on a long-term, fixed price contract, there are instances where it makes business sense for all parties to sit down at the negotiating table. Companies that supply specially-manufactured parts that are critical to a customer are likely to have the most success negotiating a unilateral price increase. Those who make parts that can be more easily sourced from another supplier have less leverage.
More broadly, companies need to apply the lessons learned from today’s tariffs in future contract negotiations. Rather than merely accepting a customer’s boilerplate terms regarding pricing in a long-term supply contract, companies must proactively negotiate for price escalation clauses which take into account the impact of tariffs and other unforeseen circumstances. Otherwise, when the next round of tariffs arise, they’ll be back in the position of begging for relief from customers, rather than exercising their rights under a contract.
The Dragich Law Firm has extensive experience helping automotive and manufacturing companies negotiate and enforce contracts. For assistance, please contact David Dragich at ddragich@dragichlaw.com or 313-886-4550.
