Editor's Note:  You can test your credit decision prowess by reviewing the following real-life scenario and then reading on to see how your chosen actions measure up to Credit Today's recommendations.

The registered letter delivered to your in-basket is entirely unexpected. So are its contents. It is from the president of Transmark Corp, a customer that owes your firm $232,639.20, most of which is current. He is claiming serious financial difficulties due to the loss of a major customer of their own. In addition, the large banking conglomerate that recently purchased Transmark's local banking partner will not renew the firm's line of credit when it expires next month. As a result, and after consulting with their attorneys, Transmark is considering filing for Chapter 11 bankruptcy protection. The only alternative to a bankruptcy filing is an out-of-court restructuring plan. This proposal gives each creditor two settlement options, but requires acceptance within the next ten days by every one of the firm's vendors. The options are:

A 24-month, 80 percent payout without interest or collateral. For your company that works out to $7754.64 per month for two years.
A single lump sum payment, payable 3 months hence, of 50 percent of the debt. This full and final settlement totals $116,319.60. Realizing a number of questions must be answered before a decision can be reached, you call the customer's controller, who has been designated by Transmark's president as the firm's vendor liaison. Your conversation is as follows.

Question: Are all vendors being offered the same settlement options?

Answer: Yes, everybody gets the same deal.

Q: Have any creditors taken you up on these proposals?

A: More than a few.

Q: Who?

A: I'm not at liberty to say.

Q: Which option is proving more popular?

A: You will have to determine that yourself. We are treating each settlement as a private matter between the individual vendor and us, and so we will not talk about what other vendors have decided to do.

Q: Has anybody gotten a better deal in the last 90 days?

A: No, as I indicated before, everybody will be treated the same.

Q: We would be more inclined to go along with the 24-month payout if we could attach some collateral. Is that possible?

A: There is not enough collateral to go around for us to treat everybody the same. There is an outside investor who will take a first position in all our assets.

Q: Is that where the money is coming from to make these payoffs?

A: Yes.

Q: My I ask who this is?

A: I'm not at liberty to say.

Q: Let's go back to the 24-month payout. Should your company miss a payment, will you agree to an accelerator clause requiring full payment of the remaining balance?

A: No.

Q: How about interest to cover late payments?

A: No. Each deal must be the same. We don't have the staff to monitor exceptions.

Q: How did you arrive at the settlement amounts?

A: They are simply the amounts we feel we can handle based on the new financing and our cash flow going forward.

Q: If you file for bankruptcy protection, how much could we expect to receive then?

A: I expect it would be substantially less than either of these settlement offers, but we can only speculate about how much it would be.

Q: What is Transmark's liquidation value?

A: I haven't looked at that. I can send you our financials, but otherwise that's something you'll have to estimate yourself.

How Would You Respond?

Out-of-court re-organization plans are a tricky matter. On the one hand, they lack the court supervision that is part of the Chapter 11 bankruptcy process. On the other hand, they hold out the hope that more money will be distributed to creditors by eliminating the time and expense of bankruptcy proceedings. That's what makes it a little like blackmail when a debtor tells a creditor, If you don't accept our settlement plan, we will file bankruptcy and you will get less than we are offering.-

As a credit pro, you will have to decide whether your company should call their bluff. In large part, that decision will depend on the integrity of the debtor and your firm's relationship with them. If it has been a long-term, profitable relationship and the owners are trustworthy, going along with a settlement could be the right decision.

Whether you take the near term payout or accede to payments over time will largely be determined by the future prospects of the debtor.

If you foresee a profitable relationship going forward, the long-term payout, which clearly provides a higher return than the lump sum, may be the best deal. If, however, you have doubts about the debtor's future, the lump sum could prove to be the better choice.

Then again, if you have doubts, maybe you should be pursuing option three: other means of recovery. However, before you make your decision, there are a few things you'll need to do.

Action Item Checklist

1. Immediately notify your sales and management team.
2. Calculate this account's profitability as a customer and put together estimates of their future purchasing potential, keeping in mind the major account that has been lost.
3. Contact other creditors to see what they have been offered and to gather any other intelligence they may have turned up.
4. Have a chat with the debtor's loan officer to find our first hand why the line of credit is being pulled.
5. Review the debtor's most recent financial statements to determine their long-term viability should they be able to reach a settlement with all their creditors.
6. Calculate the liquidation value of the debtor's business to see whether the settlement offer provides for a larger pay-off.

Food for Thought

Remember, there is a new investor involved in this deal, and they are looking for the highest return they can get. The less that is paid out to creditors, the better the deal will be for the investor.

From the debtor's perspective, therefore, the key to pushing through an out-of-court settlement is to deal with each creditor individually. Debtors will usually try to buy off the few creditors that raise a stink so they can keep the other creditors at bay and avoid lawsuits. For that reason alone, it may be worthwhile for you to hire a collection attorney.

Be that as it may, contacting other creditors is critical. You will not be able to make informed decisions without the information other creditors can provide.

Another advantage to working with other creditors is negotiating strength. Enlisting the support of other creditors to form a creditor's committee and then as a group hiring an attorney to investigate the debtor's offer is probably the best course of action.

You are in a better position to argue from strength as part of a group, and a creditor's committee, acting through their attorney, can provide a level of supervision to the reorganization plan. Furthermore, you are now in position to force the debtor into bankruptcy if they do not play fairly.