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CCCA_V2No4_Col-Davies-FIN.qxd:CCCA_V1No2_Col-Litigat-V1.qxd 11/24/08 3:33 PM Page 47 Legal Update – Davies Ward Phillips & Vineberg LLP Defending against distress How to protect yourself when dealing with insolvent companies. n today’s environment,almost every indica- For potentially insolvent customers, early with the receiver or trustee in bankruptcy. If Itor points to an extraordinarily marked identification and response to escalating cred- you are obliged to continue dealing with the increase in the level of financial distress to be it risk is key. Refusing to continue supplying insolvent counterparty, then in some cases, experienced by many companies. unless arrears are paid or some form of secu- you may also be able to obtain court-ordered How does your company protect itself rity is posted can be of material benefit. super-priority security for any ongoing against counterparties who are approaching Often, such arrangements can be structured credit exposure.In other cases,you may have insolvency? What is the most effective way to minimize the risks of later attack under legislated priority repossession rights if com- of continuing to deal with a company that is fraudulent preference legislation. plied with within certain time limits. in insolvency proceedings? How does your Terminating contractual obligations to Of course, companies in financial distress company take advantage of market opportu- supply prior to a formal filing can avoid also sometimes present excellent acquisition nities arising from such disruption? Does being bound to continue supplying during a opportunities. While the process may look your company have the right processes in restructuring on existing contract terms and somewhat similar, the acquisition of a dis- place to alert it to its own possible distress in pricing while leaving arrears unpaid.Again, tressed company is very different from an enough time to properly respond? assignment restrictions can prevent your ordinary course acquisition.These deals are Every company has numerous contractu- contract from being sold to a third party typically “as is, where is,” without any of the al counterparties: suppliers, customers, without your consent as part of the cus- standard representations and warranties. joint ventures, partnerships, licensors, etc. tomer’s restructuring efforts. Accordingly, the due diligence approach Importantly, defences to counterparty insol- In joint venture, partnership and other needs to be structured differently and mini- vency risk generally need to be thought of similar agreements, assignment restrictions, mum closing risk and speed often matter before a problem arises. buy-out rights,unwinding provisions and the more than price, affecting bid structure and Amending contractual provisions when the cessation of funding obligations may prove tactics. Such transactions also often dovetail counterparty is already insolvent can be fraught very useful in counterparty insolvency cir- with or are subject to certain court orders, with numerous legal risks,like fraudulent pref- cumstances.A partial assignment of copyright such as sale approval and vesting orders, erence prohibitions. However, existing con- rather than a software license may avoid the requiring specialized provisions in the pur- tractual provisions like assignment restrictions, consequences of having to enter into a new chase agreement and closing mechanics. termination rights and set-off rights can prove license agreement with the purchaser of Lastly, in today’s environment, prudent to be advantageous in distressed circumstances. intellectual property assets from an insolvent corporate stewardship demands that compa- In dealing with suppliers, it can be very licensor. Often, source code escrow and sim- nies have appropriate governance processes helpful to have arrangements in place that ilar arrangements prove insufficient in dealing in place to monitor their own level of finan- provide for ownership of tools, moulds and with such risks. cial distress and alert them to the issue with inventory. Existing alternative suppliers and If your company is obligated, for legal or sufficient time to properly respond. inventory banks are also often critical opera- business reasons, to continue dealing with an Experience suggests that many companies tional safeguards. Generally speaking, a sup- insolvent counterparty, it will be critical to do not have such processes in place even plier’s insolvency filing may bind your com- understand quickly whether the insolvency when they believe they do,leaving them crit- pany to continuing to perform under existing proceeding is a proposal, a plan of arrange- ically exposed to certain key dynamics that contract terms regardless of the termination ment, a receivership or a bankruptcy,because often cripple their ability to respond in time provisions of the contract. rights and obligations under each of these and in a manner that preserves the most value This can be avoided by terminating the proceedings are different. and jobs. Actively increased vigilance on all contract prior to such a filing,if the contract In some circumstances,you may be able to fronts has become the order of the day. permits this. Assignment restrictions can terminate existing contracts; in other cases, prevent your contract from being sold to a you cannot. In some cases, management is Robin Schwill is a partner whose practice focus- third party without your consent as part of still in control and is the proper party to deal es primarily on corporate turnarounds, work-outs the supplier’s restructuring efforts. with; in other cases, you should deal only and restructurings. HIVER 2008 CCCA Canadian Corporate Counsel Association 47