The stock market is down. Gasoline prices are soaring. Mortgage foreclosures are on the rise as property values slip. The value of the dollar is at an all-time low, and more and more jobs appear to be leaving the country.

America is clearly in the midst of an economic crisis. Of course, the country has survived similar downturns in the past, and will do so again. But the critical question right now is: How can a business best protect itself until the economic storm has passed? While there is very little you can do to affect the value of the dollar, the trade deficit or gasoline prices, there are steps that smart companies can take to protect their business and minimize risk.

When times get rough, payments tend to slow down, leading to aging and increasing receivables. In your desire to maintain a certain level of production, you often ignore the fact that your customers are not paying as quickly as they have in the past. Allowing that trend to continue is a huge mistake. At best, it interferes with cash flow. At worst, you might never get paid at all.

How you react is, for the most part, a business decision determined by the particular facts of your situation. But there are certain legal issues that every company should consider when customers begin to show signs of financial instability.

Right of Reclamation

Section 2-702 of the Illinois Uniform Commercial Code (UCC) offers creditors a little-known measure of protection whenever a debtor is on the verge of bankruptcy. Called the “right of reclamation,” this provision allows a company in certain circumstances to reclaim product delivered to an insolvent or defaulting customer, even if that customer files for bankruptcy. When applicable, the right of reclamation makes a creditor as whole as possible.

What do you have to do to be eligible to reclaim property when one of your customers files for bankruptcy? If you discover that a buyer has obtained goods when it was insolvent, then you have the right to reclaim those goods by making a written demand within 10 days after receipt of the goods by the customer. Since you will seldom learn that your buyer is insolvent during that relatively brief time period, this provision has obvious limitations. There are, however, instances where the 10-day requirement does not apply. For example, under Section 546 of the Bankruptcy Code, a seller retains reclamation rights as long as an insolvent debtor received goods within 45 days before filing a bankruptcy case. Additionally, the 10-day limitation does not apply if the buyer has made a representation of solvency in writing within 90 days before the delivery of the goods.

If you are concerned about a customer’s financial footing, you can demand a written representation of solvency before you send that customer any goods. Then, if your buyer enters bankruptcy within the next three months and hasn’t used or resold the goods, you will have the right to reclaim them.

Adequate Assurance of Performance

The Illinois UCC provides another right that can be very helpful in some situations. Under Section 2-609, you have the right in certain circumstances to demand "adequate assurance of performance" from a party to a sales contract governed by the code. If you are a party to a contract for the sale of goods and you have a reasonable basis to believe that the other side will not be able to perform, you have the right to send the other party a written demand for reasonable assurance of performance. Until you receive that assurance in writing, you have the right to suspend your own performance under the contract. If you do not receive assurance of performance within 30 days, then you have the right to treat the contract as repudiated.

Whether you have reasonable grounds to question the party’s ability to perform will depend on the facts of the particular situation. That is why you should always consult with your legal counsel before taking action.

The Bankruptcy Preference

With the threat of bankruptcy ever-present in today’s economy, you should also be aware of the concepts of “preference” and “preferential payment.” We could spend hours discussing what is or is not a preference and what the implications are under the Bankruptcy Code. For our purposes, however, a preference generally refers to a payment made by a debtor related to an “antecedent” (or past-due) debt. If a creditor receives this type of preferential payment within 90 days of a bankruptcy filing, the bankrupt company or a bankruptcy trustee can require the creditor to return that payment to the bankrupt estate so that it can be shared by all of the creditors.

There are exceptions. For example, if the payment is made in the ordinary course of business under the same terms that it has always been made in the past, then the payment might not be considered a preference. Or if the payment is made at the same time as the sale—referred to as a contemporaneous exchange for new value given to the debtor—then the payment might not qualify as a preference.

What does this mean for your business? Whenever you become concerned about a customer’s ability to pay a receivable, you should consider potential preferences before taking action. For example, to avoid having to return a debt payment down the road, you might put that customer on a COD basis for all future sales of goods and services. You might also consider having the customer sign a note and obtain collateral, thereby making you a secured creditor and giving you a better chance to collect upon default or bankruptcy. If you are dealing with a corporate entity, you might ask the principal of the business to sign a personal guaranty.