The Importance of Being Earnest — and Getting Your Cash Upfront

For consultants working on savings contingency models, the times are getting more risky. I spoke to another provider this week that had a client declare Chapter 11. Fortunately, in their case, the large payouts had come to an end last year, but they still ended up five-figures in the hole. Still, I think this case is representative of many more to come. This firm's client had been a middle market manufacturer with exposure to multiple sectors (i.e., not just automotive) that had been well run, up until the end. But when order volumes from existing accounts drop to zero, what can you do? Last quarter, I wrote a post that suggested, "In this environment, it would be foolish for consultants and outsourcers to pursue contingency agreements with all but the most credit worthy Fortune 500 customers. It might even make sense -- especially considering the rise in bankruptcies -- to renegotiate existing payout agreements at a discount in exchange for forward payment." My how those words are ringing true today.

Even providers that have received payment from customers are not entirely free and clear -- at least not necessarily. I know of one provider that had a supplier's creditors come after them after they were paid, following a bankruptcy filing. So if you're a provider, how can you best protect yourself? Last fall, another firm asked me the question: "Why would a bankruptcy court be more able to come after contingency fees than hourly fees or any other type of payment pre-bankruptcy? In other words, is that not just a standard risk when working with pre-bankruptcy companies regardless of how you are paid? Is there language that can prevent this type of 'come back'? I fully understand why stretching out the payment stream is risky but once paid, do not understand why it is more at risk."

I responded with the following: "Here's my logic about why contingency fees are more at risk: 1) With a regular payout, assume 50% upfront with a project, 50% on completion (or 33/33/33); 2) On contingency, I'm assuming a payout over a set period based on savings (at least in part) -- perhaps the period is one year, perhaps two. This leaves you exposed for longer since the payout is happening over a period of time after savings is realized -- which is the trap that got one firm in trouble. If you go on a fixed basis, since the ability of the courts is to only go back for a period of 3 months (I believe based on what I've heard, but confirm that with your lawyer), you're open to exposure for that much less time because the payment occurs over a shorter period. BTW ... once you are paid and in the clear for whatever the bankruptcy clawback window is, the type of model should not matter." I also suggested looking at this site for input on contract structuring and language if you find yourself in a supplier bankruptcy situation -- or a potential one that you're worried about.

So where does this leave practitioners trying to structure cost reduction contracts with consulting firms and vendors? For one, I believe it's possible to create a win-win contract structure that addresses the need for short-term savings with the need to mitigate initial cash outlays. Stay tuned on this note as we dig into this subject in early February, offering some ideas for both providers and practitioners alike.

- Jason Busch

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