May 15th, 2004

Reducing Risks Posed by Financially Distressed Clients

Reducing Risks Posed by Financially Distressed Clients

Author(s): Candice Kersh

If you're like most agency executives, you've probably had the disappointing experience of working with a client in financial difficulty. Today, it is possible for any client - even well-established companies - to experience financial difficulties. Unfortunately, many agencies ignore the risks posed by their clients' finances. Agencies often extend credit unwisely, advance funds for production and other charges, or fail to establish or take advantage of basic legal protections in their contracts with their clients. However, agencies don't have to (and shouldn't) wait until a client is teetering on the brink of bankruptcy before trying to protect themselves from liability. There are steps an agency can take to help reduce its exposure before a client gets into financial difficulty.

The Risks
Clients in financial difficulty expose agencies to at least six different kinds of potential losses:

  1. Fees. Clients in financial difficulty often fail to pay agencies their fees.
  2. Production costs. If an agency incurs third-party production charges on a client's behalf - charges for commercial production companies, photographers, illustrators, music houses, printers, facilities rentals, etc. -- these amounts could be at risk when clients experience financial hardship.
  3. Talent expenses. Many agencies produce commercials on behalf of their clients pursuant to the SAG and AFTRA agreements. As a signatory to these agreements, the agency is generally responsible for fees and other amounts due in connection with talent hired on the client's behalf. A client's failure to pay could put the agency at risk for claims from the talent or the guild for the unpaid amounts.
  4. Media expenses. Media purchases can also pose significant risk to agencies whose clients are in financial difficulty. Media companies, for the most part, take the position that the agency and the client are equally liable for media payments for purchases made on behalf of the client. (The term that is used is"joint and several liability.") So, if your client cannot pay the amount due to the media, the media companies may try to look directly to the agency to pay the outstanding amounts. Faced with non-payment of media invoices, the media may also be concerned about accepting media placements for other agency clients. Finally, when a client experiences financial difficulty, media commissions to the agency are also at risk.
  5. Studio and other agency charges and out-of-pocket expenses. A client experiencing financial difficulty also may be unable to pay the agency for studio or other agency charges, or for out-of-pocket expenses, such as travel, incurred by the agency in servicing the client's account.
  6. Non-financial risks. Don't forget the damage to your long-term relationships with production companies and others that can result from your client's inability to pay.


What to Do

Here are some steps you can take to help reduce your agency's potential financial exposure as a result of a client's financial troubles.

  1. Know your client. While there's always pressure to take on new clients, it's important to learn everything you can about a prospect's financial condition before signing on. Get a Dun and Bradstreet report or run another credit check. Search the prospect on the Internet. And don't just do these things at the onset of your relationship with the client. Update your information over the course of your engagement.
     
  2. Use a good agency-client agreement. Operating with a good, well-negotiated agency-client agreement, properly enforced, can help to provide some of the most effective means of protection from unexpected, potential legal and financial exposure. If you are not using an agency-client agreement, it's time to use one. If you are using one, remember to ask your lawyer to update your form from time to time.
     
  3. Don't fall behind on collecting your fee. Make sure your agency-client agreement includes a clear agency compensation provision, and then enforce your agreement. Letting the client get behind on fee payments can put the agency in a vulnerable position in the event the client experiencesfinancial difficulties.
     
  4. Operate as an agency. Typically, agencies enter into agreements as an agent for their client. If the agency-client agreement does not grant the agency the necessary authority to act in this capacity, or if the agency does not enter into agreements as an agent, there could be additional exposure to the agency if the client suffers financial difficulties. Review your production and other form agreements to ensure that they clearly provide that the agency is acting as an agent for a particular client with respect to the agreement. If you're working with a client in financial trouble, you may also want to get paid in advance. Keep in mind that your relationships with your suppliers are also very important.
     
  5. Handle talent effectively. If your talent relationships are governed by the SAG or AFTRA agreements, consider including in your agency-client agreement (in addition to an appropriate indemnification) the right to require your client to sign a union/guild assumption agreement. Then, when the time comes, get the assumption agreements signed.
     
  6. Ensure that you have appropriate forms and use them. Avoid the trap of moving forward into potentially costly phases of a project without using appropriate agency purchase orders and other forms. To help limit your liability, review your purchase order and other agency forms to ensure that they include the most up to date and appropriate terms and conditions. So many times forms are manipulated for a particular deal and then the negotiated terms find their way, unchanged, into the form document. Once you make sure that you have the correct form, let everyone at the agency know that they need to use that form at all times.  And, of course, if you're faxing the document, don't forget to fax the standard terms and conditions - even if they appear on the reverse side of the form. These terms and conditions are very important and provide the agency with its first line of defense in the event of a problem.

    Use an agency form of insertion order when placing media orders. An agency's insertion order should make clear the agency's position on liability - whether that position is that the client is solely liable for payment to the media or that the agency is liable to the media seller only if the agency has been paid by the client (referred to as "sequential liability"). However, expect that the forms and credit applications supplied by the media will include a different provision on liability - namely that the agency and client are jointly and severally liable for the media payments. Therefore, if you are particularly concerned about a client's ability to pay, the best way to operate is to have the media separately and specifically agree that they will look only to the client for payment.
     
  7. Avoid advancing funds and extending credit. In your effort to build client relationships, you may be tempted to advance funds or extend credit. However, doing so can pose a significant credit and cash risk to the agency in the event a client is unable to pay the amounts when due.

    To avoid fronting money, regardless of the payment schedule under which you and the client have agreed to operate generally, make sure that the payment provision of the agency-client agreement provides that the agency must receive payment from the client, under all circumstances, before the date that the agency has to make the payment on the client's behalf. Then, make sure that you diligently enforce this provision of your agreement.

    However, if you are concerned about the financial capability of your client, this payment structure may not be enough to protect the agency from liability when it comes to the media. Because of the possibility of joint and several liability with respect to the media, it may be advisable to treat media payments differently.  Ideally in dealing with all clients, but particularly when dealing with clients of questionable financial capability, you should insist upon, and diligently enforce, a requirement in your agency-client agreement that as a regular course of dealing, media invoices must be paid before the closing / commitment date for the media.
     
  8. Communicate your policies. Let clients know when they are falling behind on their bills. Make phone calls. Write letters. Or ask your lawyer to write a letter. Don't be afraid to enforce your agreements.
     
  9. Make sure you have proper legal representation. If a client files for bankruptcy, make sure to retain a bankruptcy lawyer to help you navigate the claim process. But it is best to consult with your agency's advertising lawyer as well. The advertising business is filled with nuances that could have an impact on strategies in bankruptcy. Your agency lawyer can help you and your bankruptcy counsel understand the unique legal relationships within the advertising business and devise an effective way to deal with a bankrupt entity that, in many instances, will still be your client.