Closing a Facility? Dig Deep to Avoid Contractual Issues

15 July 2015 Manufacturing Industry Advisor Blog

When closing a facility, the legal issues that most often come to mind are terminating a lease or selling the asset(s). However, those are just the tip of the iceberg. From below the surface, potential problems may arise out of contracts seemingly outside the facility closure’s scope.

Regardless of the reason, myriad legal considerations accompany a decision to close a facility. For example, we previously addressed the HR considerations. But, in many cases, issues can arise from provisions in unseen depths of contracts. We hope that the five tips, listed below, will help manufacturers avoid unwanted contractual surprises in the facility-closing process.

  1. Avoid Accidental Defaults Under Loan Agreements – Closing a facility can cause a default under lending agreements in several ways. For example, a lender may require notice, or even consent, of a change in the operating status of a financed facility. Or, actions taken in connection with a facility’s closure, such as exiting a line of business, could change the value of a borrowing base and create a default that way. When closing a facility, manufacturers should closely examine financing arrangements, even those seemingly unrelated to the facility, to avoid creating a default.
  2. Understand Security Interests in Personal Property – Disposing of personal property generally plays a significant role in closing a facility, whether it’s a manufacturing plant or merely office space. Thus, one must understand the extent to which third parties may have an interest in that personal property. Even transferring financed inventory or equipment to another location may be problematic, especially when moving the collateral across state lines or to a facility operated by a different legal entity.
  3. Address Your Supply Chain – Of course, the form of manufacturers’ agreements with suppliers, distributors, and customers vary widely. So too do the related issues associated with closing a facility. For example, the closure may create a contractual liability to suppliers with whom a manufacturer has an output agreement. Similarly, an exclusive distributor may have a claim to lost profits if a term contract is ended early. These, and other problems, may be avoided or mitigated, if the issue is spotted at the appropriate time. For example, certain contracts may be terminated merely by providing timely notice. Planning ahead, even as early as the relationship’s formation, can have a huge impact.
  4. Manage Insurance Policies – Assuming a manufacturer already carries the requisite insurance policies, timing presents the major issue on this front. Even though a facility may be officially closed on a certain date, some employees, including security and maintenance crews, may remain. Thus, communication between departments is important to ensure that the manufacturer maintains the appropriate insurance at all times. Also, equipment may remain after the closing date. Insurance should be maintained (and may even be required) on any property that remains in the facility. Additionally, closing a facility generally changes the risk profile of a company, so be sure to update relevant information with insurers. That way, your company maintains the proper coverage at the correct rate.
  5. Transfer Assets Correctly – In connection with closing a facility, companies often liquidate at least some of the associated assets. Take care to use the appropriate instruments and follow any applicable laws. For example, specialized assets (i.e., patents, trademarks, copyrights, and licenses) should be transferred using appropriate assignments. Keep in mind: assigning contractual rights may require the counterparty’s consent.

Of course, the foregoing does not encompass all the potential issues, and the examples are not exhaustive. If you are considering a closing a facility, be sure to plan ahead and consult with counsel to avoid unnecessary problems. And remember, potentially applicable provisions buried deep within contracts, which are easily overlooked, may cause problems for a manufacturer closing a facility if they are not properly addressed.

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