What if your company was forced to pay twice for all of its purchases from a particular supplier during the last month? What if that double payment obligation instead covered the last three months, six months, or even longer? Without paying close attention to notices and payment demands received from secured lenders, some unwary companies will have to “double pay” for goods they purchased and already paid for. Such is the cautionary tale from a recent case out of New York.
The New Style Double Payment Nightmare
A customer that pays its supplier rather than its supplier’s lender, after having received notice to pay the lender, may have to pay twice. As recently ruled by New York’s highest court, the customer remains obligated to pay the lender after having received such a notice, even if the customer paid its supplier for the same goods or services, and even if the supplier disputes the secured lender’s claim. The result is harsh but avoidable.
The case is Worthy Lending v. New Style Contractor. The lender in the New Style case sent the following notice to New Style:
Pursuant to Section 9-406 of the Uniform Commercial Code, payments of accounts made by New Style to Checkmate or to anyone other than Worthy Lending will not discharge any of New Style’s obligations with respect to such Accounts, and notwithstanding any such payments, New Style shall remain liable to Worthy Lender for the full amount of such Accounts.
Notwithstanding New Style’s receipt of this notice, it continued to make payments to its supplier and not the lender. The supplier went bankrupt, and the New York Court held that New Style has to make all of those payments again — this time, to the lender. It is a double payment risk for which the State of New York Court of Appeals expressed little sympathy, noting that double payment is the consequence for failing to pay a secured party that has notified an account debtor to pay the secured party directly. New Style’s misdirected payments reportedly amounted to more than a million-dollar mistake.
How Does This Impact My Company?
The New Style decision likely affects your company even if you do not transact business in New York, as New York law governs many commercial loan agreements and, thus, a lender’s right to collect a borrower’s accounts receivable.
Further, financial distress is on the rise as the impacts of the ongoing war in Ukraine, rising interest rates, supply chain disruptions, and other adverse economic conditions continue to take their toll on businesses across the United States and abroad. Many consumers and businesses have been burning through their cash reserves and increasing their debt.
Whether or not your business is financially stable, your ability to mitigate your risk of doing business with financially distressed suppliers will be important to a successful 2023. Foley & Lardner’s “Supply Chain Disruption Survival Guide” provides a superb wealth of analysis and ways to mitigate supply chain risks, including a chapter covering “Key Strategies to Protect Your Company’s Supply Chain and Mitigate Risks Against Financially Distressed Customers and Suppliers.”
Key Takeaways — Implement Risk Mitigation Processes
Does your business have risk mitigation processes in place to avoid the same fate as New Style? Awareness and diligence will ensure that you preserve your 2023 profits by avoiding such double payment obligations.
The following best practices will help mitigate the risk that your company suffers the same fate.
- Implement a process to promptly identify and log the receipt of a direct payment notice from a secured lender of a supplier.
- Ensure your accounts payable system has appropriate mechanisms to temporarily block payments to a supplier and, as needed, redirect all payments to a supplier’s lender.
- Upon receipt of notice from a secured creditor asserting its right to receive payment directly, pay the secured creditor directly or seek additional written proof of its asserted right from the lender (and your supplier).
- Monitor your supply chain for warning signs of financial distress and weakness, as set forth in the “Supply Chain Disruption Survival Guide,” and take prompt remedial action.
- Contact your bankruptcy/creditors’ rights counsel at Foley & Lardner LLP to obtain advice regarding your rights and obligations and risk mitigation strategies.