Credit Maze

This is not the type of help a business owner wants to lend, and a list of creditors in a bankruptcy filing is not a list anyone strives to make.

Even during the economic good times of the 1990s, basic materials producers of metals and paper did not generally prosper in the same manner that technology firms did. Over the past two years, the steel industry in particular has shown its weaknesses, as more than a dozen steelmakers have declared bankruptcy.

Many in the scrap recycling industry call the situation unprecedented, and the dire economic state of the metals industry is causing scrap companies to re-examine their credit terms and practices.

MAKING THE LIST

The business world has become fond of lists, with the business press often leading the way in offering lists of largest revenue companies, fastest-growing companies or “most admired” companies.

But not all published lists are ones companies strive to make. One to be avoided emanates from bankruptcy filings: the list of largest creditors. The only good thing to be said about being a sizable creditor is that such parties often have a larger say in accepting a bankruptcy plan, and may be further ahead in a figurative line to be reimbursed.

The unavoidable negative, though, in being a large creditor is that a number of sale transactions that were thought to be revenues suddenly become potential losses.

The bankruptcy of electric arc furnace steel mills has put scrap companies in the unenviable position of making some of these lists. One published report on the filing by Trico Steel, Decatur, Ala., listed two scrap companies as among its largest creditors, with the Birmingham, Ala., location of Philip Metal Services topping the list by being owed $8.6 million.

Mill bankruptcies are not new, although veteran scrap processors contacted for this story say the current situation is unprecedented in terms of how many mills have filed. “This is an unusual situation, and probably the worst situation in the history of the business,” says Harry Kletter, chief visionary officer of Industrial Services of America (ISA), Louisville, Ky.

“It really is unprecedented,” agrees Al Cozzi, chairman of Metal Management Inc., Chicago. Cozzi has experienced both sides of the bankruptcy equation, with Metal Management currently preparing to emerge from its own Chapter 11 bankruptcy.

“I was on the creditors committee for the LTV Steel bankruptcy of 1986, so I got first-hand experience then, too,” notes Cozzi.

“We’ve all been stuck at one time or another,” adds Ben Sacco, CEO of Sierra Iron & Metal Co., Bakersfield, Calif. “Those are chances we take.”

Once a bankruptcy petition has been filed, there are steps that can be taken to improve a vendor’s chances of regaining lost assets, but only if proper legal channels are followed. “I would say the first thing to do is to talk to a bankruptcy attorney,” says Cozzi.

Not surprisingly, perhaps, attorney Steven M. Abramovitz, a partner at the New York office of Vinson & Elkins, agrees. “The bottom line [for scrap companies]: if one of their buyers goes into a bankruptcy proceeding, they ought to call a lawyer immediately, because there are proactive things you can do.”

Both Cozzi and Abramovitz point to the reclamation process as something scrap companies should be aware of. “You can make a reclamation claim for material if it was shipped to the customer 10 days prior to the bankruptcy filing,” says Cozzi.

“You have to send a written demand to the debtor, and there would have to have been a misrepresentation by the debtor as to solvency,” says Abramovitz of the process.

When working with clients with a customer who has gone into bankruptcy, Abramovitz says, “the first thing I need is a list of everything they’ve shipped to that company and all their invoices from the last 20 days to try to determine reclamation rights.”

He adds, “they will lose their rights if they don’t do it immediately. You can’t just drive up and reclaim the materials. Federal law prohibits claimants from seizing assets on their own.”

“A sale is a gift until payment is collected,” is a phrase credit managers are fond of.

The saying points out the wisdom of careful credit monitoring so companies can minimize their chances of having to chase after assets lost to a bankrupt company.

If scrap companies were not already paying attention to credit reports two years ago, chances are they are now. “I don’t think it’s unreasonable to ask brokers to give you financials before you do business with them,” says Kletter.

Whether selling directly to mills or to brokers doing business with the mills (who can go down in a domino effect), scrap dealers are being increasingly watchful of financial health and increasingly careful on credit terms.

“We’ve done several things in that regard,” says Cozzi of Metal Management’s practices. “One is, every customer that we ship to has to have a credit limit. If the customer is over the limit, we won’t ship to them. Or if they’re outside their terms [for repayment], we won’t ship to them.”

The measures may seem potentially harmful to scrap dealer-mill relationships, but Cozzi believes they are necessary. “Some of these steel companies are ailing, but we—the scrap industry—can’t afford to finance or subsidize the steel industry.”

Metal Management has also shortened the window for re-payment for many of its ferrous consumers. “As business has been bad, many of these companies were moving to 45 or 60 or even 75-day payment terms. Most of the people we’re selling to, if we have any credit concerns at all, we’ve got them on 10 or 15-day terms. We have 30-day terms for the most sound customers, but they are few and far between.”

As far as monitoring the creditworthiness of customers, there are several methods available. For publicly traded companies, quarterly reports can be downloaded from the Internet, as can commentary and interpretation of the reports for more commonly traded companies.

Such detailed information is not usually readily available for private companies, but business owners and credit managers can ask for it. “Companies should not be reluctant to be proactive in seeking information from their clients,” says attorney Abramovitz. “The company being asked may welcome the opportunity to dispel rumors that might be spread by other companies,” he notes.

”If as a business owner you have a debt that is of concern, confront them directly and ask for a copy of their financials,” says Abramovitz. “That’s a probing inquiry, but the customer should be willing, if they want to keep the relationship comfortable, to comply.”

If a company is unwilling to share financials, it is not necessarily a red flag that the company is in trouble, but a vendor may wish to do some follow-up credit monitoring.

In addition to buying information from credit reporting agencies, scrap executives say their own buyers and traders can be a valuable source of information.

“We’ve been very, very focused on that,” says Cozzi. “We get a report from every salesperson and every manager weekly on who owes what.”

Abramovitz also says business owners are wise to communicate with staff members and other vendors to keep their pulse on the situation. “A good credit report is important, but gossip is vital as well. Talk to your friends and other vendors.”

“Internally, we try to sell to the same people we’ve been selling to, and we try to deal with companies that have good histories,” says Kalman Gordon, vice president and treasurer of L. Gordon Iron & Metal Co., Statesville, N.C. “We try not to deal with people who don’t have good credit.”

Gordon cites favorable geography as another factor in his company’s ability to deal with preferred consumers. “In this area, we have Nucor and AmeriSteel, and they’re pretty strong, and SMI (Structural Metals Inc.), another good company.”

Kletter believes the situation is important enough to merit attention from the Institute of Scrap Recycling Industries Inc. (ISRI), the scrap industry trade association. “They could be a clearinghouse for credit for the members. They could set up a group that could constantly check members and provide information on a confidential basis. Members must have a credit rating and must continue to supply information.”

But putting a credit reporting service in place could prove problematic for the association, which includes as members not only consuming mills and smelters, but also large scrap companies that do business with smaller companies.

ISRI president Robin Wiener says, “ISRI has evaluated the issue, and due to potential conflicts between numbers, ISRI does not currently offer credit monitoring services.”

She notes that there are credit reporting services being marketed to member companies, and that ISRI is taking the lead on the industry’s overall credit standing by making materials available to members seeking financing from lenders.

According to Weiner, another harmful aspect of the steel industry woes for scrap processors is that lenders have become reluctant to make loans to scrap companies who supply the troubled steelmaking sector.

THE PARTNERSHIP PUZZLE

The importance of close business relationships—figurative partnerships—has been extolled by many in the corporate world.

But as with a marriage or a literal business partnership, one must choose a partner carefully.

Choosing its customers more selectively has begun to work for Metal Management, says Cozzi. “We’ve gone to [consumers] we never thought would be paying us in 10 or 15 days, but they have.”

The measures have helped the company avoid making top ten creditor lists. “So far, I think we’ve done fairly well. We’ve taken a couple of hits, but we’ve been able to see the situations. We’ve walked away from mills that have refused to adjust their terms.”

Cozzi notes that even in the worst case—when a consumer files for bankruptcy—keeping a close 10-day tether on customers “is another benefit to those terms; the amount of material you can recover is greater.”

Small and medium-sized companies run the risk of getting hurt not only by bankrupt mills, but also by larger processors or brokers who go under. Three of the largest scrap consolidators of the late 1990s (Metal Management Inc.; Philip Services Corp., then based in Hamilton, Ontario, Canada; and the former Recycling Industries Inc.) all filed for bankruptcy within 12 months of each other as the 1990s drew to a close.

Processors have differences of opinion about the relative safety of selling to other processors, brokers or directly to mills. “There’s really no way to protect yourself right now, because it hits you from all directions,” says Kletter. “We have direct sales and we have sales through brokers. The only way to protect yourself is to sell direct to solid consumers, or the broker has to provide assurances that the consumer is responsible. You need to have a close financial watch and give them credit limits.” Kletter says safety can also be sought by selling through a brokerage office attached to a larger processor with physical assets, such as OmniSource Corp., Fort Wayne, Ind.

Cozzi says good credit monitoring “really comes from the top. We’ve got a top-notch credit guy, and we have a credit committee across the company.”

He says that smaller companies may be wise to purchase credit insurance policies. “I know a lot of dealers who are buying credit insurance. For smaller companies, it’s an insurance policy that lets you sleep at night.”

Says Sacco, “you have to be knowledgeable. If you sell to a broker, that can be a way to stay safe if a mill goes bankrupt. Sometimes, you want to be a big shot and sell direct, but you can get hurt.”

Doing business with a company that is troubled but has not yet declared bankruptcy may be less favorable than working with a company that has already filed, says Abramovitz.

“For amounts incurred after the company files, those claims will have a priority over claims that accrued before the filing,” he remarks. But such a tactic comes with a caveat. “That’s subject to the fact that the bankrupt company will get repayment to you. A higher priority of zero is still zero.”

Dealing with such situations is not bad news to veterans who experienced the manufacturing recession of the late 1970s and 1980s, but the landscape today could be even more challenging.

“Today, we’ve got to think like bankers,” says Cozzi, referring to very conservative bankers when he says, “We’re more concerned about the return of our money than the return on our money.” RT

The author is editor of Recycling Today and can be contacted via e-mail at btaylor@RecyclingToday.com.