When a big client files for bankruptcy protection, a claw-back provision can come back to haunt your business. One entrepreneur explains how.
In early 2007, Christopher Spiro organized one of the most successful home-selling campaigns in his firm's history. The tagline: “The End is Near.”
The marketing campaign designed by Spiro & Associates helped Engle Homes sell 141 homes in 90 days just as the real estate market was falling. “Prices would never be this low again,” Spiro reasoned. “We thought it wasn't going to last.”
Spiro and most others didn't know just how near the end everything really was. Just one year later, Engle and parent company Tousa filed for bankruptcy and nearly took Spiro with it by using a rule that allows bankrupt firms to claw back payments made 90 days before filing.
Engle had paid Spiro $541,000 for advertising in the 90 days leading to bankruptcy in January 2008 and now the court ordered Spiro to pay it back. A process server delivered the bad news. “We need to hire a bankruptcy attorney,” Spiro's corporate attorney told him.
Spiro's firm recovered from the near-death experience. Business is brisk again and Spiro moved into a newly renovated building in downtown Fort Myers with additional staff to handle work from top clients such as homebuilder Neal Communities. But Spiro says the experience changed the way he does business, including sleuthing prospective clients for any sign of trouble and asking clients to pay for media directly.
Engle's bankruptcy in early 2008 couldn't have come at a worse time for Spiro and many other businesses that had banked on the real estate boom. His lines of credit were frozen, credit cards were converted to debit cards and bank letters of credit became term notes. “We were managing our business week to week,” Spiro recalls.
In the 90 days leading up to the bankruptcy, much of the $541,000 Spiro had received from Engle was spent on advertising in local media. Spiro kept about 15% of that to pay his staff and for overhead. Now, bankruptcy court ordered him to pay it all back through a provision that allows claw backs.
“You're guilty until proven innocent,” Spiro says. “They don't care that 85% went to pay vendors.”
Spiro hired Fort Myers bankruptcy attorney Richard Johnston to help him sort through the mess. Johnston says the idea behind the claw back is that all creditors must be treated equally. So if a creditor got more than he would have gotten through the bankruptcy process, the amount exceeding that should be redistributed among all the creditors. “Most of these things do get settled,” says Johnston.
Even as settlement negotiations were ongoing, Spiro wasn't sure how long he could hold out. “We prepared a bankruptcy plan that was missing a signature and a date,” he says. “It was one of the worst times of my life.”
Eventually, Spiro settled on a plan to pay $27,000, paying $1,000 a month for 27 months. Still, during the recession, Spiro had more pressing needs. “It took me four or five years to pay the $27,000 I owed them,” he says.
What's more, Spiro had to pay for legal advice to steer through the nightmare and lost 400 to 500 hours of his own billable time. “It cost me $84,000 in legal fees,” Spiro says. “The paperwork...I must have had 10 cartons.”
Thankfully, Spiro says he kept meticulous records. The financial records of his company helped in the settlement negotiations. “I had to bare my soul,” Spiro says. “What helped in our situation was going there and putting all my cards on the table.”
But the experience changed Spiro's business operations. For example, Spiro paid for the media advertising for his clients, but now he asks them to pay for it directly and charges a management fee. Digital or social media purchases are tied to the clients' credit cards, not Spiro's.
Spiro says he's more careful about taking reputable clients and asks them in-depth questions about their business to make sure they're financially stable. “I've got a little private investigator in me,” he says.
Follow Jean Gruss on Twitter @JeanGruss