The pandemic-induced economic downturn has caused many staffing firms to wrestle with sharp sales declines, tough personnel decisions and fixed overhead. More financial challenges are looming, because even if the overall economy recovers, we can expect many staffing customers to go bankrupt in the coming months. Their businesses may be sound, but their own customers may be unable to pay them. Any gap in upstream revenue can affect the entire payment chain all of the way down to the staffing firms.

Basic exposures. Bankruptcy courts distribute customers’ assets according to statutory priorities. Unsecured creditors like staffing suppliers are among the last in line for payouts from the residual customer assets. Bankrupt customers will not pay staffing firms’ outstanding invoices for a long time, if ever.

In addition to withholding pending invoice payments, bankrupt customers or their trustees also demand that suppliers return all monies paid by the customer in the 90 days before the bankruptcy filing, called “preferential payments,” and they sue if repayment is not prompt. Some technical defenses are available, but typically, staffing firms that have contracts directly with the customers negotiate these repayments down by about 50%. These repayments will increase the staffing firms’ claims for unpaid invoices — subject to the same low expectations of collecting on those claims.

Intermediaries. Working through intermediaries — customers’ master vendor/VMS/MSP arrangements — aggravates those exposures. Typically, in these situations, the staffing firms have contracts with the intermediary and not with the customer itself. The intermediary/supplier contracts usually provide that the customers have no legal obligations to the suppliers; the intermediary will pay suppliers only after the customer pays the intermediary; and, if a bankrupt customer demands a refund of preferential payments, the supplier must pay 100% of the demanded amount to the intermediary for further repayment to the customer’s bankruptcy estate.

Under most intermediary contracts, the supplier has no unconditional contractual right to collect from anyone — even in prosperous environments. Suppliers’ services cost them, almost immediately, about 80% of what they bill, so inability to collect is a significant risk.

When customers file bankruptcy, suppliers working through intermediaries cannot file bankruptcy claims against the customers, because they have no direct financial relationship with the customers. They also cannot defend or negotiate customers’ preferential payment demands, because they promised to repay 100% of those customer demands to the intermediary.

Intermediaries, meanwhile, have no obligations and — with fees of only 2% to 4% of invoices — no incentives to pursue bankruptcy claims on behalf of suppliers or to negotiate lower preferential repayments for them with the intermediaries’ customers.

Mitigating the Risk

Here are some ways staffing firms can mitigate the risk.

Counsel. Retain bankruptcy legal counsel to handle claims, defenses, and going-forward working arrangements with bankrupt customers. Many issues — such as critical supplier status and future working contracts — require expert advice, and the whole bankruptcy process is technically and administratively challenging.

New contracts. Stop signing abusive contracts with customers and intermediaries.

Existing contracts. Seek fair modifications of contracts with intermediaries to fix the risks described above. The contractual changes are easy and usually involve the staffing firm reserving the rights to take over a customer’s bankruptcy claim from the intermediary and to defend or negotiate its preferential payments demand. It also helps to establish the intermediary as an agent of the customer (instead of an independent general contractor) so that the customer has an underlying direct obligation to pay the staffing firm.

Payment terms. Stop offering lengthy payment terms. Lending money to customers interest-free and without security is unprofitable and risky. And enforce your payment terms with aggressive collection efforts. Payment within agreed terms is one defense to preferential payment claims.

Monitor demand. Beware of surges in demand and sudden requests to payroll customers’ employees. These can augur financial distress.