Warning: Your Progress Payments May Be At Risk

Take Steps at the Beginning of the Order Process to Secure Your Rights

For most Michigan businesses, buying a custom piece of equipment, such as a stamping press, arc welder or conveyor system, is one of the most significant capital expenses they will make in any given year. But increasing economic challenges have pressured some machine manufacturers into tight financial straits that could spell trouble for a purchaser -“ unless it takes steps to protect itself from the beginning of the sales process.

A little background first: Because custom equipment is often time-consuming to design and expensive to build, a buyer often finances the manufacturing process by making partial payments along the way. These so-called “progress payments” make the transaction more attractive to both parties, because they slice what would otherwise be a large lump sum into more manageable pieces. The buyer doesn’t have to pay the entire cost of the machine upfront and then wait months -“ or even years -“ for delivery. Conversely, the seller doesn’t have to wait until delivery to receive payment.

But a buyer needs to beware. When it finances the manufacturing of a custom machine, a buyer is really acting as its seller’s bank -“ and it needs to take the same precautions to protect itself that a bank would.

In the event of financial problems that make it impossible for the seller to complete a piece of equipment, the buyer will want to be able to credit its progress payments against the price of the machine, obtain possession of it and then transfer it to another supplier to complete. A court order may be needed if the initial supplier won’t turn over the machine voluntarily.

If it does become necessary to seek a court order, the buyer will want to obtain the machine free and clear of any security interest that the supplier has granted to its bank or other creditor. The buyer can do that if it can prove that it is a “buyer in the ordinary course of business.” But, proving that may be time-consuming and expensive, as there are a number of requirements that the buyer must satisfy to be a “buyer in the ordinary course of business.”

To avoid having to prove that it meets all of those requirements, the buyer should obtain from the supplier an agreement that recognizes the buyer’s ownership of the machine and, as a precaution, grants the buyer a security interest in the machine. The buyer should also file a Uniform Commercial Code financing statement to give notice of and “”perfect” its interest in the machine.

Recognize that banks often have a security interest in their customer’s inventory, which includes the machine that the seller is building for the buyer. That means that the bank goes to the front of the line in case of financial difficulties or bankruptcy on the part of the seller.

To determine if a bank or other creditor has a lien on the machine or if it is subject to a tax lien, the buyer needs to obtain a financing statement search. If this exists, then the buyer will want to obtain the bank’s or other creditor’s written agreement that the buyer’s interest in the machine will have priority over the bank’s or other creditor’s security interest.

These documents, as well as the purchase order, must be carefully worded to preserve the buyer’s right to recover possession of the machine -“ without having to pay twice.

Jim Breay is a partner at Warner Norcross & Judd LLP, one of the largest law firms in Michigan with six offices across the state. Jim can be reached at [email protected].