June 22, 2023

Volume XIII, Number 173

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Seeking Shelter: Recession Implications for your Organization

In an interactive discussion led by Hank Harris, Director of Consulting for Ward and Smith Business Consulting, three attorneys shared their thoughts on the current state of the economy and how business owners can prepare for a recession.

Harris spent most of his career in a national management consulting and investment banking firm, where he specialized in working with privately held businesses. Having worked with hundreds of successful business owners over the years, Harris offers an insider’s perspective on important issues to entrepreneurs and privately held businesses.

The program — Recession Implications for Your Organization — featured projections on the future state of the economy, how business owners can minimize risk, the legal implications of workforce reductions, and how businesses can prepare and/or navigate through bankruptcy, if necessary.

The discussion included insights from Paul Fanning, who leads the Creditors’ Rights and Bankruptcy practice and is certified by the American Board of Certification and the North Carolina State Bar as a Board Certified Specialist in Business and Consumer Bankruptcy Law. The session also featured guidance from Emily Massey, a labor and employment attorney, and Richard Crow, a business and tax attorney.

Economic Forecasts

Harris initiated the talk by asking the attorneys to provide their opinion on what the future will bring for the economy. “None of us truly knows what the economy will do, but I can tell you that my banking clients are very nervous, causing them to step back and reassess their portfolios,” said Fanning. “They are looking at covenant defaults and seem to believe a storm is brewing.”

Fanning believes the economy is currently in a recession and could continue for another two years. “We don’t have the same overarching systemic problems we had back in 2008. But we have enough ‘little’ problems, that it’ll be significant, and it could be a few years before there is a turnaround,” noted Fanning.

In addition to the war in Ukraine, the economy is currently facing a number of issues, including:

  1. Persistent supply chain problems

  2. Headline inflation at 8.5% and core inflationat5.9%

  3. Interest rate hikes likely to continue well into 2023

  4. Retail sector weakening with inventory bloat, labor problems

  5. Two negative quarters of GDP growth (technical recession)

Regarding interest rates and the cost of money, Harris stated, “This really dates me, but when I first entered the business world, the prime rate was around 21%. So I have to chuckle when I hear the panic about mortgages because my first mortgage was around 14.5% with an adjustable rate.

Harris then pivoted and asked Massey to explain what her clients say about workforce strategies.

“The folks managing the workforce are still seeing a tight labor market,” Massey commented. “Employers are simply having a problem finding people, but with an eye towards a potential recession, companies are looking at their budget for next year. They are looking at where to trim some fat, which might mean personnel.”

A potential risk for employers regarding workforce reductions occurs with documentation. “During the pandemic, attracting and retaining employees was so difficult that it led some HR departments and managers to drop the ball as far as disciplining employees and/or holding them accountable,” explained Massey. “If workforce cuts eventually have to happen, the challenge for employers may be supporting their decision as to why they chose a particular person or group.”

Supply Chain and Labor Shortages

The fragility of the supply chain has been on full display over the past few years. Some of the problems have abated as businesses have found a workaround in procuring certain products/input materials; however, general issues continue to persist.

“Pricing pressures are a key issue some of my clients have highlighted for me,” said Crow. “This has an impact, not only when companies have to acquire materials to produce something, but also when they go to sell that product, because of having to find the right price point and maintain margins.”

The impact of pricing pressures flows into the idea that the recession is becoming a self-fulfilling prophecy. “Everybody’s getting worried about prices,” mentioned Crow.

Labor shortages are an ongoing problem. “In my practice as a business attorney in eastern North Carolina, I help major construction clients and manufacturing companies, restauranteurs, and real estate developers. I’m yet to hear anyone say they have a full staff and/or the best employees that are currently available,” noted Crow.

The shortages trickle through the system in terms of work stoppages and delivery delays. “It’s not uncommon to see a closed restaurant with a sign stating they simply couldn’t find enough people to open,” Crow stated.

Supply chain disruptions and the delay of key input products are causing significant frustration. Crow added, "Consumers and businesses up the chain are wondering why other businesses would not have another source of essential supplies. Why is one issue causing such a delay?” 

After the Fed eliminated some excess liquidity by raising interest rates, inventory may take longer to sell, and unemployment will increase. "I'm not an economist and shouldn't pontificate on this subject, but here's what I think," joked Crow. "Once inventory starts to sit, this will help with product delays. And, while painful, this will also help with labor, when companies are forced to start laying people off because right now, people have a lot of bad employees on the payroll, and they are scared to let them go."

Battening Down the Hatches

Harris then asked Fanning about what his clients are doing to prepare for the impact of a potential recession. “In terms of being proactive and lessening the blow to the company, it’s essential to find ways to become more efficient,” said Fanning. “This could include cutting staff.”

Contract review is one of the first tasks that Fanning performs when entering into a relationship with a new client. This is important because contracts dictate the parameters of the relationships between customers and vendors. Also, contracts are meant to minimize risk exposure.

“The other thing that’s really important is to find alternatives to existing service providers and vendors,” noted Fanning. “It’s vital to have a Plan B if a company you’re dealing with experiences economic distress, so you can pivot quickly.”

Employers preparing to do layoffs should be cognizant of a number of issues. “The first thing is the WARN Act, which applies to employers with 100 or more employees,” stated Massey. “Whether or not it’s triggered depends on the type of layoff.”

Providing adequate notice to employees facing layoffs is essential. Being able to show a process for determining which employees will be laid off is also an important means of avoiding disparate impact discrimination claims.

Offering severance to provide employees with a soft landing may be a good idea. “If you’re going to do that, get them to agree to a release of claims in exchange for it,” advised Massey. “This is especially important if the group you’re laying off is over 40 because they’re protected by the Federal Age Discrimination in Employment Act.”

Instead of layoffs, businesses may want to terminate bad employees. “As always, it’s essential to have documentation showing performance-based reasons for the terminations,” noted Massey.

Elon Musk's Twitter layoffs are a good example of what not to do. "You could see it was a rash decision that was not well thought out," said Massey. Providing more notice and more communications about the reasons for the layoffs would have helped the situation, similar to offering severance in exchange for a release of claims. 

“The way it was done, it’s easy to see why someone would go to a lawyer,” Massey explained. “It just proves that when you don’t communicate well, it can have unnecessary impacts on your culture and legal spend.”

Limiting workforce reductions to one instance is also advisable. “It’s better from a legal and a cultural perspective to only do it once and structure it thoughtfully,” said Massey.

Additionally, businesses should be aware that state laws apply where the individual works. "This obviously has implications for remote workers because there may be state laws indicating when you have to send their last paycheck," stated Massey. "You should also have a plan for retrieving your proprietary information and equipment."

Underperforming Vendors

Considering the likelihood that many businesses will experience financial hardship in the coming years, Harris asked Fanning to describe viable ways to prepare. “You have to figure out if this is a partner you want to be in the trenches with, so trust is a major component,” Fanning noted.

Businesses should also seek to manage payment risk where possible. Managing payment risk from vendors can be achieved by requiring:

  • Cash on delivery;

  • Collateral;

  • Deposits; or,

  • Letter of credit or surety bond.

“It’s also important to understand your rights and remedies, so you know when it’s okay to terminate an unfavorable contract,” advised Fanning.

Understanding that a wave of bankruptcies may occur, business owners should be aware that the laws generally favor the debtors. A business seeking action against an entity under bankruptcy protection can be subjected to substantial negative outcomes.

“Bankruptcy is a powerful tool. You have to know how to deal with it, whether your contract remains in place, and how bankruptcy might affect it,” commented Fanning. “There are deadlines, and at the end of the day, it’s all about negotiations and asserting your legal rights.”

To be proactive, businesses should review and update customer and vendor contracts. “It’s important to review the provisions, especially pricing provisions, from a strategic and tactical frame of mind,” concluded Crow.

© 2023 Ward and Smith, P.A.. All Rights Reserved.National Law Review, Volume XIII, Number 172
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About this Author

Matthew A. Jones Tax and Business Lawyer Ward and Smith Raleigh
Tax and Business Attorney

Matthew's multidisciplinary practice focuses primarily on tax and business law matters.  He helps businesses and individuals with tax planning and compliance, as well as business formation and transactions.  Matthews also advises non-profit and tax-exempt organizations on tax compliance and governance issues and counsels on incorporation and dissolution documents for non-profit organizations. 

Matthew's practice also includes assisting community associations in finding solutions to unique challenges faced daily.  He works with condominium,...

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