Close-Up: Don't let sinking clients take you down with them

Agencies must do what they can to ensure they are not left financially crippled when a client goes under, Bob Willott writes.

There are lots of billings league tables that agencies might like to be near the top of, but being owed the most money in a client bankruptcy is not one of them.

So Omnicom may not have been too pleased to find that BBDO Detroit was the second-biggest unsecured creditor when Chrysler filed for bankruptcy to facilitate the US government-supported merger with Fiat. Faced with unpaid bills of $58 million, Omnicom's chief financial officer, Randall Weisenburger, said that the worst-case scenario - which he regarded as virtually impossible to envisage - would actually cost the group between $25 million and $30 million, but he sounded confident that the group would emerge financially unscathed.

Last Friday, the company told Campaign: "It is obviously early in the reorganisation process, and we continue to work closely with our client. As far as the potential balance sheet impact to Omnicom, we stand by our statements made on 27 April."

The Media issue

For such a large amount to be unpaid, it is almost certain that much of it is related to media. If so, the group will presumably have negotiated terms with US media owners that enabled Omnicom to apply the concept of "sequential liability". This prevents the media owner from pursuing an agency for payment unless and until the client has paid the agency for the media space. But it provides no compensation for lost media commission or any other remuneration due to the agency. However, Omnicom agencies are also likely to have taken out credit insurance.

Sequential liability arrangements similar to those available in the US may also have been applied elsewhere. Nevertheless, the possibility remains that some of the bills will remain unpaid. If so, Omnicom may seek to persuade Chrysler's successor company that its agencies are more likely to make available the creative work developed for its bankrupt predecessor if a sensible arrangement can be made in relation to unrecovered costs.

Agencies in danger

BBDO may have made the mistake of assuming that Chrysler was too big to fail and that either the US government or someone else would bail the car-maker out. That belief - coupled with the expectation that, if Chrysler didn't pay, the media owners would take the hit - would be enough to foster over-confidence and lose Omnicom the interest it could have earned if those bills had been paid sooner.

Fortunately, no other marketing agency was among Chrysler's largest creditors, but agencies working for General Motors will be concerned about rumours this week that its financial crisis may not be resolved by a government-backed restructuring. But clients don't have to be as big as Chrysler or GM to bring down an agency.

Any agency that is over-dependent on one big client is potentially vulnerable, not least because it will be hesitant to press too hard for payment, which can be a grave mistake. Agencies that specialise in sectors that are vulnerable to economic cycles are also at greater risk.

Reducing the risk

Obvious protective steps to take are credit insurance or prepayment of invoices (especially for media). If credit insurers decline to cover a client, its custom may be worth giving a miss.

McCann Birmingham learnt this lesson the hard way at the end of 2008, when it was left with a bill of £900,000 for MFI airtime because, while the client had prepaid most of its media before going into administration in December, broadcasters were still owed for media space booked in the run-up to Christmas. The agency became liable for the costs because it took on the MFI business without credit insurance.

Retainers can also reduce the credit risk, if only because default sets alarm bells ringing. The US concept of sequential liability may not apply everywhere but is worth applying if possible. Then take a look at clients' balance sheets. Do they have enough readily realisable assets to pay all bills when they become due? Are they over-dependent on borrowings?

Finally, an agency can do a lot with its own affairs to mitigate financial risk. "Rainy day" resources were laughed at during the boom, but it's worth retaining sufficient reserves and working capital to pay at least three months' operating costs in the admittedly unlikely scenario that all client revenue vanishes.

- Bob Willott is the former editor of Marketing Services Financial Intellect.

WHAT IS SEQUENTIAL LIABILITY?

- Sequential liability is more of a commercial concept than a legal one. US advertising agencies have been fighting for it since 1991, and the last major recession. It simply means that once the client has paid the agency for media, the client is no longer liable to the media owner; but unless and until the agency gets paid by the client, the agency is not liable either. Media owners have always resisted the concept, preferring both the client and agency to be liable.

- Custom and practice in the UK is slightly different. Agencies act as a "principal" in their dealings with media owners and other third parties, rather than as an "agency" in the legal sense.

- Historically, the upside for agencies was that in the absence of any terms to the contrary in the client/agency agreement, the agency was entitled to retain any discounts or rebates negotiated with media owners or other third parties. The downside was that they were liable for the clients' spending, even if the client went bust and the agency was never paid. But with credit insurance, that risk could be managed.

- Now, in the age of the auditor, discounts and rebates have to be returned, so the upside is diminished or even extinguished. And the credit crunch means that credit insurance is either uneconomic or unavailable, so the downside is harder to manage.

- Against this background, sequential liability is rational and makes sound financial sense for advertising agencies. If third parties won't accept it, there are a range of other options, all with pros and cons. The simplest is either to ask clients to pay 100 per cent upfront for media and production, with advance payments held in a separate client account until they are due, or get the client to contract direct with the third party. Brinsley Dresden is a partner, media brands and technology, at Lewis Silkin LLP.

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