Bankruptcy in Outsourcing – An Overview of Avaya’s Chapter 11 Filing

Written by Vandana Mohanchandran

The likelihood of a bankruptcy is a legal risk that affects customers, service providers, employees, and supply chains including subcontractors and indirect customers. Bankruptcy rules have special clauses in outsourcing as it does not involve the sale of goods by a vendor.

With the bankruptcy filing of telecommunications company Avaya on January 19, 2017, the company will restructure its debt under the protection of a Chapter 11 bankruptcy filing. Avaya intends to emerge from this with minimal impact on customers. However, it is possible that Avaya will sell its network infrastructure business.

Avaya’s Chapter 11 Bankruptcy Filing

Avaya is an enterprise voice and unified communications vendor with a portfolio of network infrastructure products that it attained with its acquisition of Nortel in 2009. The networking portfolio includes data center and enterprise routers and switches, as well as a wireless LAN solution. Avaya’s networking business is known for the quality of its products, but has never been an essential part of Avaya’s overall business, which is integrated communications.

Avaya says it presently has a 10-year-old debt structure, which has been intact since Avaya was primarily a hardware vendor. Currently, it says 75% of its sales are software making it difficult for Avaya to pay its investors. The shift to software means majority of the new sales will generate moderate, periodic revenue, rather than large, hardware sales. With Avaya’s changing business model, its debt becomes harder to manage. The company is showing sales growth, but Avaya will be at a disadvantage if it sells its networking business.

What This Means for Avaya’s Customers

Avaya’s contact center technology is considered very valuable to its clients and the industry and will continue to be important, especially for large government and other enterprises that rely on contact center technology solutions. Additionally, Avaya has a substantial number of patents from hardware and software products, which have residual value.

Although the company has filed bankruptcy, it is important to know that Avaya continues to have good financial performance and is able to continue to support its client base in the future. Avaya’s technology products and services are expected to continue to have long-term value in solutions, regardless of the final outcome.

Key Issues in Bankruptcy that Affect Outsourcing

It is essential for outsourcing parties to know about bankruptcy before signing a contract. Business leaders should understand the fundamental concepts of a new entity, assignment, rejection of contracts, fraudulent transfers, and the legal consequences of the filing a bankruptcy petition relating to intellectual property, assets held by investors and, payment streams to service providers.

  • Lost Deals – Bankruptcy may deprive both the customer and the services provider of the benefits of the initial contract. The parties can negotiate measures to limit the damage to some extent, but once bankruptcy is filed, exit procedures and strategies become less predictable.
  • Customers and Suppliers Affected by Bankruptcy – Bankruptcy of a customer, or of a direct or indirect supplier, could deprive business leaders of cash flow. Additionally, it could enforce duties to defend and preserve the bankrupt’s assets, presuming that the bankrupt is not insolvent.
  • Immediate Effects of Filing Bankruptcy – By filing for bankruptcy, a bankrupt debtor can freeze trade credit existing at the petition date. This is potentially beneficial in the short-term but considerably disastrous in the long-term as most suppliers insist on a cash-and-carry payment procedure.
  • Executory Contracts – Bankruptcy can result in the downfall of executory agreements for future performance. A debtor has the power to reject such contracts as a principal tool for restructuring and reorganizing the capital structure. The debtor is unable to avert the other party from terminating the contract for actual breach. Therefore, it is absolutely essential for service providers to manage credit risks.

It should be noted that special attention must be paid for contracts surrounding intellectual property and continuity of services. Having a thorough understanding of the general rules of US bankruptcy can help focus on solutions if such a situation were to arise in the future, both pre-petition and post-petition.

To know more about legal risks that affect customers, service providers, employees with respect to filing of bankruptcy, subscribe to Supply WisdomSM. Contact us for more information or to get started with a free trial.

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