How to minimize risk if purchasing partners go bankrupt?

Oil platform of PV Drilling in Cambodia. Photo: PVD

The risk of losing hundreds of billions

In early June, Singapore-based oil and gas contractor Kris Energy filed for liquidation of assets due to inability to pay debts. Previously, from October 2020, PetroVietnam Drilling and Drilling Services Joint Stock Company (PVD) signed a contract to supply a jack-up rig to Kris Energy to carry out the drilling program in Cambodia.

At the end of Q1/2021, PVD had VND107 billion of receivables with Kris Energy. In a recent comment, SSI Research said that PVD may not have to make provision for this VND107 billion because this amount is still within the payment term. However, Kris Energy's ability to fulfill financial obligations is affected so PVD will need to make provisions.

Previously, many other Vietnamese enterprises also faced the same risk as PVD when their foreign partners went bankrupt, causing hundreds of billions of dong of debts to be converted into bad debts. Typically, Song Hong Garment Joint Stock Company (MSH) is also struggling with hundreds of billions of dong in debt from New York & Company (USA) – a member of the retail company RTW Retailwinds after this unit filed for bankruptcy from July 2020.

In the financial statement of the third quarter of 2020, MSH recorded a receivable of VND219 billion from New York & Company. In detail, MSH expected to collect VND107 billion and has made a provision of VND112 billion for this debt. Gradually, while the receivable amount is decreasing, the amount for provision is in contrast.

Specifically, in the fourth quarter of 2020, the recoverable amount for New York & Company's debt dropped sharply to only VND64.5 billion and by the end of the first quarter of 2021, it continued to decrease to VND32 billion.

Meanwhile, MSH's provision for this debt also increased to VND153.5 billion in the fourth quarter of 2020 and continued to increase to VND186 billion in the first quarter of 2021. The receivables of New York & Company only decreased slightly to VND218 billion in the fourth quarter of 2020 and remained unchanged since then.

Previously, the bankruptcy of the US retailer Sears Holdings in October 2018 also caused a great shock to Thanh Cong Textile - Investment - Trade Joint Stock Company (TCM) because its two subsidiaries Sears Roebuck and Kmart were holding 7% of TCM's revenue. Since then, even though more than two years have passed, the receivables of VND100 billion for the two enterprises is still in the financial statements of TCM and has remained almost unchanged. In the financial statement of the first quarter of 2021, TCM also expended nearly VND100 billion on making provision for its receivables.

Pay attention to payment methods and risk management

When purchasing partners go bankrupt, damage to businesses is inevitable. Typically, MSH's business administration expenses in 2020 increased sharply by 60%, leading to a sharp drop in gross profit margin compared to 2019, from 21% to 19.7%. Profit before tax in 2020 also decreased by nearly half, to only VND283 billion.

For PVD, the financial statement of the first quarter of 2021 recorded VND105 billion of bad debt, mainly from the Petroleum Exploration and Production Corporation and the domestic oil and gas exploration and production one member limited company and the provision has been made for VND97 billion for this bad debt.

If PVD has to set aside more receivables, the provision will double which will make it difficult for PVD to complete the current business plan. According to SSI Research, if it has to make provision of VND107 billion, this year's profit after tax of PVD may be halved, to only VND90 billion.

Economic expert Nguyen Tri Hieu said that when a purchasing partner goes bankrupt, the ability to collect debts of enterprises is very low. To minimize this risk, Mr. Hieu advises businesses to open letters of credit (L/C) at banks for every transaction instead of using traditional methods of collection or money transfer and it is best to use the L/C. certified by the bank of the importer’s country.

At that time, if the partner goes bankrupt, the bank will have to pay to the enterprise providing that the enterprise provides a set of export documents with full documents and bills of lading in accordance with the L/C. "The more accurate and complete the export dossier is, the lower the risk will be," said Mr. Hieu.

Experts also recommend that businesses need to regularly monitor and capture information about purchasing partners. With new partners, it is necessary to thoroughly study their financial capacity, ability to pay.

PVD's story is a typical example. Before going bankrupt in early June 2021, Kris Energy had been in financial trouble for many years and the contractor hoped production from the Cambodian oil field would help the company avoid bankruptcy. However, according to this contractor's announcement in April 2021, the output from Cambodia's oil field has not been as expected, and this has led to the failure of the finance restructuring plan of the company.

Thus, PVD's business contract with Kris Energy has shown great risks right from the start. This is also a lesson for other businesses when signing cooperation contracts, selling goods and providing services without fully assessing the risks that may occur.