Tuesday, May 24, 2005

Foot: The Art of the Deal - A Fable About Pretextual Negotiation

Fred owned and operated WidgeCo: a small business that built and sold widgits. Business was generally pretty good, although he experienced a short downturn two years ago when he tried to market a new "retro" widgit, which was nothing more than a regular widgit covered with orange shag carpeting (he named this model the "Superfly 5000"). He took out a large loan from Bank to finance the purchase of the shag carpeting and collateralized it with WidgeCo's inventory. The cratering of the Superfly 5000 in the widgit market put a large financial strain on WidgeCo. He missed two payments on his loan in 2004. However, the downturn attributable to the failure of the Superfly 5000 was reversed by surging sales of his other models. He resumed making payments on his loan, though he remained two months in arrears.

Bank wanted to diversify its business by breaking into the widgit manufacture and retail market. Unfortunately, Bank had no widgit inventory, no resident knowledge of the construction of widgets, and no widgit making infrastructure. One day while Biff, Bank's Vice President in charge of Repossessions, was flipping through his files, he came across WidgeCo's folder. Looking through it, he discovered that WidgeCo was 2 months behind on it's loan. He noted the Bank's standard promissory note and accompanying security agreement signed by Fred in the file. The note included two clauses that pricked Biff's imagination:

4) DEFAULT. The borrower shall be in default of this agreement in any of the following circumstances:...

(c) borrower fails to make timely payment for two (2) consecutive payment periods...

7) ACCELERATION. If an event of default occurs, Bank may, at its option, declare the entire amount of the loan immediately due and payable. If Borrower cannot satisfy the terms of this agreement and extreme circumstances exist, Bank may seize any and all property offered by Borrower as security for this loan (in the security agreement attached hereto).

Biff knew that Bank had never in its history enforced the repo provision in its promissory note, preferring to go through the courts to obtain collateral on defaulted loans rather than by using self-help remedies. There were two reasons: first, it was just bad business; and second the legal department believed that the repo clause was unconscionably unenforceable - its use would likely expose Bank to lawsuits and bad publicity. But still...

Bill became excited at the thought that this plan he was formulating could be a ticket to a corner office and a seat at the executive table. After doing some research, he decided that the Widge-o-matic 3500 would be a good model to start the business. He knew just how he could play this chump; this "Fred".

With the loan documents in hand, Biff ran to his Beemer and sped off to pay Fred a visit.

Fred was helping a customer when Biff burst through the store's door.

"Are you Fred, the owner?" Biff asked.

"Why yes, yes I am," Fred replied.

Biff pointed to the opposite corner of the store, "We need to talk."

Once they were away from the customer, Biff started in: "I'm Biff. I represent Bank. Going through your records I noticed that you are two months behind on your debt to us." Biff thrust the loan documents toward Fred. "You will note that this puts you in default of the note you signed for bank. We are accelerating the debt, and you must pay it off now."

Biff let the words drift through Fred's stunned ears for a moment before stating the obvious: "you don't have the money, do you?"

"N-no," Fred stuttered.

"Well then. In accordance with the security agreement you signed, I will have to repossess all of your inventory."

"Whoa there pardner!" Fred exclaimed. "The value of my entire inventory is way more than the amount of the outstanding debt. You can't take it all."

"Oh yes I can," Biff taunted, "It says so right here in the agreement: 'all inventory.' If the sale of the collateral yields more than the amount of the debt, Bank will of course refund you the difference."

"But what will I do without any inventory? I'll go broke!" Fred started to sob.

"Tough darts, pal. You signed the note, and you defaulted on the loan. Time to pay the piper."

Fred was in full tears now, "Can't we work something out?"

Biff smirked. Gotcha. Set the hook.

Biff paused for a long moment. "Well. I suppose I could take some of your inventory, but delay the satisfaction of the debt until the value from the sale, and your continuing payments on the debt, pay it off."

Fred wiped the tears away, "That sounds fair. *sniff*"

Biff paused again so as to appear in thought. "Tell ya' what. I'll take all of your existing inventory of the Widge-o-matic 3500 and we'll call it a deal."

"But that's my best seller! How about my entire stock of the Superfly 5000?"

"Or I could just go by the agreement and take all of your inventory..."

"Fine. Take the Widge-o-matic."

"I'm glad we were able to reach this compromise, Fred. You have saved your business and the entire Widgit industry." For now, Biff didn't add. He suppressed a smile until his back was to Fred and began carrying Widge-o-matics out to his Beemer.

After Biff had left, the customer -who had witnessed the whole incident - came over to Fred. "That guy just handed you your ass, buddy," he said in a voice that was a perfect blend of pity and disgust.

"I know," Fred replied. "I just wanted him to like me."

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