WHEN DISTRIBUTORS GO BELLY UP

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WHEN DISTRIBUTORS GO BELLY UP

Lessons and Reminders from the
PGW Bankruptcy

by David Cole

For all but a few of the
publishers involved, the conclusion to the recent Publishers Group West (PGW)
bankruptcy was happier than most could have hoped. Although subjected to some
harrowing sleepless nights and many lost hours of work, almost all are
continuing in business. They have made new distribution arrangements and have
suffered only modest losses, especially in comparison to what they might have
feared, given the history of distributor bankruptcies over the past 20 years.

The entire episode, however, has
been a powerful reminder to independent publishers of the precarious nature of
their businesses.

For small publishers, working with
a distributor provides certain advantages. A distributor can free you from the
worries of warehousing, order taking, and shipping books. Even more important,
with the combined revenues of many publishers supporting an established sales
force (either on salary or on commission), a distributor can efficiently make
your books available throughout the industry supply chain and give a promising
book from the smallest publisher a prominent place in the market. Moreover,
despite the seemingly large fees distributors charge, they usually perform
these services at a price competitive with the cost of doing the tasks
yourself.

On the negative side, working with
a distributor puts you as a publisher in a dependent position, delaying your
payables and constricting your cash flow. As the PGW bankruptcy reminded
everyone, a distributor’s problems can place your entire business in jeopardy
even if you are successful and prosperous.

Why the PGW Bankruptcy Was
Different

For those who have witnessed
previous distributor bankruptcies, when Advanced Marketing Services (AMS), the
parent company of PGW, declared bankruptcy on December 29, 2006, the initial
response was to fear the worst—a huge loss of receivables for publishers,
lost inventory, and a wave of publisher bankruptcies.

Fortunately, a very different
scenario came to pass. Because PGW’s business was sound and profitable, it
attracted buyers—first Perseus Distribution, a division of Perseus Book
Group, and then National Book Network (NBN)—that were anxious to acquire
the PGW accounts. Both were willing to pay publishers a large percentage of the
money owed them, offering a lifeline for publishers while, at the same time,
relieving the AMS estate of significant debt.

Responding to an active creditors’
committee comprising a group of PGW publishers, the bankruptcy
judge—whose actions won consistent praise from the
publishers—approved the sale of PGW as a separate asset within the
framework of the AMS bankruptcy.

The bankruptcy proceedings
themselves were the subject of as much drama as is to be found in the
publishing world—competing bids, late-night meetings, and a group of
publishers who refused to sign on with one or the other or both of the
competing buyers and whose fates were highly unclear. (Those who would like to
follow the entire history from beginning to end should take a look at radiofreepgw.blogspot.com
for a contemporaneous, thorough, humorous, and well-written, albeit one-sided,
account.)

When Perseus eventually prevailed
in the competition to acquire PGW’s distribution contracts, 124 of PGW’s
approximately 150 clients made the switch, and Perseus became the largest
distributor in the country. Among the publishers who chose not to sign on with
Perseus, 14 signed on with National Book Network; two signed with each of three
other distributors—Independent Publishers Group, Ingram Publishers
Services, and Random House; two were sold; and each of the others made
different arrangements.

Now Number 1

Ironically, Perseus Distribution
is a recent arrival to the independent distribution scene that was formerly
dominated by the 30-year-old PGW, its we-try-harder competitor, NBN, and
several smaller distributors—including Independent Publishers Group,
Consortium, SCB, and Midpoint. Two years ago, Perseus Distribution was formed
after Perseus Capital, the owner of Perseus Book Group, financed the purchase
of Client Distribution Services, a Random House spinoff that gave clients a
range of distribution and fulfillment options. Then last year Perseus bought
Consortium Book Sales & Distribution, a company known for its emphasis on
literary publishers.

Now this considerably larger
Perseus is in the process of digesting its many acquisitions. According to
Matty Goldberg, its vice president for sales and marketing, the back-office
functions—order entry, customer service, credit, and
collections—for all divisions are being consolidated in the Perseus East
Coast office, while all warehousing will be done in the company’s Jackson, TN,
distribution center. The CDS and PGW sales teams have already merged and will
have had their first combined sales conference by the time this article
appears.

On a reassuring note for the many
West Coast publishers represented by PGW, the company intends to retain the
core staff of sales and publisher relations employees in the San Francisco Bay
Area, just as it has maintained a Consortium office in Minneapolis. As an
interesting sidelight, Perseus does not currently have the rights to the PGW
name, and a banner now hangs over the Berkeley office displaying the court-anointed
epithet, transition vendor.

Publishers Moving Forward

As might be expected when an event
touches so many lives and businesses, there has been a wide range of responses
among publishers to how the bankruptcy unfolded, how it has affected their
livelihoods, and how they feel about their options as they look to the future.
Not surprisingly, larger publishers seem to have fared better than smaller
ones.

Steven Piersanti, president and
publisher of Berrett-Koehler Publishers, Inc., probably one of PGW’s bigger
accounts, served on an ad hoc committee during negotiations and basically had
praise for all the parties involved, particularly PGW president Rich Freese and
Charlie Winton, founder of PGW and currently CEO of Avalon Publishing Group.
For Berrett-Koehler, Piersanti reports, the disruption was minimal. Ready for a
change, his company decided not to take the Perseus offer and signed with
Ingram instead. Within two weeks of exiting from PGW, it had books shipping
from Ingram, Piersanti says, adding that he was pleased with the deal his
company had negotiated and the responsiveness of Ingram’s staff.

Ray Riegert, publisher and owner
of Ulysses Press, did take the Perseus offer, which he termed “very fair.”
Observing that Perseus has an excellent organization, he praised David
Steinberger, its president and CEO, as an “earnest and dynamic businessman,
genuinely interested in independent publishing,” and he added that Steinberger
did an excellent job in getting the deal to go through. Riegert did note that Perseus’s
terms were not as good as those he had at PGW, that he had taken a sizeable
loss, and that his sales cycle had been disrupted. Nevertheless, having had a
record sales year in 2006, he looks forward to even greater success in 2007.
(Ulysses’ title MuggleNet.com’s
What Will Happen in Harry Potter 7 hit the New York Times
children’s bestseller list the week we spoke.)

Smaller publishers told somewhat
different stories. Alan Fields, owner of Windsor Peak Press, and Bernard
Kamaroff, owner of Bell Springs Publishing, both decided to sign with NBN and
were influenced by the fact that Perseus would be offering free shipping to
bookstores and charging publishers the full cost for that service. PGW had
previously split those costs. With their smaller sales, both felt that their
losses in the bankruptcy plus the higher costs would be a drag on their
operations, although neither felt that their companies were endangered.

Kamaroff reported that he had lost
an entire sales cycle for his book 422 Tax Deductions for Businesses and Self Employed
Individuals, which was at the printer the day AMS declared
bankruptcy. Subsequently he had to lay off two employees, and at present he is
packing and shipping direct orders himself. Beverly Potter, whose Ronin Press
is a one-person operation, made the transition to Perseus but said that she
felt railroaded by the bankruptcy proceedings and was especially concerned that
she would take another big hit when three months or more of returns were
eventually processed.

Before You Sign a
Distribution Agreement

The cautionary tale in all this is
hard to miss: When trouble comes, the weakest are most affected. Figuring out
how to apply this insight, however, is difficult, and the best moves are not
simple either. While small publishers are usually those most desperate for
distribution, they have little or no leverage when negotiating a distribution
contract.

“How Publishers Can Protect
Themselves When a Distributor Goes into Bankruptcy” by Jonathan Kirsch, in this
issue, discusses applicable legal safeguards. Here are some basic business
guidelines.

● Keep in mind that, as Elise Cannon emphatically
points out, “Distribution is not for everyone.” A former PMA board member and
long-time PGW employee who has just been promoted by Perseus to the position of
director of field sales, Cannon goes on to say that, when you’re starting out,
you should “get your book listed at a wholesaler and online retailers. Later,
when you have grown, you can attract distributors.” Then, once you have built a
solid sales record and a consistent publishing program, bringing out new books
every year, you can shop around among the various distributors and publishers
offering distribution services.

● Check the financials of any distributor you’re
considering to make sure that they are sound. Problems will usually show up in
this process, but not always. (Some of the larger and more sophisticated
publishers working with PGW had gone over the AMS/PGW books not long before the
bankruptcy and missed, or underestimated, the warning signals.)

● Talk to publishers who are working with the
distributor you are considering and make sure they are getting paid on time.
Also try to gauge their general level of satisfaction.

● Check the distributor’s reputation with bookstores.
Look at how it does business, its discounts to retailers, and whether it gives
free freight. If so, will you bear the entire cost, and how will that extra
expense affect your bottom line?

● Be sure you will have easy access to someone in a
responsible position at the distributor you are comfortable working with. This
is essential.

● Compare the distributor’s terms with the competition’s.
You want the best rate structure and payment schedule you can get. Find out
what extra charges you might be subject to.

● Because working with a distributor is akin to a
marriage, evaluate your own level of commitment and that of the distributor you
have in mind. Your distribution contract is for a set period of time, and you
can make a change when it expires, but that is always costly and difficult.

David Cole is a member of
the PMA board, owner of Bay Tree Publishing, and author of The Complete Guide to Book
Marketing (Allworth Press).

How the Law Might Help You
Protect Yourself Against a Distributor Bankruptcy

by Jonathan Kirsch

Whenever a distributor goes
into bankruptcy, as hundreds of unhappy publishers have learned for themselves in
recent months, the publisher is going to endure a kind of perfect storm of
financial distress. For that reason, the bankruptcy of a distributor may put
the publisher itself out of business.

The first problem is that the
distributor will probably be unable to make payments on previous and ongoing
sales of the publisher’s titles, thus cutting off the publisher’s cash flow for
an indefinite period. Second, the distribution contract will remain in effect
unless and until the bankruptcy court permits the publisher to take its
business to another distributor. And, finally, the unsold inventory of the
publisher’s titles still in the distributor’s possession is likely to be sold
off to satisfy the distributor’s debts to other creditors.

Is there anything a publisher can
do now to avoid or minimize these problems if its distributor goes into
bankruptcy later on? This article presents a few tactics that are available and
commonly used in the publishing industry to cope with the problems of a
bankrupt distributor.

Caveat: Let’s get real. The
tactics described below generally require the distributor’s cooperation, and
most publishers are going to find that the distributor is not willing to make
the concessions that would afford them an extra measure of protection in the
event of bankruptcy. A more effective approach—and perhaps the only
practical approach for most publishers—involves checking out the
financial stability and business practices of a distributor before signing a
distribution agreement. (See “Lessons and Reminders from the PGW Bankruptcy” by
David Cole, in this issue.)

Desirable Deals

Automatic
termination clauses. Many
contracts in the publishing industry include a clause that provides for the
right of one party to terminate the contract in the event of the bankruptcy of
the other party. Be forewarned, however, that these so-called ipso facto
clauses are not, as a general rule, enforceable in bankruptcy when it comes to
property in the possession of the “debtor,” as the party in bankruptcy is
called. Rather, the property in the possession of the debtor will be applied to
pay the creditors, and the ipso facto clauses will simply be ignored.

Consignment
contracts. Most distribution
contracts are based on consignment of the publisher’s titles to the distributor
for distribution and sale. That is, the publisher’s books are never actually
purchased and owned by the distributor; instead, they are stored in the
distributor’s warehouse until they are sold to a purchaser, and ownership of a
book passes directly from the publisher to the purchaser.

It’s usually advantageous to the
publisher to make sure that the distribution agreement clearly states that
ownership of the publisher’s books is reserved by the publisher until it passes
to the purchaser in a completed sale for which payment is actually received.
(The publisher should, by the way, also make sure that the inventory is insured
against loss or damage while in the possession of the distributor.) As a
practical matter, however, the fact that a consignment clause appears in the
distribution agreement will generally not prevent the bankruptcy court from
treating the publisher’s inventory as an asset of the debtor and selling it off
to pay the creditors.

Some aspects of the agreements
between publishers and distributors (such as fulfillment and marketing services
provided by the distributor on a fee-for-service basis) are treated as
“executory contracts,” in the parlance of the bankruptcy laws. In the case of
an executory contract, a distributor that wants the benefit of the contract
must accept the burdens too, such as making payments on amounts owed prior to
the bankruptcy. A publisher, however, cannot safely rely on these principles to
obtain payment for books previously shipped. A better approach, discussed in
detail below, is obtaining and perfecting what is called a security interest.

Security
interests. The only effective way
for a publisher to prevent its books from being sold off for the benefit of
other creditors is to obtain a security interest from the distributor. Property
that is subject to a security interest may still be sold by the debtor,
but—as a general if not invariable rule—the proceeds of the sale
will be applied to pay the amounts owed to the secured creditor.

To obtain a security interest in
its favor, the publisher needs a distribution agreement that includes a
properly drafted clause by which the distributor secures its payment
obligations to the publisher by granting the publisher a security interest in
the publisher’s inventory and/or other specified assets of the distributor. Or
the security interest can be granted in a separate document, commonly known as
a “security agreement.” (Bear in mind, though, that the security agreement will
not be enforceable in a bankruptcy or against competing secured parties until
it is “perfected,” which generally requires a public filing as discussed in
detail below.) In either case, however, the property in which the security
interest is granted must be specified in the document itself.

At a minimum, the security
interest should apply to all the publisher’s books and other merchandise that
will be placed into the distributor’s possession and the accounts receivable on
the sale of such books and merchandise. Ideally, the distributor will also
grant a security interest in other assets of the distributor, such as money on
deposit in bank accounts, real property, personal property, and
receivables—but it is likely that the distributor has already granted a
security interest in these assets to other creditors.

Even if some assets are
unencumbered, the distributor is unlikely to be willing to grant a security
interest in such assets to any single publisher. Indeed, as a practical matter,
be forewarned that the distributor may be unwilling to grant a security interest
even in the property of the publisher itself, and the distributor may have
already granted a general “floating” security interest in all inventory “now
owned or hereafter acquired” to its primary bank lender.

The granting of a security
interest by the distributor is only the first step. The security interest must
be “perfected” to be effective and enforceable in bankruptcy or against third
parties. Although there are several ways to perfect a security interest, the
most common approach is to prepare and file a formal notice known as a
“financing statement.” Most creditors use a standard form called a National
Financing Statement or, more commonly, a “UCC-1.” (“UCC” refers to the Uniform
Commercial Code, a set of standardized laws that apply to commercial
transactions.)

Once filled out, the UCC-1 must be
filed with the appropriate government agency. For corporations, LLCs, and
similar entities that come into existence by virtue of a filing at an office of
state government, the proper place to file the UCC-1 is that state. Different
rules may apply, however, if the distribution company is a sole proprietorship
or, for example, a partnership that is not created by virtue of a government
filing. The UCC-1 itself does not require the distributor’s signature, but the
distributor must have authorized the secured party to file the UCC-1 by, for
example, signing the distribution agreement or the security agreement in which
the security interest has been granted to the publisher.

The UCC-1 will apply only to the
property of the distributor that is actually described in the form
itself—that is, the specific property in which a security interest has
been granted to the publisher in the distribution agreement or the security
agreement. Those descriptions can be very general, however; “all inventory” is
a common example.

If all formalities have been
properly observed, the perfected security interest should prevent the proceeds
of any sale of the secured property from going to the benefit of general
creditors rather than to the publisher. The distributor can grant a security
interest to multiple parties, however, in which case each secured creditor has
priority based on which one perfected or filed a UCC-1 first. In other words, a
publisher with a security interest must get in line with other secured
creditors, some of which may have filed and perfected their security interests
before the publisher.

There is a method of jumping the
line and getting priority over previously perfected security interests for
property actually supplied by the publisher as a secured creditor. But the
rules are complex and are strictly enforced in bankruptcy. Unless the security
interest is granted and notice is given to the competing secured party before
the publisher places its inventory into the distributor’s possession, the
publisher’s security interest will be second in priority after the original
secured party. If a distributor has previously granted a security interest to a
lender or other creditor, it may automatically attach to assets that come into
the possession of the distributor, including the books delivered to the
distributor by the publisher. Under these circumstances, a perfected security
interest in favor of the publisher will not prevent the publisher’s titles from
being sold for the benefit of a creditor whose security interest was perfected
first.

Guarantees
and letters of credit.
Theoretically, a publisher can secure the distributor’s obligations by
demanding personal guarantees from the owners or managers of the distribution
company. Under such circumstances, the publisher would be entitled to make a
claim against the guarantors, whether they are individuals or another company,
if the distribution company itself is unable to meet its obligations to the
publisher. Another theoretical approach is to demand some form of prepayment
for the books to be delivered to the distributor, such as a letter of credit or
a deposit into escrow. As noted above, however, it is unrealistic for most
publishers to expect or even ask for such accommodations from a distributor.

Critical
vendor status. Once a bankruptcy
is filed, the distributor becomes a “debtor-in-possession” and can continue to
sell books in the ordinary course of business, but the distributor is limited
when it comes to major out-of-the-ordinary transactions. In addition, the
distributor is not allowed to pay trade creditors that are owed money for goods
delivered before the bankruptcy filing, except in a few very limited and rarely
applicable circumstances.

The amount and priority of
payments will depend on, among other things, which creditors have succeeded in
acquiring and perfecting a security interest in the property of the debtor. But
it may be possible for a publisher to prove to the bankruptcy court that its
ongoing supply of books is sufficiently crucial to the distributor’s business
to justify getting paid sooner rather than later. Under these circumstances,
the publisher may be designated as a “critical vendor,” and amounts owed to the
publisher for the supply of new inventory may be paid before the claims of
unsecured creditors are paid.

Critical vendor status does not
mean, however, that the amounts owed on previous sales will be paid on a
priority basis. Then, too, it will be difficult for any single
publisher—and especially a publisher that supplies a limited number of
titles to the distributor—to demonstrate that it is entitled to be
treated as a critical vendor. Critical vendor payments are disfavored and are
being severely limited in bankruptcy courts nowadays.

Ask an Attorney

Once a bankruptcy is threatened or
filed, or a distributor’s financial distress is detected, the publisher will be
best served by consulting an attorney who specializes in bankruptcy and
creditors’ rights. The prudent publisher, however, will consult an attorney
before entering into a distribution agreement, because most of the tactics
described above must be implemented in the distribution agreement itself and in
advance of the filing of bankruptcy.

Bankruptcy laws and procedures are
complex, highly technical, and strictly enforced, and the assistance of an
attorney with appropriate expertise is the best way for a publisher to avoid
being swamped in a bankruptcy perfect storm.

Jonathan Kirsch—an
attorney specializing in intellectual property and publishing law and an
adjunct professor on the faculty of New York University’s Professional
Publishing Program—serves as general counsel of PMA. He gratefully
acknowledges the assistance of Martin S. Zohn, a partner in the Los Angeles office
of Proskauer Rose LLP, for his invaluable expertise in bankruptcy law.

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