by Autherine B. Smith

Created on: August 14, 2009   Last Updated: January 12, 2010

The day of reckoning has come to California for paying vendors and contractors in IOUs. The state reportedly has issued IOUs and warrants in excess of one billion dollars.

Many business men and women have retained counsel to file suit. Ironically, even the contractor's day in court will most certainly be impacted by the budget crisis. One of California's cost saving measures involves closing the doors to the state courthouses

for one business day per month. The projected savings for California, from this measure, is calculated at in excess of 80 million dollars.

Absent a long standing relationship and an outstanding credit rating, banks are not likely to accept IOUs. Some businesses may have to find non-traditional alternative financing. Reportedly, community banks, credit unions, and even check cashing businesses are offering to redeem IOUs for fees and substantial face value discounts.

California has set specific terms for the use of alternative financing involving its IOUs. In the case of a sale, the bill of sale must be notarized and properly executed by the original IOU payee. Be careful if you use the advancing technology of computers to invest in these instruments. It would be prudent to consult with your lawyer and your accountant before acquiring one of these IOUs.

California taxing authorities, however, may accept IOUs and warrants as payment for tax vendor and contractor tax obligations. California's Franchise Tax Board and the state's Board of Equalization have decided to accept IOUs and warrants as payment for taxes owed to the state by the vendor businesses. Contractors and vendors are forewarned that any resulting overpayment may take up to four months to be returned.

California is not alone in dealing with the problem of paying outstanding IOUs.

In the Commonwealth of Pennsylvania, many lawyers who handle court appointments in the state family and criminal courts on behalf of indigent parties have not been paid for months. In July, 2009, these lawyers, through their counsel, filed an emergency motion in the United States District Court for the Eastern District of Pennsylvania asking that the city and the courts pay the agreed upon legal fees, fees which they say are already well below market rates.

The law governing negotiable instruments is the law of contracts. Assuming properly authorized signatures, the IOUs and warrants must be paid according to the terms of the instruments.

Unfortunately, for small vendors and contractors, the nuts and bolts of their businesses cannot continue without payment being made soon. According to the California Department of General Services, the state has contracts with approximately 14,000 small businesses, the majority of them located in California.

Typically, states and municipalities are considered the most secure of creditors, lifelines for small businesses.

For businesses which can hang on, the IOUs offer a great incentive. California is offering to redeem its IOUs with a 3.75% annual percent interest rate, in October 2009, or earlier.

The weight of contract law is on the side of the vendors and contractors holding California's IOUs. The IOUs must be paid. Will California businesses be able to stay in business long enough for the ultimate payments to affect their bottom lines in a positive way? Regrettably, the return on the vendors' investment may be diminished by the outlay of legal fees to collect the outstanding payments.

Elected officials are also frustrated and many are now speaking out. This can only add to the concerns of vendors holding IOUs.

Sources: The Associated Press, Philadelphia Inquirer, United States District Court for the Eastern District of Pennsylvania PACER

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