Even for businesses in full financial health, supply chain vulnerability can cause unwanted disruption

Whilst the feared “tsunami of insolvencies” arising out of the pandemic has not to date had the devastating impact on the economy that many had initially predicted, as we move into a period of easing of government support and lifting of enforcement restrictions, businesses need to be alive to potential weaknesses in their supply chain to put them in the best position to navigate this period of change. We take a look at what might happen to suppliers and customers, see what those events could mean for you and what you can do to mitigate against those effects.

Early warning system

Preparing for financial distress affecting your supply chain can go right back to when the relationship is first forged. The earlier you can spot it, the more you can do to mitigate the effects. If you can build performance reviews or reporting functions into your contract with a new supplier, you will be better informed as to how each supplier is doing. Even if you don’t have those facilities available, spotting red flags and collating that information centrally during the life of the contract is key. Difficulty sourcing an order from a supplier could point to their difficulty in obtaining raw materials, which may mean they have not been paying their bills. Requests from them for you to pay sooner could point to cashflow issues. Changes in a customer’s ordering patterns may also point to an internal cost-cutting exercise. These are flags which can warn you of impending financial difficulty, but if your internal teams are not communicating with each other, the cumulative effect can be missed.

Plan of action

Once the difficulties are spotted, you need a plan of action. This will depend on the circumstances, but your starting point should be a series of questions such as:

Will you (can you) source another supplier?

If not, is it possible for you to help them through their difficulties?

If it is a customer in difficulties, have you got effective retention of title provisions in your agreement which will allow you to mitigate your losses? Is there anything which you need to do to make sure those provisions are more effective (e.g. insisting on separation of your goods in the customer’s warehouse)?

Your questions will be specific to your business but thinking about them now will save a lot of time later.

Distress processes

There is now a range of rescue and insolvency processes which could affect either your suppliers or your customers. At one end there are processes designed to improve the financial health of the company so it can emerge fitter and better able to cope with the current economic climate and at the other they can bring the business to a close.

Moratorium – designed to give a company breathing space while it finalises a rescue package

CVA and Restructuring Plan – two different processes which allow businesses to compromise even dissenting creditors to effect a rescue

Administration – usually results in a sale of the business and assets of the company to realise monies to pay creditors

Liquidation – a terminal process in which the business is usually wound up and the assets sold off piecemeal to realise monies for creditors

Depending on what process is affecting your supply chain, there are things you can do to limit the impact.

Distress effects

If a supplier enters a Moratorium, CVA or Restructuring Plan (“rescue processes”), you should notice no real change in service. The purpose of these processes is that companies continue their business in the usual way while they improve their financial position. If a company enters Administration, the business may well survive, and any new owner of that business is likely to want to continue the relationship with you. Liquidation is the only real process in which you may find your supplier disappearing overnight.

If a customer enters any insolvency processes (other than a Restructuring Plan), then you may feel concerned about continuing to supply them, particularly if they owe you money. Unfortunately, the government introduced new provisions last year which prevent you from terminating a contract to supply goods or services simply because a business has entered an insolvency process. It is possible to tweak terms and conditions to reduce the effect of this, and you are still able to terminate for late payment or other breaches. If your customer is in real financial difficulty, the likelihood is they will also have breached a few contractual requirements. Remember, however, that the rescue processes are intended to rescue the company as a going concern, so it is important to engage with the company to understand fully what is happening and what the plan is before taking any steps to terminate.

Administrators’ mindset

If the company has entered administration, the focus of the administrators is realising the business and assets of the company for as much as possible to maximise returns to creditors. Their primary duty is to act in the interests of creditors as a whole, so everything they do is motivated by that duty. Usually, the best realisations come in the form of a sale of the business as a whole as a going concern. If the administrators choose to trade the business while advertising it for sale, they will want to continue to supply the customers of the business and the business will need materials to do that, so it is not necessarily a bad idea to continue to work with them. They may expect a renegotiation of terms and your stance in those negotiations will depend on a number of factors including how important that business is to your supply chain and what the likely future of the business is. So once again, early communication with the administrators will be a determining factor in how you approach the negotiations.

Preparation is all

Essentially, as with most things in life, having a plan of action will go a long way to helping you navigate any period of change ahead.