Suppliers of goods and services are critically dependent on others within their supply chain for both the provision of essential items and cashflow, as starkly highlighted by the uncertain economic climate of the past few years.
Stretched payment terms should sound an alarm, but the signs of financial distress can also include delayed or incomplete delivery of goods, unavailability of key management or the laying off of staff.
Being aware of, and taking measures to manage, counterparty risk is an essential part of good business hygiene. Where a counterparty does show signs of financial distress, taking early and proactive steps can go some way to protect your company's position and minimise potential losses. Our “top tips” are below – but these are no substitute for taking timely advice tailored to your specific situation.
1. The starting point: contract review
Understanding the key terms of the contract governing your relationship with your counterparty is essential. In reviewing the terms of your existing contract seek to understand both parties' rights and obligations, the contract's duration, and any automatic renewal or termination clauses. Ask whether the implementation of the contract in practice has diverged substantially from what was written on paper. Have breaches have been allowed to continue unremedied? If so, it might it be arguable that the original written contract has been amended by the actions you or the counterparty have taken. A clear-sighted review will provide a baseline for any future action – whether this involves practical changes to ensure compliance with the existing terms of the contract, or legal ones such as renegotiation of its terms or its termination.
2. Is renegotiation an option?
The result of such a review may be a decision that, either due to changes in the position of the parties or the market as a whole, it is not desirable to continue with the contract on the existing terms. Scope to renegotiate terms will depend, of course, on the circumstances and relative bargaining strength of the parties. Practical changes which a supplier may seek to implement might include shorter payment terms or requiring payment in advance for goods or services. Ensure that any variations to the contract comply with its terms and are documented in writing (and then complied with in practice).
3. Assess contractual termination rights
A critical part of your contract review will be to consider what termination rights are available to you, both pre- and post-insolvency. Even if termination is not a desired outcome, the ability to terminate may be key to your negotiating position. Consider both your available rights to terminate the contract and the applicable notice period. For example, if you have the right to terminate for breach, there may also be a requirement that you give the defaulting party a period within which to remedy the breach, and it is only if they fail to do so that you are then entitled to terminate. If termination is the desired outcome, it is generally preferable to do so before your counterparty enters into a formal insolvency process, because of statutory restrictions on terminating supply contracts after entry into that process for insolvency-related reasons.
4. Check retention of title clauses
If you seek to rely on retention of title (RoT) provisions, ensure these clauses are properly incorporated into your contract and are enforceable. Many RoT claims fail due to the RoT clause not being properly incorporated as it is referenced either too early, or late, in the process. For instance, RoT statements are often included in a delivery note or invoice – which is likely too late to be enforceable. To ensure the clause is enforceable, it should be included in a contractual document which is signed by the customer. Consider also how your RoT goods are to be identified, if you are required to enforce. Are they clearly labelled, easily identifiable, and/or required to be kept separate from other goods? And are those requirements being followed in practice?
5. Make sure you remain "top of mind"
Where a counterparty has fallen into arrears and is failing to pay invoices, it is essential to ensure that their debt to you is not allowed to fall off the radar. As an unsecured creditor, you would rank alongside all other unsecured creditors if the counterparty enters an insolvency process. However, the commercial reality is such that (at least pre-insolvency) the debts of key trade creditors will often be prioritised, to enable the company to keep functioning. Suppliers who do not press for payment, but continue to make supplies, will likely find the counterparty happy to let their invoices accumulate. You should therefore contact the decision-makers at the counterparty in writing and hussle for payment – and seek to maintain the pressure, including by withholding supplies if necessary. As a key supplier, you are in a strong position to ensure arrears are paid, especially if continued supply is critical to the counterparty's business.
6. Consider whether credit support may be available for ongoing supply
You may remain concerned about security for any continued supplies (if not made on a retention of title basis). Security from the counterparty itself is unlikely to be available – or, if it is, will be subordinated to existing security and therefore likely to be of limited value. Security granted prior to the counterparty’s entry into an insolvency process is also likely to be vulnerable to challenge and might be unwound: this doesn’t mean it shouldn’t be taken, but rather that you should be realistic about the value you place on it. In smaller start-ups and family-owned companies, it may be possible to obtain personal guarantees from directors as a condition of ongoing supply. This can provide additional protection if the company defaults, although you would need to consider whether the director in question has sufficient resources to back their guarantee – and, reputationally, whether you would want to be seen taking enforcement action against an individual.
7. A last resort: use statutory demands and winding-up petitions cautiously
Using statutory demands or winding-up petitions as a method of debt recovery carries substantial risks, particularly where there is any dispute over the debt. A statutory demand can be served on a company by a creditor owed more than £750, and failure to pay the demand within three weeks can be used as evidence of insolvency to support a winding-up petition. However, the party asserting the demand should be cautious of doing so, particularly where there is any dispute regarding the claim, or where a counterclaim exists. The debtor is likely in such circumstances to apply for an injunction preventing the presentation of a winding up petition, and if successful, the creditor may be held liable for the debtor’s costs of doing so – therefore finding itself even further out of pocket.
8. Seek professional advice
Proactively managing counterparty risk requires a thorough understanding of your contractual rights and obligations, effective negotiation, and informed use of the legal tools available. Where dealing with counterparties in financial distress, we would (naturally!) recommend seeking legal advice tailored to your specific situation, to enable you to navigate these complex issues effectively.
Tim Carter
Helen Martin