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Maintaining Service Continuity When A Major Supplier Goes Bust

This article was originally published in November 15 by In-Procurement

I still have a wry smile when I read a termination clause like this.

“A party to this Agreement may terminate this Agreement by providing 30 days’ notice in writing in the event that bankruptcy or insolvency proceedings are brought against the other party, or if an arrangement with creditors is made, or a receiver or administrator is appointed over any of the other party’s assets, or the other party goes into liquidation.”

The negotiating teams on both sides will use phrases like “of course, something like this isn’t really going to happen; but of course we would need protection in the contract just in case it does”. They will reassure their executive sponsor that the contract contains a long list of obligations that apply if a termination event occurs, and that we have “protection and indemnity for any costs that arise as a result of termination”.

As if any of that matters.

Termination rights are only as good as your power to enforce them, and if a company goes into administration those powers disappear, or at the very least are suspended for a long period of time.

This article explains why, and gives a few ideas on what you can do about it.

Supplier insolvency triggers termination rights that you can’t enforce

When a company of any size is, or is at risk of, becoming insolvent, it may enter administration. The administrators take over the affairs of the company and seek to sell the business and/or its assets and wind up its affairs under a strict set of statutory rules.

When an administration order is awarded it triggers a moratorium on the rights of creditors, who have to apply to the courts to enforce any rights that they believe they have (for example, to receive goods that they have paid for, or to transfer title to assets). The court’s decision doesn’t depend only on your contract – they will also balance your rights against the rights of all other creditors to the company.

That sounds a bit abstract, so I’ll use a real example. I worked on behalf of a client whose major IT supplier went into administration suddenly in 2013. The supplier held several million pounds worth of my clients stock under a bill and hold arrangement. The stock was needed for projects that my client was contractually committed to complete within a specified timetable. My client had paid for the stock. It was theirs. The conversation with the administrator went something like this.

“We have a lot of equipment in the warehouse that we need to recover this week.”

“Send me the details of your claim and I’ll consider it.”

“How long will that take?”

“I don’t know, we have to wait until all creditors have submitted their claims.”

“But we need it now!”

“That’s not my problem, The company who originally supplied the equipment hasn’t been paid for it, so they claim that they own it as well.”

Regardless of the rights set out in the contract, the practical position was this – my clients equipment was in a locked warehouse, with no means of recovery. If we didn’t get access to it, then we would be liable for penalties to our customers for failure to deliver their projects. The only options available were to wait (for months or years); to buy entirely new equipment, or to negotiate directly with the other creditors to settle the claim on the equipment in the warehouse.

An equally difficult position applied to employees of the bankrupt supplier, some of whom were working on the same projects. They found themselves without a job, with substantial unpaid salaries and expenses, and no certainty over what was going to happen to them. Our contract provided for the provision of TUPE information if a termination event occurred. In theory, we could use this right to transfer the people involved in our contracts. The conversation went something like this…

“We want to transfer over some of your employees, pursuant to our exit rights”

“Understood, but I’m going to make 450 of them redundant tomorrow morning, so unless you transfer £x million by the end of today to cover the payroll they won’t be my employees any more.”

“What?@!”

No one knows how to do hardball negotiation like an insolvency practitioner…

If a small supplier gets into financial difficulty, then the problem is mostly theirs to solve. But make no mistake, if a major supplier gets into trouble then its your problem too. Without robust management, the crisis can quickly overwhelm you and your customers as well.

Here are some things you can do now to mitigate the impact, both before and after the crisis hits.

Prevention is Better Than Cure

  1. Check and recheck creditworthiness. Its routine to conduct a credit check on a new supplier. However, its far less common to revalidate their creditworthiness once they are established.
  2. Look out for the warning signs. The accounts payable team had noticed a change in the failing supplier’s behaviour months before they went into administration. Invoices were being submitted ahead of delivery or completion, the supplier had started making extensive use of factoring to get early payment and in the words of the team leader “you could just tell that something wasn’t quite right”.
  3. Maintain diversity of supply. As a supplier becomes established, the amount of business they do with you (and your dependence on them) will increase. You need to evaluate your most critical supply relationships and have a contingency plan if they get into trouble..
  4. Possession is nine tenths of the law. Ensure that you have possession of equipment, software and other assets before you pay for them. Bill and hold arrangements are very common within complex supply chains (where the supplier is paid for the goods, but retains them in their warehouse until the customer is ready to take delivery). However, if the supply chain fails for any reason then you will face a long and costly battle to recover what you think is yours by right

Managing the Impact of Major Supplier Failure

  1. Mobilise a core crisis management team including legal, HR, finance expertise and a core programme office to co-ordinate the response. Individuals within the supplier will often be unaware of the scale and nature of the problems, and are likely to put a positive spin on the position even if they are. You should always assume the worst and plan based on this.
  1. Streamline governance and approvals. Provide a simpler, quicker process for assessing what actions to take and to get approval to spend money, mobilise resources or enter into new contracts. A daily call with board level executives responsible for finance and procurement can be essential to enable you to act decisively when it matters.
  1. Communicate constantly. The crisis management team must communicate both up AND down within the organisation. They need to set out the truth of the current situation, being as candid as possible (this is hard, as often there are highly confidential negotiations being conducted in parallel); provide lines to take and clear messages of sales and service teams to use with their customers, and manage the PR and press interest that is often associated with a major supplier failure.

About the Author

Kelvin Prescott is the Director of Newbury Management Consultants, a specialist consultancy providing commercial advice to the public and private sectors. He has over 15 years experience of leading major procurement programmes in public sector organisations, including the MOD, National Policing Agency and Cabinet Office. Since 2009 he has also helped a number of small and medium sized companies to build their public sector businesses, particularly in the areas of agile software development and implementation. www.newburyconsulting.co.uk.


 



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