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Beyond the pandemic: rethinking the supply chain

Insolvency

The COVID-19 pandemic has increased the risk of financial and operational distress among suppliers, with the insolvency of a key supplier having dire consequences on production plans.

This is leading manufacturers to keep a very close eye on their supply chains and the financial health of suppliers of vital inputs.

Understanding a supplier’s situation

To help understand suppliers’ pressure points and anticipate problems, heightened diligence of their finances, supply chain and business continuity arrangements is recommended.

A customer’s key concerns are likely to be ensuring continuity of supply to minimise business disruption and whether they can recover any sums owed to them by the supplier.

Continuity of supply

If a customer has concerns about the ability of a key supplier to continue to make supplies, they should put in place a contingency plan in case of a failure or likely failure, to migrate to a new supplier. This should focus on the customer’s ability to terminate their existing supply contract and what steps need to be taken to ensure as smooth as possible a transition to the new supplier.

Many contracts allow for termination where a counter-party becomes insolvent. Customers should look at what rights they have under their contract, and whether any applicable insolvency laws would prevent them from exercising those termination rights. The insolvency regimes of some jurisdictions contain restrictions on terminating contracts by reason of insolvency, although there may be other breaches that the customer could rely on (such as late delivery).

Customers should make sure they have access to the information needed to migrate to a new supplier and understand the likely timeframes involved. They should also identify potential workarounds for any likely gaps.

When negotiating supply contracts, customers should ensure they have adequate protection through termination provisions, rights to access information and reporting requirements.

Creditor profile

If a customer is owed money by the supplier, eg in respect of prepaid amounts or refunds due, the customer is likely to be an unsecured creditor and so will rank behind any secured creditors in an insolvency. Often unsecured creditors make no recovery on the sums they are owed.

If the customer is holding any of the supplier’s products, equipment or machinery, this could be used to create negotiating leverage for payment of the sums owed. 

Managing a supplier in distress

If a supplier is in financial distress:

  • keep control over missed deliverables and take action quickly – you may lose the right or ability to act if the supplier has entered into an insolvency process;
  • keep in touch with your suppliers to help assess the seriousness of any issues;
  • consider what steps are required to migrate to a new supplier, for example by looking at your contractual termination rights and assessing what information or data would be required by the new supplier;
  • look for triggers and opportunities, such as withholding payment, to provide negotiating leverage and renegotiate terms (where permitted by contract and legislation);  and
  • consider purchasing assets from an insolvent supplier.