Ed Husband details what you need to know to protect your business from being pulled down by the demise of other companies in a turbulent time.
This past year has seen the financial demise of a number of high-profile businesses – Carillion, Maplin, Toys R Us, and House of Fraser, to name but a few. Although this has had an immediate impact on the employees of those companies, the thousands of businesses that contracted with them are also feeling a ripple financial effect.
So, how can businesses supplying a customer best protect against the financial failure of a customer?
As it’s not always apparent at the start of a business relationship whether a customer is financially sound, it’s always prudent to carry out financial due diligence, particularly when entering into large or longstanding commercial commitments.
However, even in a business that appears financially sound, things can deteriorate very rapidly. Because things can change so quickly, the single most important thing to have in place is an effective contract, which operates to protect your business from the beginning of the legal relationship.
Effective payment terms can protect your business. Is your bargaining position strong enough to require payment before delivery of your product or service, either in whole or in part? If not, ensure that your credit terms are short and are effectively policed.
What are your rights in the event of non-payment? Charging interest for late payment should be a given, but what about your right to terminate the contract or withhold services or payment?
In what circumstances can you bring the legal relationship to an end? As well as for non-payment or breach of the contract, provision should be made for other insolvency events, such as the liquidation or administration of the customer, or even upon the preliminary steps taken towards those insolvency events.
Perhaps most importantly for suppliers of goods, they should ensure that they have a clause by which they retain ownership in the goods they supply until they have been paid. Retention of title clauses have long been included in standard contractual terms, and can operate effectively to enable you to recover your goods provided that they are properly incorporated, worded right, and that you enforce those rights promptly in the event of non-payment.
This is very much a starting point, but it is also worth remembering that you need to ensure that it is your contractual terms that prevail, as a customer’s terms will invariably favour them. Which terms apply is not always obvious, particularly where parties each purport to operate on their standard terms (perhaps printed on purchase orders or invoices), so having a signed agreement is always best.
Equally, changes to insolvency legislation and processes mean that many older contracts are often simply not fit for purpose, so ensure that your terms are regularly reviewed.
It’s rare for a customer to fail without there being a number of warning signs, which would enable you to take pre-emptive steps to improve or protect your position. Typical warning signs might include: slow payment or requests to extend payment terms; unusual requests for price reductions or discounts; a delay in filing accounts or accounts that include a qualified report from auditors; a change of accountants or auditors; the resignation of directors; an increase in unfounded complaints about the goods or services that you provide; and market gossip.
Keeping alert to these kinds of signs will mean that you can act quickly to protect your position.
Of course, there is a limit to what can be achieved in documentation, and any party entering into a commercial contract should ensure that a proper credit control system is in place. Where the subcontractor or supplier has concerns as to the financial position of the company, it should also consider reducing the period and/or amount of credit allowed, obtaining alternative forms of security (for example, a bank guarantee or letter of credit), and taking out credit insurance.
It is equally important to act promptly to enforce your contractual rights as, when a company goes into compulsory liquidation or administration, any existing legal proceedings are suspended, and a creditor cannot begin new legal proceedings against the company unless it has permission to do so from the court.
However, even when faced with this, some contractual rights can still be enforced without needing to start court proceedings. For example, if you have taken security to secure a debt, you will stand first in line to recover any monies out of the insolvency.
If there are mutual debts owed between you and the insolvent company, these will be automatically set off in either a liquidation or administration. This will mean that any monies you owe can be set off in full rather than you only receive a small dividend.
And, lastly, the retention of title rights mentioned earlier will survive insolvency, meaning that you will retain ownership of your goods and be entitled to recover them. If a liquidator or administrator sells those goods, he or she can be personally liable to compensate you.
However, insolvency practitioners will scrutinise such clauses very carefully, so it is important to get robust professional advice when faced with this situation to maximise your prospects of a successful recovery.
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