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COVID-19: the supply chain

20 April 2020. Published by Paul Bagon, Partner and Tim Moynihan, Senior Associate and Vanessa Beazley, Associate

Concerns regarding the strength of UK supply chains and the consequences which arise when links in the chain fail, are not new and were recently subject to significant scrutiny in the context of Brexit negotiations. But with COVID-19 causing a host of new problems for already stressed supply chains, what can businesses do to protect themselves?

In August 2018, following the collapse of Carillion, the Government announced that it would legislate to prohibit the enforcement of clauses in supplier contracts which allow a contract to be terminated on grounds that one of the parties to it has entered formal insolvency.  Legislation prohibiting the exercise of so called ipso facto clauses has not yet been published and now, as a result of the pandemic, supply chains have become even more vulnerable. 

Restrictions on travel, forced closures, reduced demand for certain types of goods, rules on social distancing and sickness induced quarantine have made the performance of many supply contracts and the viability of market participants very uncertain.  Businesses find themselves at risk of financial loss flowing from non-performance by suppliers or non-payment by customers.   

The Government has published guidance for public bodies on supporting 'at risk' suppliers by maintaining cash flow and protecting jobs.  While this is a welcome development, what guidance is there for private sector suppliers who are also at risk? 

Existing rights

There are, of course, existing ways in which a business can look to protect itself from non-payment by a counterparty.  They include hedging by way of factoring, invoice discounting and/or credit insurance, the exercise of contractual rights, and, as a last resort, using debt enforcement via statutory demands and winding-up petitions.

Debt enforcement continues to operate in the ordinary course and the courts are continuing to hear winding up petitions – albeit it at a slower rate.  Businesses, however, may be concerned about the negative publicity that may arise from issuing a petition against a counterparty struggling as a consequence of COVID-19 in addition to being wary about the damage that taking such steps may cause to commercial relationships.  In any event, the winding up of a counterparty that has not been trading or generating revenue during the pandemic may see minimal returns to creditors and certainly where such debts are unsecured.

It is common for supply contracts to contain protections against insolvency or non-payment by a counterparty; in particular, through the inclusion of retention of title (RoT) provisions.  In short, RoT allows a supplier to repossess its goods on the occurrence of contractually specified events – usually either non-payment or counterparty insolvency.  The repossessed goods can then be resold or repurposed.

In respect of existing debts, companies are advised to review their terms and consider the availability of self-help remedies such as reliance on RoT provisions.  In respect of future supplies, businesses should be ensuring that their terms contain RoT rights and that:

  1. those rights are triggered at the earliest opportunity – e.g. on non-payment rather than only on the occurrence of formal insolvency.  This is key given that the government support package may see counterparties pause economic activity whilst maintaining a going concern status;
  1. the RoT rights are "all monies" – i.e. the right to repossess applies to all outstanding amounts and all goods held by the counterparty; and
  1. that the counterparty retains sufficient operational staff and resources to maintain the insurance, security and storage of the goods subject to RoT.

However, care should be exercised; the enforcement of RoT rights makes sense for goods that are not perishable and can be resold.  Businesses should be alive to the additional costs of insurance, storage and security for repossessed goods that they may not be able to resell quickly or possibly at all.

As a practical matter, suppliers should take steps to ensure their goods are easily identifiable and, while observing social distancing, consider their options to assess actual stock levels held by the customer so that logistical risks are minimised on the enforcement of RoT rights. 

Typically, credit insurance policies will protect insureds from non-payment by customers due to defined events, which may include the insolvency of the customer, protracted uncured defaults or actual defaults.  Suppliers with existing credit insurance should familiarise themselves with their policy terms and conditions and adhere to them, particularly with regard to reporting late-payment triggers and ensuring compliance with any mitigation actions required by the policy.

Improving rights

In the present circumstances, renegotiation and augmentation, rather than termination, could appeal to both parties to a supply contract, even if it results in less attractive terms than those in the existing contract.  Such steps will maximise the opportunity of preserving commercial relationships allowing the resumption of ordinary course trading after the COVID-19 crisis ends. Parties who agree to renegotiate should establish from the offset whether their discussions will be subject to contract, i.e., they will not be binding until a formal contract has been agreed.  Once agreed, the new terms should be recorded formally in writing and any contractual provisions on variation should be complied with.

Parties may seek to negotiate the inclusion or expansion of RoT rights, the taking of security or varied payment terms.  We do not consider those options in detail here but businesses should carefully consider whether anything obtained from a counterparty will survive a subsequent insolvency event.

Any improvement to an ongoing contracting position or in respect of previous indebtedness will require careful consideration and advice.  As we have previously reported despite the relaxation of the wrongful trading provisions in response to the pandemic, all other Insolvency Act provisions remain in force.