What should a customer expect when its supplier enters formal insolvency

Protections now exist in law to prevent suppliers from abruptly ending their supply to distressed customers higher up the supply chain.

This is part of a series, find out more about how to manage supply chain distress in the manufacturing sector.

Both customers and suppliers in the manufacturing sector should seek professional advice to understand their legal and contractual options to account for insolvency events impacting their supply chain.

Supplier in formal insolvency

If your supplier enters a formal insolvency process, you may only find out when formal insolvency documents are filed at court. 

Typically suppliers will seek to enter administration, though customers can expect new suppliers experiencing financial difficulty to explore new mechanisms provided for under the recently enacted Corporate Insolvency and Governance (CIG) Act 2020 in the UK, which are aimed at helping companies maximise their chances of survival, protecting jobs and supporting the UK's economic recovery.

A notice of intention to appoint administrators is a precursor to a formal appointment. Notices of intention to appoint administrators are publicly available on certain searches and winding-up petitions can also be identified by a public search. If you become aware that a supplier has filed one and this is the first news of an insolvency, take urgent advice on your options, both from a contractual stand point and from the commercial perspective of how best to protect the continuity of supplies. 

Customers should seek to understand the objectives of administrators – they are answerable to creditors and obliged to secure an outcome that benefits creditors. Their duty is not to customers, and customer interests are likely to be secondary to the administration strategy. As an example, stock building and a focus on resource, though likely to be in the interests of customers, will often not be primary objectives of an administrator or not without justification for such a strategy. 

Leverage your relationship

A manufacturer's relationship with its suppliers is typically closely linked, and this degree of interdependency is likely to require customers to enter into trading arrangements with supplier administrators. Customers should assess how or when it is appropriate to consider all legal options to secure continued trading of the supplier, or whether the formation of a customer group may assist by enhancing bargaining power.

Where possible, customers should ensure they capitalise on the interdependency of the two companies to secure their involvement in any sales process supplier administrators may oversee, and seek dialogue with any proposed purchaser of the insolvent supplier.

One option insolvency practitioners will often pursue is an accelerated 'pre-pack sale' of a distressed company. The form of such a sale can vary, and include:

• ·vertical consolidation, where a customer brings supply in-house;
• customer-backed management buy-outs;
• customer-backed resource partnerships; or
• acquisitions funded by specialist in-distress investors.

If an insolvent supplier is sold, customers should prepare to revisit contractual terms and be cautious to protect all machine tooling rights. There will be opportunity to renegotiate arrangements and it is essential to be alive to the risk that tooling falls into the hands of unapproved third parties. 

Customers and suppliers throughout the supply chain should be wary of the 'pebble effect' of an insolvency event and assess very quickly what the wider impact of a failure will be on supply and seek to mitigate the fall out.