Handling a distressed supplier in your supply chain

Out-Law Analysis | 22 Jul 2020 | 9:05 am | 2 min. read

As the world comes to terms with the 'new normal', businesses will need to take stock of how efficiently their re-commenced production lines are operating. Original equipment manufacturers (OEMs) at the top of the supply chain will need to identify, and come up with a plan to address, any weak links
Warning signs

Being able to identify and evaluate the early warnings of supplier distress will enable businesses to manage uncertainty over supplier viability. It will be important to distinguish between businesses looking for allowances due to the short-term impact of Covid-19, and those looking for concessions because their financial distress has become severe.

Signs to look out for include:

  • requests for price increases;
  • delays in receiving payment or erratic payments;
  • requests for increased payment, credit terms, deposits, up-front payments or reduced retentions;
  • product or service quality issues;
  • breaches of contract terms or service level agreements;
  • ·non-delivery in accordance with agreed schedules and contract terms;
  • changes in management or high staff turnover;
  • lack of communication, particularly silence after persistent enquiries;
  • reductions in or withdrawal of credit insurance;
  • market intelligence supported by authoritative sources; and
  • profit warnings or announcements of bank covenant waivers.

Where to start?

In a multi-layered, interdependent and complex supply chain, there may be several avenues of distress - but when operating with limited time and resource, focus on those businesses that present the highest risk of exposure.

An experienced team should be appointed for each of the following steps.

Observe

Monitor the creditworthiness of suppliers in your supply chain.

Identify

Check stock or component levels. Assess those activities that are integral to your business operations and quantify your exposure.

Investigate

Quickly get up to speed with the risk from both internal data – such as financial information, debt levels, inventory, inter-dependency of supply – and external data. Use this data to make a systematic assessment of the risk and any disproportionate reliance on certain suppliers.

Examine

Perform a contract review of the key terms and conditions of trading with distressed suppliers. In particular, identify approval, novation and termination procedures and any other contract levers. Reflect on the interconnectivity with cross-border suppliers. Categorise suppliers into low, medium and high priority.

Communicate

Proactively engage with those critical businesses to get the measure of the true extent of the risk.

Prepare

Formulate a contingency plan for continuing either with or without the supplier, including considering a supplier cull to reduce the number of vulnerable relationships and potential supply chain interruptions. Assess any risk of a lender exercising step-in rights. Re-establish ownership of tools, and assess the strength of any third party relationships.

Mitigate

Adopt strategies to increase resilience and protect against supply chain risk: changing payment terms; requiring pre-payment; considering a formal collaboration or acquisition to bring supply in house; dual or multi-sourcing supplies; seeking alternative tooling suppliers; bringing in interim management or professional turnaround specialists; exercising any audit or monitoring rights in full.

Secure

Consider funding outside of insolvency to mitigate financial cost and downtime associated with insolvency. Request prioritised security for emergency support or super priority funding for new moratorium as an option. Seek to protect production by insisting on separation of stock and components.

Enhance

Consider demanding or enforcing enhanced rights of entry and inspection for audit purposes, or seek strengthened intellectual property rights in exchange for your continuing support.