Manufacturing suppliers: what to do when you are in early stages of distress

Out-Law Analysis | 22 Jul 2020 | 9:48 am | 3 min. read

Suppliers may be able to take advantage of relationships held with original equipment manufacturers (OEMs) to alleviate financial pressures that risk sinking their business.

The economic challenges posed by the coronavirus crisis threaten manufacturing supply chains that already typically operate on tight margins. Opening dialogue with OEMs is one example of the proactive and informed engagement suppliers should look to undertake with customers, financiers and other stakeholders at the first signs of distress.

There may come a tipping point where the role of directors must shift away from their duty to promote the success of the company for the benefit of their shareholders to protecting creditors and value in the business. This means suppliers must tread a careful line with the level of transparency they provide about the financial difficulties they find themselves in and balance carefully the interests of their creditors against those of their customers.

Communicate

A spirit of openness is however important for suppliers when they first encounter financial difficulty.

Suppliers should declare a potential breach of their contractual agreement with OEMs to those manufacturers before the breach occurs. This will show the OEM that the supplier is acting in good faith and is likely to increase the chances of a practical solution being agreed in collaboration that is satisfactory to both parties.
Suppliers should give advanced notice of breaches of financial covenants agreed with funders and investors. Being transparent will help to build trust and understanding which can lead to new credit arrangements being agreed before problems become insurmountable.

Seek alternative funding

One of the ways that suppliers may be able to address potential financial problems is by raising fresh capital. There may be an option to obtain increased funding from existing shareholders and investors, while suppliers in distress should also explore what government- and industry-specific funding support and incentives are available.

Being prudent is also important. To this end, suppliers should implement cash conservation and recovery measures to rapidly bolster cash flow, and they should further revisit financial forecasts and projections.

Be proactive

Suppliers should look to capitalise on any symbiotic relationship or interconnection they have with the OEM and its supply chain. Having open and clear discussions about the financial situation before the situation becomes too critical will be key to cooperation in the medium term.

Our experience in dealing with distressed automotive suppliers shows that there is often a solution to be reached with customers and other stakeholders which could avoid the catastrophic consequences of insolvency if it is addressed by stakeholders at the correct point in the decline.

Temporary arrangements between OEMs and suppliers may offer scope to protect the interests of both parties. Consider increasing an OEMs rights of inspection as a quid pro quo for the OEM relaxing other trading or payment terms.

For the customer, the downtime and loss of output may be more costly to them than the financial investment required by a distressed supplier.

Another option to help reverse fortunes might include looking into whether and how a change in working practices or shift patterns might increase manufacturing capacity and productivity, while suppliers should also review workforce planning to identify whether further efficiencies might be achieved. Turnaround specialists and legal advisers should be engaged to help businesses identify the right options for them and navigate legal and contractual issues that could arise.

Implement protective procedures

There are legal mechanisms available to distressed businesses to help them recover from financial difficulty and avoid insolvency.

In the UK, one rescue tool that can be considered is a company voluntary arrangement (CVA) through which businesses can ask creditors to accept a proportion of the money owed to them. In many cases creditors may be happy to accept reduced repayments if the alternative is liquidation of the company and an even smaller share of the liquidated assets.

Fresh options are open to suppliers under the new Corporate Insolvency and Governance Act. These include the new debtor-led moratorium, which allows viable businesses time to restructure or seek new investment free from creditor action, or the new restructuring plan which is modelled on the existing scheme of arrangement but with the addition of the ability to cram down classes of creditors. Such measures open up opportunities to undertake financial restructuring whilst management remain in control and are likely to facilitate customer support, including via funding arrangements. 

Specialist advice should be obtained before pursuing any of the options.