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Identifying and addressing customers in financial distress

Jo Ford, partner at Cripps Pemberton Greenish, offers advice to business leaders on how they can make better commercial decisions by identifying whether or not a client has entered an insolvency process

The Corporate Insolvency and Governance Act 2020 (CIGA), which came into force on 26 June 2020, significantly restricted suppliers’ rights to terminate or suspend their contracts with insolvent customers.

This makes it even more important to spot signs of financial distress before the company concerned enters a formal insolvency process. This enables a supplier to make a planned decision as to whether to continue supply, and how to protect themselves if so.

CIGA provisions

CIGA introduced both temporary provisions aimed at helping businesses survive the pandemic, as well as permanent measures that had been in the contemplation of parliament for several years. The permanent measures are intended to provide further options for business rescue, alongside the existing insolvency regime - administration, liquidation, company voluntary arrangements (CVA) and schemes of arrangement (though the latter is less commonly used).

Moratorium

The new moratorium procedure gives a company or LLP time to consider its options and implement a rescue plan. It provides an initial 20-business-day payment holiday on pre-moratorium non-financial debts, and is protected from legal or enforcement action and forfeiture proceedings by its landlords.

The moratorium can be extended by the directors for another 20 business days, and further extensions are possible with creditor consent (for up to a maximum of one year in duration) or the consent of the court (for such a period as the court sees fit).

Restructuring plan

This is similar to the existing scheme of arrangement, and allows companies in financial difficulty (or their creditors or members) to put forward a new restructuring plan as an alternative rescue option. This sits alongside the existing choices of administration and company voluntary arrangements, which both allow a company to trade through its financial difficulties.

Virgin Atlantic Airways was the first company to take advantage of this new rescue tool; its restructuring plan became effective on 4 September following court approval.

Contract termination restrictions

Under the new legislation a supplier is prohibited from terminating or suspending supply where their customer is subject to specified insolvency procedures. Although similar restrictions already applied to suppliers of certain essential services (such as utilities and some IT services), this new law extends restrictions to all types of supplier, with the exception of financial services companies. The prohibition will not apply to ‘small suppliers’ until 31 March 2021.

Any provision of a contract ceases to have effect if it would be triggered by the customer being subject to an insolvency procedure. So a right for the supplier to terminate, or change payment terms, or suspend its supply, would have no effect. This is still the case if the provision takes place automatically, without the supplier having to exercise a right.

Any right under a contract for the supplier to terminate or suspend the contract because of an event occurring before the insolvency procedure started cannot be exercised once it has started. So if a customer had overdue invoices prior to the insolvency procedure, you cannot rely on that to terminate once the procedure starts. However, you can terminate before the insolvency procedure starts, or if a trigger occurs after the procedure starts.

Distress signals

Suppliers can no longer afford to wait until they are notified that a customer has gone into liquidation or administration before deciding whether to continue trading with them. Looking out for signs that a customer may be in difficulty enables suppliers to make an earlier decision about whether to continue trading, or take steps to protect themselves against customer insolvency.

The following signs may be an indication of financial distress:

  • Persistent late payment of invoices;
  • Failure to engage or respond to queries about bill payments;
  • Resignation of company directors (you can set up an alert against a company at Companies House, which will inform you by email of any new filings);
  • Staff redundancies;
  • Closing premises.

Protecting yourself

While it is impossible to fully protect yourself against the risk of customers becoming insolvent and leaving you with unpaid debts, these steps may assist in mitigating this risk:

  • Carry out due diligence on customers prior to entering into any significant commitments – consider whether committing to supply a customer is worth it, in circumstances where it may not be possible to stop simply because the customer becomes insolvent.
  • Monitor customers’ financial positions and payment statuses, and ensure credit control procedures are robust – this will identify issues at an early stage, and enable you to cease work or take enforcement action to recover outstanding debts;
  • Consider prompt enforcement action if a customer appears to be in financial difficulty. Rights can still be exercised prior to the insolvency procedure starting, and if the customer is considering rescue or restructuring options, it will not want these to be derailed by a disgruntled creditor;
  • If you decide to work with companies that appear to be in financial difficulty, then requiring payment up front mitigates the risk of potential non-payment.

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