How to contingency plan for insolvency in a global supply chain
Published on 18th Nov 2022
Early contingency planning can significantly reduce the shock of customer or supplier insolvency
In this edition of our distressed supply chains series, we consider the three key factors in contingency planning for potential insolvency in the supply chain, being (i) early planning analysis and due diligence, (ii) regular monitoring of key supply chain relationships; and (iii) taking early action if something goes wrong.
Businesses that carry out early analysis of their supply chain risks before the opportunity for distress or insolvency in the supply chain arises are far better equipped to resolve supply chain disruption in the future.
In identifying supply chain insolvency risk, considerations include:
- Who are your key customers and suppliers?
- If a key customer or supplier faces financial difficulty, how would you replace those revenues, source replacement products/services and how would this impact your profit margin?
- Would you need to take enforcement action to get paid, or to recover assets belonging to the business? If so, how much would this cost and how quickly would it be resolved?
- Would such disruption cause you to breach other contractual arrangements? If so, what would the impact of these be on you and your wider supply chain?
Carrying out due diligence on supply chain relationships at the outset is a critical starting point for contingency planning.
Where possible, contingency planning measures will often include limiting your reliance on a particular supply chain partner, identifying alternative partners and therefore reducing your exposure to risk should a particular supplier or customer experience financial difficulties.
It is also sensible to consider contractual protections for when things go wrong. This could include requiring pre-payments or implementing credit limits, inserting protections in your supply contracts to prevent the transfer of title before payment, including obligations to provide up-to-date financial data and clearly setting out each party's obligations and remedies.
Once you have conducted your contingency planning analysis, it is important to ensure that it is kept up-to-date. This should include the ongoing monitoring of key relationships, of your partners and their industry, including:
- Financial information available through public filings (for instance, at Companies House), credit agencies and other monitoring services. Important aspects to monitor include declining revenues, increasing liabilities, refinancing arrangements, changing management structures and discrepancies in the financial data. Note the limitations of such data, such as how regularly it is updated or if it appears unreliable for any reason.
- Information available on other companies within their group, especially those which may be reliant on group company services to trade or have exposure to group company debts through cross-guarantees and security.
- Overlaying industry intelligence – have there been any specific products shortages, limitations on services or sector-related difficulties which have arisen recently?
- Keeping in contact – maintain regular contact with your key supply chain partners and discuss the impact of any issues which arise.
While many businesses will carry out such analysis in relation to their customers, it is important to remember that your suppliers are a critical part of your supply chain too, and therefore they should also be monitored.
Taking action early when spotting the warning signs
Once the contingency planning is in place, and you are regular monitoring your customer and supplier relationships, it is vital to take early action when something of concern is identified.
This may include where you notice changes or delays in your supplies, the quality of goods or services provided, or the frequency or method of payments. Market rumour or reputation issues over social media may also indicate issues, but should be treated with caution.
By taking immediate action to protect your business and other supply chain partners, the impact of an insolvency in the supply chain can be mitigated. Steps may include:
- Requiring payment before further supplies are made.
- Reducing or removing credit facilities and requiring payment in advance.
- Enforcing your contractual rights such as liens, set-off retention of title rights and making demand for overdue debt.
- Keeping in regular contact to discuss payment issues and/or unexpected delays and attempt to work through a way to resolve them.
- Implementing your contingency planning measures by working with alternative partners to avoid disruption to your own business.
- Make sure all relevant teams are informed of the issues and how they are to be resolved (particularly where your business has large departments or several teams).
To assist you in spotting potential issues in your supply chain, download our free warning sign checklist .