Strengthening your business against increasing insolvencies: contractual safeguards and practical approaches

In November 2023, the Office of National Statistics recorded a total of 2,466 registered company insolvencies in England and Wales, revealing a significant uptick in both creditors’ voluntary liquidations (CVLs) and compulsory liquidations compared to the previous year.

This increase in business insolvencies can be attributed to several external factors such as rising inflation, soaring energy prices and customer spending reductions.

In this article, we outline safeguards your business can take when you are dealing with potentially insolvent customers or suppliers through strategic contracting drafting and practical considerations.

The role of commercial contracts

Commercial contracts play a pivotal role in safeguarding your business when engaging with potentially insolvent customers or suppliers.

Whilst at the time of contracting it may seem that your counterparty is in good financial condition, events over the last few years such as Covid-19 and the Russia-Ukraine war have highlighted that we never know what is around the corner, meaning that you should enter into your contracts with prudence and foresight of potential issues, however improbable they may seem.

Whether you are a customer or a supplier, trading with a potentially insolvent company poses risks to your organisation in respect of cash flow, profitability and equity value as it can lead to:

• Late or non-payment of invoices;
• Supply chain disruptions;
• Loss of goods or services, ultimately affecting your own delivery obligations;
• Significant devotion of time and resources, distracting from your day-to-day business and profit-making operations; and
• Limited scope for debt recovery.

Considering this, there are a number of key clauses and concepts that your commercial contract should cover to protect you in the event that you are trading with a potentially insolvent organisation. These include, but are not limited to, the following:

• Termination: include clauses that allow you to terminate or suspend the contract in the event of non-payment or potential insolvency (noting that the Corporate Insolvency and Governance Act 2020 places restrictions on termination where a party enters into insolvency proceedings).
• Credit and payment terms: Clearly define credit terms and payment terms in your contract. Specify when and how payments should be made and consider inserting a right to vary payment terms to ensure quicker payment.
• Retention of title: where you are selling goods, insert a retention of title clause which gives you a potential right to reclaim your goods and mitigate potential losses.
• Audit rights: ensure you have sufficient audit and other monitoring rights to allow you to continually assess and monitor the financial status of your counterparty.
• Personal or parent company guarantees: if the risk of insolvency is material, consider requesting personal or parent company guarantees to provide you with an additional layer of security if your counterparty becomes insolvent.
• Legal charges: in some cases, it may be appropriate to take a charge over your counterparty’s assets (such as a property) to boost your priority order of a claim in the event of insolvency.

The specific contractual mechanisms you use to protect your business may vary on a case-by-case basis, so please do contact us if you have a query about what you should include in your commercial contracts.

Practical considerations

As well as the above contractual mechanisms, you should also manage the risk of trading with a potentially insolvent company through practical processes and procedures, for example:

• Conduct thorough due diligence: before you enter into a contract, conduct thorough due diligence into the financial status of your counterparty, for example by running credit checks and company searches.
• Train your staff: train your staff on detecting the early warning signs of financial distress, for example by monitoring payment patterns and other key indicators.
• Build relationships: build relationships and maintain clear lines of communication with individuals within the company to provide you with insights into any issues they may be facing and promote honest and open discussions.
• Contingency planning: ensure that you have robust and effective contingency plans in place should your counterparty become insolvent.
• Continuous credit monitoring: Continuously analyse and track the credit scores, financial health, solvency status and related issues concerning your customers and suppliers during the course of the contract using one of the various online monitoring services available in the market. This will help you to identify emerging risks, mitigate bad debts and make proactive business decisions should a company be found, for example, to be dropping in credit scores.

Next steps

If you would like to discuss any specific issues your organisation may be facing, or if you would like more information on how to protect your organisation, please:

• Book a 30-minute FREE Consultation; or
• fill in the form below requesting a call back from Haroon Younis, Partner & Head of Commercial.

Please note that this information is for general guidance only and should not substitute professional legal advice. If you have specific concerns, we recommend consulting one of our legal experts.