Insolvency in the food and drink supply chain – managing the risk

The latest quarterly figures from The Insolvency Service for Q4 of 2023, covering the period October to December, show that company insolvency volumes in England and Wales reached a 30-year high. 25,158 registered companies entered some form of insolvency in 2023. The food and drink sector has not been immune to this, and indeed has seen some of the biggest rises in insolvency as many businesses face significant financial challenges.

Multiple headwinds

A key driver in UK food and drink insolvencies has been soaring costs for ingredients, materials, energy and staff, exacerbated by inflationary pressures and the war in Ukraine, as well as a lingering post-pandemic hangover. In addition, interest rates increasing to levels not seen for over a decade have forced up the cost of borrowing, at a time when consumers are cautious about overspending. The result has seen a failure of smaller businesses in the food and drink supply chain, particularly those that had been surviving due to historically low interest rates.

In many ways these economic factors, added to the unique buying power of the end consumer, has caused a perfect storm for the food and drink industry. Supermarkets are competing to keep costs down for customers, while hospitality trade for restaurants and bars has been impacted by lower consumer spending, meaning that many suppliers already working on thin margins are feeling the pain and struggling for cash. It is therefore vital for businesses in the sector to consider their own financial position and resilience, as trading with potentially insolvent companies, or those in financial distress, can present risk. Viable businesses could suffer from cashflow and profitability issues due to late or non-payment of invoices, as well as experiencing supply chain disruption, with time and cost then consumed in seeking to address such matters.

Due diligence

Insolvency risk can, to an extent, be managed at the outset, by carrying out thorough due diligence into the financial status of any trading counterpart, by getting to know the people involved and their business, and by running credit and company checks. It would also be prudent for financial checks to remain ongoing for the duration of the dealings, while paying close attention to any warning signs or industry news about financial distress.

Guarantees

If there is a particular concern with any trading counterparty, personal or parent company guarantees could be considered and requested. This would offer added security in the event of issues that may be encountered in recovering outstanding payments. By protecting against bad debts, cashflow can be managed and maintained, in turn improving a company's own financial position and strength.

The importance of contracts

A key legal consideration in safeguarding against the potential impacts of insolvency in the supply chain is understanding contractual terms with customers or suppliers. Businesses should be aware of their contractual terms and conditions to ensure that they provide adequate protection. For example, clauses to terminate or suspend contracts in the event of non-payment or insolvency should be considered, with credit and payment terms clearly defined. It should further be established what payments are contractually due if the other party to the contract becomes insolvent or is on the verge of insolvency, to avoid the possibility of double payment.

Thought should also be given to including a retention of title clause in contracts, which allows ownership of goods to remain with the supplier until full payment is received, even following delivery of the goods. These clauses can be powerful tools where a purchaser enters an insolvency event without making payment of goods, allowing the supplier to evidence that the goods still belong to them and to allow recovery.

Cash is king

Having robust billing and credit control procedures in place will help ensure that payment is received for goods or services provided, and invoices rendered. Where customers are having difficulty adhering to payments, any credit terms offered may have to be reevaluated. Offering early payment discounts could be considered as a method to ensure cash is received in the short term, even if that has an impact on profit. Overdue payments should also be chased proactively, with prompt assistance sought to recover debts where required, and thought given to any late payment charges which can be charged. The message is that in order to maintain cashflow, options to recover outstanding payments should be explored, with prompt action then taken. Delay can have the effect of reducing the prospects of making a full, or any, recovery, particularly if debtor companies are also managing liabilities owed to other creditors.

Supplier prices and relationships

Manufacturing companies may also consider seeking greater transparency from suppliers in terms of their costs, so that they are aware of any decrease in the price of ingredients and materials. This may present the possibility of renegotiating prices to ensure that cost reductions are passed on, which may in turn boost margins.

While advantage may be taken of any price decreases, it would be prudent not to lose sight of the importance of certain suppliers in terms of business continuity, and the potential disruption that supply issues or shortages may cause. There may be benefit and protection to be gained from being a key customer of a particular supplier, especially when resources are scarce. Building relationships with suppliers will support such considerations, although also having a contingency in place in the event of the insolvency of a critical supplier should not be overlooked, to protect your own business.

Taking prompt action

While steps can be taken to protect a business as best it can from the possible consequences of insolvency within its supply chain, it will nevertheless remain important to act quickly and decisively should an insolvency event, or the prospect of an insolvency event, occur. It can have a severe impact on a company's own business, which it should seek to mitigate as much as possible. Acting early and seeking advice is key to addressing potential problems, to protect your business, maintain cashflow, and safeguard against any threats to continued trading.