Over recent months we have had a number of clients approach us for advice on their contractual rights where their supplier appears to be in financial difficulty and, perhaps more importantly, the practical steps they should be taking to reduce the potential effects of losing a key supplier.
While every contract and circumstance must be considered individually, below are three important questions we ask our clients when a key supplier is in financial distress.
1. Do you want to terminate the contract?
The contract may contain a provision that allows a business to terminate the contract where the supplier is suffering an insolvency event or financial distress. However, termination may not be the best option. For example, the pool of alternative companies able to provide the services may be limited and/or it may not be cost-effective.
If termination is not the desired outcome, the contract may include alternatives. For example, a business may have the right to “step-in” and provide the services or it may grant a business the right to remove the supplier’s requirement to provide certain services.
Terminating a contract in a situation where a supplier is in financial distress rather than due to its insolvency can also be a tricky area for a business. If the supplier has not suffered an insolvency event but is underperforming due to financial difficulties, the business may need to consider using other grounds for termination. These other grounds can often be less clear cut and, if used incorrectly, could result in a claim by the supplier for breach of contract on the grounds of wrongful termination.
2. What contingency plans are in place?
The contract may contain obligations on the supplier to provide (and update throughout the contract term) business continuity plans to deal with interruption with key dependencies and exit plans to deal with transition of the service, whether that is to the business or a replacement supplier.
Businesses should make sure that these plans are available, up to date and address their main concerns. At this stage, it is also worthwhile considering reviewing your insurance policies to ascertain whether you have appropriate business intervention insurance to provide cover for this scenario.
3. Do you have everything you need to provide the services?
While the supplier may be obliged to provide assistance during a transition, the supplier has minimal incentive to do so following termination or if they are about to be replaced. Therefore, to ensure continuity of service, a business should ensure it has obtained all the information and equipment it needs to continue providing the services before taking any action.
For example, a business should think about whether it will require any specific documentation or information to enable it to continue to provide the services. If there is any documentation or information that will be required then the business should identify where these are located and, if possible, obtain copies prior to termination or replacement of the supplier.
If a supplier is suffering financial distress, establishing what information and documents will be required is vital to ensuring effective continuity of service during the transition period.
Following the steps suggested above should help a business to feel more confident about how both it and the supplier will deal with this situation. It should also help the business acquire the information or documentation required to continue to operate and to avoid disputes as to whether termination of the contract is valid and legal. If your supplier is in financial distress then we would be happy to provide advice on your contractual options and the relevant practical considerations.