The first step in managing and mitigating risk is identifying that risk. Of course, none of us who has been in business since before 2008 can have failed to recognise that there is a real risk of our trading partners going bust, but there is now evidence to suggest that as the economic downturn drags on we may already have become rather blasé about it, perhaps on the assumption that there is really very little we can do other than perhaps putting up the shutters, sticking our fingers in our ears and humming very loudly until things get better.

It is true that in business we can never entirely bomb-proof ourselves, nor would we suggest that it is desirable to attempt to do so. Commerce requires that we all take calculated risks every day, else there would be no money circulating and we would all stagnate. Even in the boom years, insolvencies were capable of toppling other businesses in a domino effect. That said, there are simple things we can do to ensure that the risks do not threaten our own businesses unduly. The aim of this article is to share a few (largely common sense) tips from our experience of dealing with potentially insolvent trading partners, both first hand and when advising others.

STEP ONE: NAVIGATION: KNOW YOUR TERRAIN

When crossing a minefield, it is rather helpful if we know the location of the mines, or at least how to recognise one before we get too close. Knowledge is power and in the case of trading partners there are many ways to gain relevant knowledge and keep it up to date. A credit monitoring system is a good start, but more important is to try to understand how they are funded, who the controlling mind is and something about their attitude to risk. Do they have good track record in management? Did they build their own business or are they second generation wealth? Are they able to run a business effectively in lean years? Are they part of a group which could easily restructure leaving our particular exposure stranded? The key is to put ourselves in a close position where we are likely to have advance notice of any financial difficulty rather than just an invoice going unpaid beyond normal credit terms.  It also pays to diversify our trading interests and in particular our supply routes so that we are not too close to any one potential explosion.

STEP TWO: EQUIPMENT: TOOL UP WITH CONFIDENCE

Minefields are best traversed in an armoured Humvee, head to toe in Kevlar and accompanied by a mobile bomb squad, but that is rarely practical or cost effective in business terms. Few can afford to keep professionals engaged all the time on a purely preventative basis. Even so, recognising that from time to time a mine will blow somewhere near us, it is only natural to look to insulate ourselves from damage. There is invariably something we can do to mitigate the risk here.  Even if we are not in a position to negotiate real and valuable security over the assets of a trading partner or of directors granting personal guarantees, we can at least ensure that we have the right terms and conditions in place and identify our goods clearly in case we need to exercise our retention of title. If we are involved in projects, we can seek to ensure the right managers are in place, escrow accounts, retentions, and so on. At the very least we can keep an eye on our credit exposures and avoid having too many eggs in the same basket, or for that matter linked baskets within the same group.

STEP THREE: REACTIONS: KEEP YOUR HEAD IN A CRISIS

If, despite our best efforts, we find ourselves in the blast zone of a trading partner’s actual, or threatened, insolvency we should avoid the mistake of assuming that just because a trading partner tells us they are going into administration or liquidation that they really are and we should seek clarification of this as soon as possible. If a formal procedure has not yet begun it may not be too late to seek to improve our position, and we will need to take careful note of what is happening because directors can often expose themselves to personal liability to us by handling matters poorly.

There is a great deal of misunderstanding about formal insolvency procedures generally, and ignorance as to the options available to creditors. Insolvency is rarely the end of the road for the underlying business, and elsewhere within this issue we identify some of the opportunities which it may produce; in appropriate circumstances these may allow us to defuse the mine altogether. However, even if we are only in damage limitation territory, there is much we can do with a bit of clever footwork, including establishing the earliest possible dialogue with the insolvency practitioner, getting down to site to identify goods and submitting an early and well supported proof of debt so that we can engage constructively in the procedure and help to shape its outcome. We might be able to enhance our dividend prospects by supporting routes to recoveries into the insolvent estate, such as by ensuring that contracts are completed and appropriate claims pursued, including where appropriate the directors. If we have been close to our trading partners, we may have valuable evidence which could support such claims and/or lead to disqualification orders which might help to prevent future exposures for ourselves and others.

If we do find that we are bearing the full force of a trading partner’s insolvency, we need to ensure that our own core business survives. Again, there is a great deal that can be done here, and early professional advice is the key.

CONCLUSIONS

2012 is likely to be another challenging year for many businesses. Whilst there is room for cautious optimism in that a great many businesses have now stripped back their costs to a minimum and are therefore well placed to take advantage of a recovery, respected trade bodies such as R3 have long identified that the past 3 years of economic uncertainty have also created a huge subculture of ‘zombie’ companies propped up by cautious enforcement practices from the banks, landlords and HMRC. It would therefore be a mistake to assume that we are out of the danger zone. However, provided we navigate that zone with the above common sense lessons in mind (and key amongst these the recognition of the need to take professional advice at the right time) there is every reason to assume that good, sustainable businesses will survive the minefield relatively unscathed.

If you would like to discuss any matters raised in this blog please contact mike.pavitt@parissmith.co.uk