Monitor Financial Distress in Your Supply Chain

19 August 2015 Manufacturing Industry Advisor Blog

While American manufacturing has experienced a resurgence in recent years, some manufacturers continue to face challenges. Witness for example the recent chapter 11 filings of Colt, Boomerang Tube, and Everyware Global. Sometimes, manufacturers struggle because a supply chain partner—a major supplier or customer—is struggling. In order to manage supply chain contracts, manufacturers need to watch for early signs of financial distress in their customer or supplier base. Then, they may quickly react to red flags and garner an advantageous position.

Trouble in the Supply Chain?

Manufacturers should watch for supplier requests to increase prices or accelerate payment terms. Similarly, cash-strapped customers may ask for financing support. In addition, a manufacturer’s deteriorating market position, failure to effectuate cost reductions, and changes in key management positions all may indicate financial distress. Manufacturers should employ tactics in order to secure continued supply when faced with a financially troubled supplier. By managing contracts after identifying a troubled supplier or customer, manufacturers can often mitigate risks, or even improve their positions.

Manufacturers should prioritize, understand, and address troubled supplier situations with advance awareness. That’s why companies should continually analyze their contracts to maximize leverage, and understand available legal options. To alleviate the pressures of financial distress, manufacturers should exercise common law and statutory remedies in order to purposefully tweak standard terms and conditions of new contracts (or negotiate changes to existing contracts). The terms of these contracts significantly impact the manufacturer’s ability to re-source production to a healthier supplier, recover tooling, and utilize certain remedies.

Use Remedies Strategically

Common effective remedies include requesting adequate assurance of future performance under section 2-609 of the Uniform Commercial Code or considering a contract repudiated by the supplier. If a customer files for bankruptcy, there are time-sensitive steps to follow to reclaim materials of finished goods supplied within a short window of a bankruptcy filing. But manufacturers must act quickly or potentially forfeit rights and opportunity.

Of course, contractual terms have a significant impact on each party’s lien rights, setoff rights, and the ability to terminate contracts. Furthermore, contractual terms affect whether a contract is considered an “executory” contract in bankruptcy, whether it is integrated with other contracts, and the impact of this on the duty to perform in bankruptcy. You may be able to take control of those issues. By recognizing a troubled supplier or customer, you can probably renegotiate the terms in your favor. There are, not surprisingly, risks to manage along the way. Through understanding these risks and remedies available to you and a bankrupt company, manufacturers can protect themselves from the powerful tools that a customer or supplier can wield in bankruptcy.

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