How to assess and mitigate contract risk
Economic turbulence can expose, in the starkest terms, where your business is vulnerable to the financial difficulties suffered by your suppliers and customers.
This article examines the typical risks associated with customers and suppliers, suggests both practical and legal mitigations to these risks and highlights why an active contract management process is a necessary part of you doing business so that your contracts are fit not only for purpose but for the time.
If you would like to discuss any of the topics or issues raised in this article, please contact our team of expert commercial solicitors. We can help identify and reduce risks across your contracts, so you can stay focused on managing and growing your business.
Jump to:
- How to assess and mitigate contract risk
- What is the risk if a supplier or customer defaults?
- Which suppliers and customers pose the greatest risk to you?
- How to get advance notice of a supplier or customer default
- How an active contract management plan can help in a recession
- You will be someone’s supplier or customer
What is the risk if a supplier or customer defaults?
The primary risk to you and your business is that you do not get paid.
- Customers: your customer fails to pay for goods or services delivered. You may have paid for component parts and/or staff costs.
- Suppliers: failure to deliver component parts may mean that you cannot produce a product or deliver a service to your end customer. This puts you in breach of your contract your customer who then refuses to pay. You may have paid for other material, components and staff costs. You may have paid for the materials in advance and therefore risk losing this payment.
In both scenarios, you are significantly exposed financially. This impacts not only your bottom line but also your cash flow, potentially making you incapable of paying your creditors, your employees or your suppliers, who may all raise legal actions against you.
If this failure to pay impacts your ability to make loan repayments, then this could put any secured assets at risk. If you have given any personal guarantees in support of loans, then this risk could extend to your home and other personal assets.
Which suppliers and customers pose the greatest risk to you?
In managing the risk of supplier and customer default, a first and critical step is understanding where your greatest financial exposure lies. Which customer or supplier default would put your business in the worst financial position? This may be a single customer/supplier or a combination of customers or of customers and suppliers.
This is not a review to be performed once or once every so often. It is an active and on-going process. Order volumes may change. Times change. Personnel change. Ownerships changes. Maintaining active and regular reviews and risk management assessments allows you to take account of these changes and then take your own appropriate actions in order to protect your business.
How to get advance notice of a supplier or customer default
Many business owners and managers believe that their ultimate protections come in the form of the legal remedies in their contracts. This belief can mean that you overlook some straightforward practical mitigations that might avoid those contractual remedies altogether or might give you time to apply the best contractual remedies for you.
The best mitigations are those that give you notice of the financial difficulties of your suppliers or customers in advance of an actual failure to deliver or pay. These mitigations are active and include:
Build a relationship with your customers and suppliers
Regular communication is key with suppliers and customers. This allows you to spot any differences in personnel, delay in responding to calls or messages or evasiveness in confirming payment or delivery. This may mean extra time to take your own action or to take advice so that you know what action you will take.
Perform on-going due diligence on your customers and suppliers
It is essential to keep yourself informed in relation to the financial standing of any suppliers or customers, whose default exposes your financially. Public news may highlight if stores are closing down, stock is being sold off and/or employees laid off. These can all be indications of a failing business and all can mean you taking action before your own business is impacted.
Equally, find out as much as possible about other creditors of your suppliers and customers, especially those who are secured and potentially take priority over you in any insolvency.
Credit control procedures/stock management
The maintenance and review of your credit control and stock management information is also essential. Are there, for example, any customers that have started to slow down their regular payment practices? Have extensions of payment deadlines been requested? Have credit limits been exceeded, or have credit increases been requested? Spotting this early allows you to understand the options available to you before the situation potentially deteriorates.
Similarly, with your suppliers, are there unexplained delays in their deliveries? Or has there been a change in quality, packaging or support?
How an active contract management plan can help in a recession
Many business owners or manager breathe a sigh of relief when they have a standard contract or terms and conditions of doing business and do not realise that these contracts can soon become out of date or inappropriate for the particular economic times.
Equally, many times contracts, purchase orders and other supply chain documentation are stored without checking what actions will be needed if a customer fails to pay or a supplier fails to deliver.
Our related content on contract lifecycle management explains why an active approach to contract management can bring multiple benefits and save time and money.
In a recession, this contract lifecycle management means that you can benefit from a specific action plan and particularly in relation to those customers and/or supplier whom you have identified as particularly significant to the financial health of your own business. This action plan may include:
Ensuring all contract documentation is complete.
In order to enforce any contract, that contract needs to be effectively signed. In addition, if that contract contemplates additional documentation, for example giving you the right to some form of security or payment guarantee, then this additional documentation needs to be signed and in place.
Knowing your contractual rights and remedies.
There are several contractual remedies that may be available to you and which may provide protection to you.
Customer contracts:
- Retention of title clauses: give the seller rights over goods delivered in preference to secured and unsecured creditors. It is critical that these clauses include the ability to repossess the goods and prevent the buyer from selling them. These clauses often provide that the customer must name and store your goods separately. It is important that you confirm that this is indeed, taking place, otherwise your ability to reclaim your goods might be invalidated.
- All monies clause: are your retention of title clauses sufficiently robust? Do they give you a remedy against one non-payment for particular goods or for the repayment of all monies due? An ‘all monies due’ clause potentially makes your life much easier in reclaiming monies owed, no matter in relation to which goods.
- You may have rights over the proceeds of sale of your delivered goods.
- Is any retention of title redundant because your goods have become mixed with others or incorporated into a finished product? Are they perishable or have a low resale value? In these cases, you will need to look at other remedies and protection, namely credit insurance.
Supplier contracts:
- Termination rights: do you have rights to terminate the contract on non delivery and source the goods elsewhere?
- Withhold payment: do you have the right to withhold payment on late of failed delivery?
- What damages are available if your supplier fails to deliver?
- Are you able to reduce the price in the event of late delivery?
- What can you do if there is only partial delivery?
Unsure about any of your current rights?
If you are unsure about any of your current rights and remedies and whether they are sufficiently robust to protect you please contact our friendly, expert commercial solicitors
Amending your contracts.
The practical mitigations that highlight when a supplier or customer is facing financial difficulty and an active contract management plan allows you to consider making variations to your contracts with particular suppliers and customers. These variations could include any of the remedies set out above and also could:
- Reduce the period of customer credit, amount of credit or both.
- Look to take alternative forms of security to protect you against non payment.
- Requiring your customer to take out credit insurance
- Requiring your customer to pay a deposit or pay into a fund.
It is also important that your customers and suppliers understand that any additional time that you grant them to for delivery or payment does not amend any contractual rights and remedies that might be applicable. An active contract management lifecycle means that you can prepare standard form letters and messages allowing you to quickly manage these situations. If you would like to discuss doing this, then our commercial solicitors will be very happy to help.
More information on the value in regularly reviewing and updating your terms and conditions of doing business can be found in our article, updating commercial contracts.
Knowing what an administration/insolvency means and what to do
This is all about being prepared for the worst eventuality. It is important that you understand what a customer or supplier insolvency or administration means for you and your contractual remedies. This allows you to be able to take appropriate action to protect your own business as much as you can.
Procuring enhanced credit insurance
Your review of your contracts and your financial exposure means that you can then put in place adequate insurance for any risk that is not adequately protected contractually.
You will be someone’s supplier or customer
It is always worth considering, when you are carrying out the risk mitigations and contract reviews suggested, that you are someone’s supplier and/or customer. They may well be carrying out their own reviews and mitigations in relation to the financial health of your business. As a result, an understanding of this topic will also give you context to any contractual discussions that they raise with you in order to protect their own financial position.
