This article was originally written for and featured in Boating Business.
As Britain continues to struggle to get out of recession, an ever increasing number of finance directors are being faced with the same dilemma, says Paul Taylor. A key customer wants extra time to pay its invoices.
As a result, this one customer now owes a material part of the supplier’s book debts. The supplier is now so exposed that it’s scared to take enforcement action, fearing the customer will go into liquidation and the debt will never be recovered.
The finance director may now well be asking himself – ‘have I fallen foul of a zombie company?’
A ‘zombie’ company?
So called ‘zombie’ companies are businesses making little or no profit, which are kept in business by either their banks relaxing the terms of their credit facilities; an extension of credit agreed with suppliers; entering into time-to-pay agreements with HMRC; or a combination of all three.
Such companies are only able to defer payments and pay just the interest on their debts, rather than making material payments of the principal debt itself. The outcome is these companies accrue so much interest/costs that they have very little prospect of ever being able to repay their liabilities.
The ‘curse of the zombie’
Firstly, banks are showing remarkable levels of forbearance and are reluctant to push struggling companies into insolvency.
Yes, they are reluctant to lend new money, but the value of these companies’ assets, which have been used to secure the lending, has often materially reduced and the banks would prefer to wait to enforce in hope that the values increase.
Secondly, suppliers have now become so exposed to these companies that they cannot afford for them to fail. Unfortunately, this has a knock on effect down the supplier chain as each debtor in turn is now deferring payments and spreading the ‘curse of the zombie company’.
This is evident in the fact that although the country is now in a double-dip recession, the number of corporate insolvencies actually fell last year. Recent figures from insolvency specialists R3 have shown there are 146,000 ‘zombie companies’ currently in the UK that are on the brink of insolvency. This equates to nearly 8% of UK trading companies.
What can you do?
This is the important question for all companies at present to ensure that they do not fall foul to the curse.
The best line of defence is to avoid unpaid debts/undelivered goods in the first place. A robust credit control policy should be a mainstay of a well run company. There are a number of elements to this.
Firstly, consider taking out credit insurance. This is becoming increasingly popular, but exclusion clauses need to be carefully reviewed. At the same time set credit limits for individual customers.
Use a carrot and stick approach – the carrot is a discount for early settlement and the stick is interest for late payment.
It’s worth registering at Companies House for their web watch service (http://bit.ly/aEcLO9) in order to monitor filings from key suppliers and customers.
Use this information to chase down unpaid debts and make sure commercial partners know you will not be fobbed off by repeated promises to pay. If you are in a hole, don’t keep digging and don’t be afraid to call a customer/supplier’s bluff by putting them on a stop list.
Insist on payment for the remainder of the goods, if a customer questions part of an order, and get to know the cheque run date(s) of key debtors. Ring them up the day before and make sure your invoice is included.
Alternatively, insist on post dated cheque(s) or personal guarantees from directors/shareholders, if a customer can’t pay.
Retention of Title (RoT)
For businesses that are a supplier of goods, a RoT clause should be an essential part of the terms and conditions. However, a well drafted RoT clause will be of little use unless it is properly incorporated into commercial dealings.
At the very onset of a commercial relationship it’s important the customer signs a copy of the terms. It’s just as important to ensure that the terms are then included on all purchase forms/invoices.
Ideally, a RoT document should have sub-clauses that oblige the customer to store the goods separately and also to label them as belonging to the supplier; include a right to enter the customer’s premises to check that RoT provisions have been complied with and/or to recover goods.
RoT clauses should be enforceable on non-payment and without having to wait for a formal insolvency event. RoT should include an all monies clause. This may allow recovery of all goods even if some individual invoices have been paid.
However, the goods being claimed under a RoT clause must still be capable of identification and a supplier must be able to link them to specific invoices. The goods should also be marked with the name of the supplier, with serial numbers deployed and quoted on relevant invoices.
Keep it confidential
You may have concerns over a supplier/customer but it’s not a good idea to broadcast these.
For example, in one of the earliest cases involving use of emails, Norwich Union was held to be vicariously liable for alleged defamatory comments made by its employees about Western Provident Association (WPA).
Norwich Union employees were using the internal intranet to circulate emails amongst themselves alleging that WPA was in financial difficulties and that the then DTI was investigating WPA.
WPA discovered that such emails were being circulated and obtained an order directing Norwich Union to preserve all of the offending emails and produce hard copies. WPA later obtained a further order allowing it to conduct a search of Norwich Union’s email records.
The case was settled out of court by means of an apology and damages (reportedly £450,000 plus costs).
Spread the risk
Lastly, if a company is beholden to one supplier/customer, what is the Plan B if this supplier/customer was to fail?
Merger and acquisition specialists have been reporting that more companies are exploring opportunities for vertical integration to protect their supply chain. A distressed supplier may be receptive to an acquisition approach from a customer.