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UK automotive supply chain should take action given changes to UK insolvency law

Changes to UK insolvency law for automotive sector

The changes to UK insolvency law will impact the UK automotive supply chain over the coming months, placing significant pressure on the sector

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Andrew Burn

Partner and UK Head of Automotive

KPMG in the UK

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Despite pressures building with the sector over the last few year, there have not been many high profile insolvencies in the UK automotive supply chain.  As the impact of COVID-19 continue to reverberate across the global economy, this is something that is likely to change in the months and years ahead.

Changes to the UK insolvency regime are likely to have an impact on all businesses operating within the sector. OEMs and Tier 1 suppliers should be mindful of these changes and the impact on their existing supplier risk management (SRM) processes.

Managing liquidity through lockdown

The liquidity impact of COVID-19 has already placed significant pressure throughout the sector. For those businesses with sufficient reserves, unencumbered assets on which to generate further funding or access to government support (CBILS etc), the challenge posed by the COVID-19 lockdown has proven to be significant but manageable. Unsurprisingly, those that were already struggling before COVID-19 may have already failed, whilst the prospects of others look bleak once government support tapers away by October 2020.

There’s a further group of automotive suppliers that fall somewhere in the middle. Having weathered the initial impact of COVID-19, these businesses are heavily reliant on car maker volumes rapidly returning to pre-crisis levels. If, as seems likely, the global economic recovery takes some time, the operational gearing of many suppliers means they are especially susceptible to sustained reductions in the volume of parts being ordered.

With the pandemic response having depleted the reserves of almost every business, going into a sustained period with lower volumes/orders is likely to mean that they will burn cash that they do not have. 

This is therefore likely to lead to greater stress or distress in the supply chain.

New Insolvency Legislation

In many respects, the proposed amendments to the Insolvency Act 1986 seeks to deal with some of these issues.

The creation of a pre-insolvency moratorium period of 20 days and supplier protection conditions (otherwise known as ipso facto) means that suppliers of a business in insolvency and in a moratorium will be required to continue to supply the distressed business without capacity to apply any leverage (e.g. price increases or repayment of outstanding debts).

Of particular note:

  • The concept of ipso facto prohibits the termination of any contract for the supply of goods or services (or “doing any other thing” in relation to that contract such as varying it) where a moratorium comes into force, a company goes into administration or liquidation or an administrative receiver is appointed, a CVA takes effect or a convening order is made in respect of a Part 26A Plan. The prohibition does not apply to schemes of arrangement.
  • A supplier can still terminate for non-insolvency grounds if the default triggering the termination right occurs prior to the relevant insolvency proceeding.  However, if the right is not exercised prior to any insolvency the right to do so will be suspended.

For car makers, the new legislation should mean that they will almost certainly become aware of suppliers in difficulty, not least because they will almost certainly be invited to participate in the development of agreed pre-insolvency moratorium restructuring plans. 

For Tier 2+ suppliers exposed to distressed companies, they will be now be required to produce and supply their components without the ability to impose price increases or seek “ransom payments” by demanding debts be settled prior to recommencement of deliveries.  For the car makers, or any business with continuous production processes, this will be helpful as it provides a degree of certainty in the supply chain.

Adapting to new rules

Both suppliers and customers should be aware of these new provisions, review existing and future agreements to take into account the impact of the new legislation.

Key considerations include:

  • Potential for increased nervousness throughout the supply chain.  To avoid being impacted by the ipso facto clauses, a simple solution for suppliers exposed to the (di)stressed business could be to reduce payments terms or stop trading before the appearance of a moratorium.  This could mean suppliers reacting quickly or pre-emptively to conjecture or market rumours, in doing so creating greater working capital demands that ultimately fall onto the OEMs. The chain needs to be alert to that risk.
  • Funding the moratorium.  All moratoriums will need to be monitored by a qualified insolvency practitioner (“the monitor”), in a manner not dissimilar to their supervisory role in CVAs. The monitor will need to be comfortable that a moratorium period is sufficiently funded in order to be able to conclude that is has a reasonable chance of resulting in a successful rescue of the Company.  Directors will therefore already need to demonstrate sufficient funding prior to applying for a moratorium, which is likely to fall to OEMs to support.  Critically, moratorium debts are expected to have super-priority in any subsequent insolvency.  

Taking actions

It is reasonable to envisage a future state whereby funders and customers will need to work more closely together in situations where automotive suppliers become distressed. There is likely to be greater use of innovative loan instruments or charges to enable survival funds to be introduced into failing suppliers.

Given the liquidity challenges facing the entire sector, including many OEMs, and the uncertainty surrounding consumer demand in the months ahead, the capacity for the car makers to ‘bail out’ suppliers is diminished. Effectively applying cash preservation will therefore become critical in all areas of the automotive sector.

Finally, for Automotive and Tier 1 suppliers the new legislation may impact on their SRM processes and how they work with stressed or distressed members of their supply chain. SRM teams should urgently consider whether their existing ‘toolkit’ of responses remain appropriate and how best to help ensure their supply network is resilient, reliable and sustainable.

© 2020 KPMG LLP, a UK limited liability partnership, and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.

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