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