Lee Swinerd, corporate partner at the Institute for Turnaround and director of Interpath Advisory, explains how the UK insolvency practice jeopardises the supply chain and can lead to production stoppages

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In a truly global industry like automotive, where a company is located can influence customers’ sourcing decisions. Of course, there are many other factors including price, capability, capacity and logistics, but do the experiences of local restructuring practices influence sourcing decisions as well?

In our view, the answer is “partly”.

If we compare and contrast three core markets, you can see why the UK may be considered less favourable than, say, the USA or Germany which also have well-established restructuring procedures.

The USA is a debtor friendly regime where the expected outcome is that a business is restructured and will survive a period of financial or operational distress. The Chapter 11 process results in limited disruption to the day-to-day operations of the tier one supplier, and OEM (and other) customers will not feel overly concerned about continuity of supply.

In Germany, while the long-term outcome is less certain than in a Chapter 11 process, if a tier one supplier enters administration proceedings, then the principle of continuity of supply remains embedded within the local legislation. Suppliers need to continue to supply materials and products on existing terms and conditions. Customers will need to fund production losses incurred throughout the period of administration. But fundamentally, customers can remain reasonably confident their production lines will continue with minimal disruption.

A reluctance to provide 
In contrast, the most likely procedure in the UK, an administration, provides less certainty to the OEMs (or any customers) regarding ongoing supply. And there is certainly that perception with global automotive supply chain.

Here, administrators can continue to trade the business in insolvency but require all future costs/liabilities to be covered. Historically, the senior lenders often provided this certainty to the administrators to protect or enhance the going concern value of the business as it was sold. However, these days, secured lenders are reluctant to provide such surety to the administrators and so the pre-pack has surged in popularity, whereby the business is sold immediately at the point of the insolvency proceedings taking effect.

Lee Swinerd_IFT

Lee Swinerd, corporate partner at the Institute for Turnaround and director of Interpath Advisory

However, even a pre-pack provides some elements of risk. The administration process will often trigger contractual clauses that allow both customer and supply contracts to be terminated. They can also provoke difficulties with landlords, and there is no obligation on a trade (or other) supplier to continue to provide product to the ‘Newco’. While it is usually anticipated the new owner will provide sufficient working capital to resolve any short-term supplier problems, our experience indicates this can still be quite a difficult process.

OEMs and other customers can, and often do, agree to fund the administration to ensure parts continue to be made and reach their production lines. Ideally this should be agreed prior to the appointment to minimise disruption risk. Such an agreement will cover ongoing trading losses during the administration period but, and more importantly, can also deal with supplier ransom risk, whereby pre-appointment liabilities are covered by the customer funding should they need to be settled by the administrators in order to maintain a flow of product or services from the supplier.

Risk to production 
Despite changes to the insolvency regime under CIGA whereby a supplier ought to be obligated to continue to supply products (the ipso facto rule), the practical implications of this look to be difficult to implement in the UK. There seem to be a number of loopholes where the potential remedies for the administrators take time and, therefore, production is likely to have been disrupted by the time a remedy is granted by a court.

But the most challenging element of the UK regime is that each stakeholder has the ability to leverage its position differently which creates an uncertain environment for the OEM to operate in and can run the risk of operational disruption and increased costs of protecting supply. Given c.80% of all components manufactured in the UK are exported, then the contagion effect of a relatively small supplier in the UK can be significant across a global OEM.

We believe this perceived risk is a contributory factor to customers choosing to source parts away from UK-based suppliers.

To reduce this risk, we advocate a collaborative approach between customers, their suppliers and key financial stakeholders to work through the potential solutions and reach a consensual outcome while keeping the financial cost to the customers as low as possible. When this approach is adopted a UK administration process can be an effective tool to help a business restructure and put itself back on a stable platform.

UK automotive suppliers are at a possible disadvantage when competing with European or global counterparts, but it is still possible to reach a workable outcome providing the stakeholders cooperate throughout a UK based restructuring process. It is important for the UK’s restructuring community to help change the perception that the UK’s processes are more detrimental compared to those of other jurisdictions.