Insolvency refers to a financial state where an individual, company, or business is unable to meet its financial obligations and repay its debts. It occurs when liabilities exceed assets, making it difficult or impossible to fulfil financial commitments as they become due.
Insolvency doesn’t always lead to a company or business being wound up, or an individual being made bankrupt. However, it can be a forerunner to a winding up petition being presented against a company/business or a bankruptcy petition being presented against an individual -, especially if the entity/individual is unable to negotiate repayment terms with creditors or adjust its finances to become solvent again.
The Insolvency Service is currently announcing monthly business and individual insolvency statistics for England, Wales, and Northern Ireland, and monthly statistics for Scotland, in order to give up to date information regarding insolvency volumes.
The Office of National Statistics shows that for November 2023 registered business insolvencies for England and Wales were 21% higher than in the same month in the previous year. The business insolvencies consisted of 359 compulsory liquidations and 1,962 creditors’ voluntary liquidations (CVLs), again increased from the year prior.
The role of commercial contracts
When engaging with potentially insolvent business, suppliers, or customers, the role of commercial contracts becomes even more important and plays a role in safeguarding your business. Dealing with financially vulnerable entities means there are increased risks, and well-structured contracts can help mitigate some of these risks. See below an outline of how commercial contracts play an important role in such situations:
- Risk assessment and mitigation: Contracts allow for a thorough assessment of the financial stability of customers or suppliers. They can include clauses that require financial disclosures, credit checks, or periodic financial reporting to monitor the party’s financial health throughout the agreement.
- Clear payment terms and conditions: Contracts should set out clear payment terms, such as, deadlines, methods of payment, and penalties for late payments or defaults. This clarity helps in managing cash flow and reduces the risk of non-payment.
- Security measures: It is advised to implement security measures within the contract, i.e. requiring advance payments, personal guarantees, letters of credit, or collateral in order to secure your position in situations where the other party faces insolvency.
- Termination and exit clauses: Ensure you include clauses that allow for contract termination renegotiation if either party faces financial distress. This will not only protect your interests but it will also provide an exit strategy if the other party’s financial situation deteriorates.
- Priority in insolvency proceedings: Contracts can include clauses that secure your position in the event of the counterparty’s insolvency. For example, creating a right to reclaim goods or establishing priority for payment over other creditors.
- Continuous monitoring and communication: Contracts can include obligations for ongoing financial disclosure or reporting meaning you can monitor the other party’s financial status regularly. Therefore, giving you open communication to address any concerns you may have.
- Contractual rights and remedies: Ensure you clearly outline rights and remedies in case of either a breach or default due to insolvency. This can include the right to stop services, end the contract, or seek compensation due to losses incurred.
- Insurance and indemnification: Consider using provisions related to insurance coverage or indemnification in order to protect yourself from losses from the counterparty’s insolvency.
- Legal and expert advice: Before signing anything seek legal advice to ensure the contracts are appropriately drafted to protect your interests and assets in case of the counterparty’s insolvency.
Comment
When working with potentially insolvent customers or suppliers, well-drafted contracts are a must in minimising risk, protecting your interests, and outlining clear expectations. However, it is important to note that contracts can not remove all risks associated with insolvency and a comprehensive risk management strategy should include various approaches beyond contractual agreements.
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Craig Bennett is an Associate in our expert Dispute Resolution team.
If you have any queries about the subjects discussed above, please do not hesitate to contact Craig or another member of the team in Derby, Leicester, or Nottingham on 0800 024 1976 or via our online enquiry form.
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