How can I protect my business from customer insolvency?

How can I protect my business from customer insolvency?

Have you noticed that your customer has missed some payments recently? Is it suddenly hard to get through to their accounts team? These are often red flags that your customer may be in financial trouble.
It’s painful to see how Covid 19 has impacted the economy with devastating effect. Many companies, from start ups to national chains, are faltering and going into administration.

“Even some stalwart names have declared bankruptcy this year,” says Kim Simmonds, our Founder and CEO. “So if customer insolvency has become an issue or you think it might, it would be worth looking at the contract terms to see what wiggle room you have.”

Many of our Microsoft Partner clients provide essential IT Services and often are managing their licences on behalf of the Independent Software Vendors (ISVs) for their customers. Our clients, the MSPs, also will hold all the contractual risk with these licences and we have seen more of our clients come to us with issues as to what happens in the event their customers become insolvent. We wanted to provide a few helpful notes to (1) understand your position before your Customers go insolvent; (2) what happens now your Customer is insolvent; and (3) what can you do to stop this happening from now.

Understand your position before your customer goes insolvent

If your customer hasn’t started administration proceedings, you should do whatever you can to ensure they remain solvent and can continue to pay the bills. Understandably you won’t want to rock the boat with your customer or enter into awkward conversations but it is important to ensure they can meet their payment obligations in time. Failing that, what can you do?

• You can look at your termination or suspension rights. Does the contract give you the ability to terminate or suspend services if your customer fails to pay on time or misses two consecutive payments?
• If you are managing third party licences (for example an enterprise arrangement with Microsoft) and you are holding the contractual relationship with your customer and separately with Microsoft, have you looked at the contract with Microsoft/other third party to find out what happens if your customer misses more than two payments or has difficult paying (before an insolvency event)? If not, are you able to negotiate this in? Given the climate we are in and given the fact despite the climate this is still is not the norm, I think this contractual right ought to be pushed by a lot of Microsoft Partners to avoid you having to carry the charges for your soon to be insolvent customer.
• If you offer a credit facility to your customers, are you managing and monitoring it closely now to spot the red flags? If so, do your contract terms specify your right to stop the credit facility when necessary?

What happens when your customer becomes insolvent

For providers of IT Services, it’s not good news.
This is because, under The Insolvency (Protection of Essential Supplies) Order 2015, IT services are considered an essential supply – just like gas, water, electricity – which effectively negates the termination rights in your contracts upon insolvency. Yes, as unfair as it may seem, the normal “get out” clauses that protect many businesses won’t work for you. (This is only for contracts after October 2015).
It gets worse if you are selling third party licences. Both you and that third party are obligated to provide those licences even though you won’t get paid. However, the third party will of course demand payment from you, so you’re stuck between a rock and a hard place, holding a liability you can’t shift.

What can you do in this scenario?
• In your third party contracts stipulate that as soon as the supply is deemed no longer needed, that you can terminate the licences and all further obligations to pay (including any termination fees).
• When the insolvency process begins, ask the appointed insolvency practitioner to guarantee payments of charges incurred from that date. (They will often put this high on the priority list as these are essential supplies so it’s worth ensuring you do this.)
• Ask the court for permission to terminate based on “Supplier hardship”. This is slightly harder to get through as you really will need to show that it will cause a big enough hardship on your business in totality.
• Terminate the contract if post insolvency supplies are not paid within 28 day. This is a way to mitigate your risk by knowing there is not more than a 28 day window for such free services. This is allowed under The Insolvency (Protection of Essential Supplies) Order 2015.

4 ways to limit your risk

You must be mindful of the above issues at all times but to summarise here are the steps you can take both internally and contractually to try and protect yourself as much as possible:
1. Have an internal ‘checks system’ to red flag bad payers. Don’t let them continue to be bad payers- have a chat with them in light of our economic environment and ask for financial assurances in whatever form you need.
2. Ensure your contracts give you the right to terminate or suspend the services immediately upon a failure to pay. By all means, give them a grace period from the due date but have this as your arsenal. If this marries up with some internal red flags, don’t hesitate to take the steps to start the termination process before you get to insolvency crisis.
3. With third parties you are managing, whether through services or licences, ensure they allow you to continue to provide their services through an insolvency event but that as soon as the insolvency matter has ended (and hopefully that 28 day window shuts) than all payments will fall away. There will not be any termination fees or fees owing to the end of the term.
4. In the same vein as point 3 above, also ensure that you can terminate a third-party service or licence in the event your customer fails to pay you on time. This allows you to get out of paying until the end of the term (which could be several years) and having to find the money to pay.