The importance of early involvement of customers and suppliers in self-administered insolvency plans
Insolvency is still a stigma and only rarely seen as an opportunity. Yet, many business owners could profit from it. The Act to Further Facilitate the Restructuring of Companies (ESUG) of 1 March 2012 is the German legislator’s attempt to motivate companies to consider filing for insolvency early on. The legislator, through planned insolvency by self-administration, provides a company with options to retain the company and to prevent liquidation or disposal of assets by way of an asset deal. Although the process can be structured to be almost legally watertight, virtually always the same concerns are expressed in initial meetings with business owners. Concerns of loss of reputation often keep companies from taking the legally required first steps. Most affected parties not only lack the requisite knowledge of the potential offered by a self-administered insolvency plan but also lack the understanding of the risks involved in insolvency.
A business owner who is informed about the possibilities offered by a self-administered insolvency plan in an initial meeting usually expresses the following concerns:
- Suppliers will jump ship as they will lose money in the process. If we do not receive resources, we cannot function properly.
- Customers will no longer be loyal to our company, as their confidence in the company will wane due to the insolvency. Without customers, the company will generate no sales.
However, both concerns are completely unfounded and do not materialise, as we can show by a variety of examples. Suppliers almost always have an interest in continuing to supply a company, as otherwise they would be left to look for new sales channels. This entails a large expense and is often associated with a considerable loss in yield. Of course, suppliers do lose money in on-going insolvency proceedings. This is of course unpleasant and does not immediately build trust. If, however, the supplier can be convinced by evidence that the company, reorganised un- der the plan, will have sufficient liquidity to pay supplier invoices in the future, and moreover has an equity ratio that is no longer negative but is clearly moving in a positive direction, the supplier can be easily convinced that the company will be a safe and solvent customer in the future. Usually, for the first few weeks under the insolvency plan, the company will have to pay for the supplier’s good and services in advance. However, as the proceedings progress and the suppliers’ confidence in the customer’s solvency increases, the supplier will gradually alter the payment terms, considering that advance payment is an extremely laborious process.
In any event the supplier has no interest in creating new sales channels, because here he is in competition with third parties and must often accept worse payment terms as initially competition only exists with re- spect to price. Moreover, sometimes even prelisting fees must be paid, which is common practice in retail. In any case, suppliers will always prefer keeping old customers to looking for new ones. If the supplier chooses to do other- wise, however, the loss of its customers may have even more harmful effects than a mere one-off, non-recurring loss. It is even conceivable that this would plunge the very supplier into a crisis that could only be resolved through restructuring measures on its turf. A plan-reorganised company with strengthened liquidity and reduced debt is therefore significantly more attractive to the supplier than an uncertain new customer. If the supplier cannot be convinced – which is rather the exception –, the company can still switch to other suppli- ers. After all, why would a new supplier refuse to deliver if advance payment is offered? This of course is a point which applies equally to the affected supplier/creditor, who can monitor whether his client actually develops the way it was predicted.
Customer behaviour can be analysed similarly. Likewise, the customer will not assess the insolvency negatively but rather see it as a sign of proactive entrepreneurial per- formance if he is explained the method by which the crisis will be overcome by the company’s management. Our experience shows that the insolvency self-administrator does not receive negative reactions from customers but rather is greeted with positive encouragement. In general, the proceedings are still unknown to the customer, and for that reason it is also recommended, just as with respect to the suppliers, to explain the proceedings with the help of the competent advisor using a projected balance sheet and projected profit and loss statements. This will clarify to the client the professionalism with which the debtor is meeting the challenge.
The customer’s confidence regarding the company’s future will be significantly strengthened thereby. Sometimes it makes sense to let the customers in on what is being planned, even before the actual petition will be filed. This is particularly the case if the customer is to some degree dependent on the potential debtor. This may be the case e. g. with ongoing projects or when the customer receives important components from its supplier, which cannot be obtained elsewhere in the short term. This dependence is regularly found in the automotive industry. The auto maker always returns to specially tested parts. This is perfectly necessary as shown convincingly by constantly occurring recalls the costs of which often run into billions for auto maker.
Given this background of the impending insolvency, the customer is often prepared to take liquidity support meas- ures. This most likely occurs through easing the payment terms, which can also give substantial additional liquidity to the company in advance of filing the petition. Moreover, it is not infrequent that the esteemed customer itself is one of the causes of the insolvency risk because the profit margins imposed by the customer’s conditions are not sufficient to cover costs. If the insolvency debtor can make this transparent, the customer may even be willing to accept some of the loss.
This requires, however, that the customer has to get involved closely and early in the whole proceeding, including possibly an involvement as a member of the creditors’ committee during the entire proceedings. The decisive criteria for the customer are the advisor’s competence and the evidence he brings regarding the successful outcome, and possibly also his industry-specific knowledge. Moreover, it is advisable to determine, when one is pre- paring for the proceedings, which customers and suppliers will be informed, and how and when. Sometimes a simple letter, in which the proceedings are explained, is enough but sometimes a personal visit is necessary. This requires a kind of information strategy that should be developed before the proceedings commence. The major customers and suppliers should not learn about the proceedings from the media but rather receive privileged information in advance as a trust-building measure.
In summary, it can be said that as a rule the concerns that were expressed initially vanish “into thin air” and the flow of information between customers and suppliers can become an opportunity to create an even stronger bond and increase trust in the proceedings. Many company owners who have successfully executed such proceedings can attest to this.