Managing the impacts of your customer’s potential insolvency

Recent data published by Australia’s corporate regulator, the Australian Securities and Investments Commission (ASIC), indicates that the number of corporate insolvencies in Australia continues to rise. In an industry where the margins are notoriously tight, transport and logistics operators can find themselves in parlous financial circumstances very quickly if one of their customers suffers financial stress.

ASIC’s recent insolvency statistics are troubling and show no sign of improving in the short to medium term:

As the number of corporate insolvencies rises, so too does the risk that your customers may default in payment of your invoices or worse, that those late payments will become bad debts. It is therefore important that you can identify the warning signs of insolvency and that you are across some of the ways that you can limit the impact of your customer’s insolvency on your business.

The following provides a broad overview of corporate insolvency and good practice in managing risk in relation to the same.

Identifying that your customer may be or become insolvent

A company is insolvent when it is not able to pay its debts as they become due and payable. Insolvency is primarily determined by a cash flow test where the central question is whether there are sufficient cash flow sources, including funds that may be reasonably raised, to satisfy the company’s debts.

Common corporate insolvency outcomes include the placing of a company in voluntary administration, and if business rescue by voluntary administration is not possible, liquidation or receivership.

Whilst not definitive, some of the indicators that your customer may be experiencing financial difficulties, or is approaching insolvency, include where your customer:

• starts making late payments, or requesting extensions of time to pay invoices;
• is avoiding communications with you, or becomes difficult to get a hold of; or
• appears to be understaffed or have reduced the workforce.

Significant changes to the customer’s corporate structure, the registration of judgments and an increase in the number of credit checks on the customer are also indicia. These can be determined by running searches of ASIC’s public registers.

Managing risk

There are several measures that you can take to limit the adverse consequences for your business arising from your customer’s insolvency.

Due diligence

You should undertake due diligence investigations in relation to potential customers prior to entering into any commercial arrangements with them. This is particularly important if you are considering extending credit to those customers. You should also monitor your clients’ financial status on an ongoing basis, particularly in long-term dealings.

Contract terms

Your agreements with your customers should include robust terms that are fit for the circumstances of each customer, particularly in relation to the payment of your accounts. A reported reason for the recent increase in insolvency in the Transport, Postal and Warehousing sector is the difficulty in obtaining payment for services performed.  Accordingly, transport and logistics operators ought to pursue payment sooner rather than later.

Parties are generally best placed by securing upfront payment rather than proving that monies are owed at the stage of external administration and ultimate liquidation of a company. Alternatively, you can structure payments by insisting on milestone payments upon completion of pre-defined stages rather than by lump sum payment upon final completion of a project or performance objective.

Taking security

You can also mitigate your risks by including security provisions in your customer contracts.

Those security provisions could include:

• a lien provision, enabling you to maintain possession of the customer’s goods that are in your possession until all outstanding invoices are paid and if not paid, to sell those goods;
• a requirement that your customer provide a bank guarantee that you can call on if they default;
• a personal guarantee given by the directors of your corporate customer — a very effective tool which quickly highlights whether a customer is a serious payer or not; and/or
• where applicable, the right to register a security interest on the Personal Property Securities Register.

Contact us

If you are a transport and logistics operator seeking advice on your service agreements, please contact a member of our Transport & Logistics group.