When businesses assess insolvency risk, the focus is usually on their own financial position — or perhaps on the potential failure of a major customer or supplier. But what happens when a major creditor fails?
A creditor entering administration or liquidation can alter an established commercial relationship almost immediately. Long-standing payment arrangements may be reviewed, informal concessions withdrawn, debts pursued more aggressively and valuable contracts or debt portfolios sold to third parties. For a business already managing tight working capital, that change can create an unexpected liquidity problem.
Risks associated with creditor insolvency
If a creditor becomes insolvent, its failure can affect a business in several ways at once.
- The debt does not disappear (and may be pursued more strictly). Outstanding amounts are assets of the insolvent company, which an administrator, liquidator or any purchaser of the debt may pursue for recovery — often on stricter terms than the original creditor allowed. For example, a business paying £25,000 a month by informal agreement could be asked for the full £250,000 balance.
- Access to finance may be disrupted. If the creditor also provides an active facility, such as an overdraft, invoice finance or asset finance, its insolvency may affect the availability or administration of that facility or result in it being transferred to another funder. The contractual position and terms of any replacement arrangements will be critical.
- Other essentials can be lost, too. A creditor supplying goods, property, equipment, licences or infrastructure can leave a business needing to settle what it owed whilst sourcing a replacement, often on worse terms and with upfront payment required.
Together, these risks can create sudden pressure on working capital that was not reflected in short-term forecasts.
What to do to safeguard against creditor failures
Check whether competing balances can be offset
Where a business owes money to an insolvent lender or finance provider, and that provider owes money back, perhaps a deposit or a refund, the two amounts do not always cancel each other out.
When mutual amounts are due between the parties, insolvency set-off (where mutual dealings are automatically balanced) may apply. However, the position will depend on the nature and timing of the respective claims and the relevant insolvency rules. Businesses should not assume that amounts can simply be netted off in the ordinary course without first establishing the legal position.
Map out what is owned, leased and secured
A failed creditor may hold security over company assets or retain ownership of equipment the business is using. Its administrator or liquidator may seek to realise, enforce or sell those rights as part of the insolvency process, subject to the relevant contractual and legal position.
A short audit can answer a few key questions in advance:
- Which essential assets are owned outright?
- Which are leased or financed?
- Who holds security over them?
- What contractual rights could be exercised if the counterparty became insolvent?
Having these answers ready means a business can respond quickly rather than working it out for the first time once an insolvency is already underway.
Stress-test the failure of important creditors
Boards should consider creditor failure as part of financial resilience planning. Reviewing creditor relationships regularly can reveal exposures that might otherwise stay hidden.
For significant creditors, management should be able to answer the following:
- How much do we owe?
- Are the payment terms contractual or dependent upon informal arrangements?
- If recovery became more active following an insolvency, could the business meet it?
- If the creditor provides something essential, is there a fallback in place?
- Would we need additional working capital if the relationship ended suddenly?
An unexpected creditor failure can affect cash flow and day-to-day operations at the same time. Working through these questions in advance helps a business manage that disruption instead of being caught off guard by it.
Seek professional advice to ensure business resilience
A creditor’s failure can look like someone else’s problem at first. But when a business depends on an existing facility, informal payment flexibility or a particular funding relationship, the impact can be significant.
Understanding those dependencies, documenting key arrangements and stress-testing the cash flow impact can help ensure another company’s insolvency does not become the trigger for a business’s own financial distress.
At Opus, we can help assess the financial and operational impact of a lender or finance provider’s insolvency, consider the implications of existing funding and security arrangements and identify options for maintaining liquidity and access to finance. Where specialist legal advice is required, this can be considered alongside the wider restructuring strategy.
Contact us at rescue@opusllp.com or call 0203 995 6380 to arrange a call with one of our specialists to discuss your next steps.