Wake-up call: Have you got zombies in your supply chain?

A growing number of companies are still clinging on in the face of insolvency. Jonathan Cole and Forida Khatun explain what to do if one of these zombie companies is in danger of affecting your supply chain.

 

The problem

 

As a consequence of the relief measures introduced to combat the financial repercussions caused by the pandemic, there has been a significant rise in the number of ‘zombie companies’ in the supply chains of UK businesses, particularly in the hospitality sector.

 

The law

 

Zombie companies are businesses which are still operating but are unprofitable, unproductive and are often burdened by debt. These businesses are particularly prevalent as a consequence of the catastrophic events of the past 18 months which would normally have caused their insolvency.

 

Instead of insolvency, various legal and commercial lifelines have been afforded to such companies courtesy of responsive relief measures introduced by the government including the ‘bounce back’ loans, furlough, and restrictions on lease forfeiture.

 

In particular, the Corporate Insolvency and Governance Act 2020 introduced various temporary measures designed to restrict the ability of creditors to wind up such companies. These relief measures have meant that it is estimated the number of zombie companies in the UK has increased to approximately 20% of all businesses.

 

Expert advice

 

Having a zombie company in your supply chain can cause all sorts of tricky legal issues given the economic uncertainties surrounding them. Such issues may include a reduction in quality or late delivery of supply. Conversely, if you are supplying goods or services to a zombie company, you may experience credit control difficulties and complex legal issues arising from such failures to pay surrounding title to goods, suspension of services and your ability to exit the relationship.

 

These sorts of issues are likely to cause disruptive service as well as reputational and financial damage. Consequently, it has never been more important to know exactly who you are engaging with and to have a robust contract in place to clearly govern that engagement, in order to mitigate against the impact of a zombie in your supply chain.

 

To-do checklist

• Do your due diligence Research the viability and vulnerabilities of existing and any prospective new businesses in your supply chain.
• Such due diligence may include searches at Companies House and the various Insolvency Courts and Registry Trust to determine the extent to which a business may be involved in or face litigation.
• Spot the warning signs Use social media platforms and press articles to understand what others are saying about the company. Have there been an increased number of complaints? Is the company seeking to revise payment terms or supply deadlines? These can all represent red flags.
• Keep your ear to the ground Ask questions of your contacts in the industry, as you may obtain helpful anecdotal feedback on a particular company that you are considering engaging with.
• Have a robust contract If you are due to engage with a new company or placing a new order with an existing supplier, you should ensure that you have a robust contract in place which gives you sufficient protection, as well as the tools to exit and seek recovery of any loss as may be necessary.
• Actively manage your cash flow Make sure that any deadlines are being met and if necessary are renegotiated with suppliers, so as to ensure that payment only follows adequate performance.
• Communicate If you spot issues with a business in your supply chain, have open and frank conversations with them and try to address any issues early, so as to avoid a problem escalating.
• Take advice If you think that you may have a zombie company in your supply chain, take legal advice on how best to extract yourself from a contract. Such advice can prove invaluable at an early stage in preventing issues with zombie companies from escalating.

 

Beware!

 

As the world attempts to move forward from the past two years, there is likely to be a substantial number of zombie companies which simply cannot continue, with a tidal wave of insolvencies predicted in the next few years. The impact of such companies and any such insolvencies in your supply chain should not be underestimated.

 

With margins already being squeezed and the hospitality sector continuing to feel the effects of the pandemic, a supply chain issue caused by a zombie company could in itself have a devastating impact on the viability of your otherwise good business.

 

Jonathan Cole is a partner and Forida Khatun is a trainee solicitor at London law firm Goodman Derrick

 

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