As we settle into 2017, the annual trading updates from high street retailers are emerging.
The news is mixed. It's widely acknowledged that the sector will continue to face headwinds and the brave retailer, who takes the initiative, may well secure its survival. In this article we look at the very immediate legal issues related to insolvency protections that a retailer can look to tackle. It pays to be prepared for doomsday to ensure your business never becomes one of the casualties.
Saving the profitable
Protecting the core of a business can ensure survival through uncertainty and economic down-turns.
Even in the US where there is economic growth, Macy's, the Gap and Walmart, have all looked to close stores to reduce costly overheads and focus on extracting maximum profit from the business through other routes to market.
Retailers should be prepared to pre-empt serious liquidity issues by opening discussions with any stakeholders to whom debt is owed ahead of time. If the retailer can come to a deal with creditors to accept a reduced payment to settle the debt (a 'haircut') or other compromises, the retailer can look to address underlying cost and avoid ending up on the doorstep of insolvency.
Pre-packaged deals are another useful structure, common in retail, to extract maximum value out of the profitable parts of the business. In particular, a retailer can leverage the value of its data this way which, in the current climate of profiling and big data, should not be underestimated. It is possible for the business to get sufficient consensus with its organisation to do a deal with a purchaser to buy the profitable elements of the business which becomes effective the moment that the administrator is appointed. These deals are incredibly intensive and time pressured as everything needs to be in place before the administrator's appointment and before any investors call in their charges, so require substantial planning. They are however a survival mechanism to allow a business to dispose of liabilities whilst taking forward its positive parts, for the benefit of creditors (albeit through acquisition by a third party). Few administrators want to actually operate a retailer (presuming it is viable to do so) so pre-empting this by having a purchaser in-hand before the administrator is appointed will protect the maximum value of the business.
Common practise amongst retailers a few years ago was to use company voluntary arrangements to effectively force landlords into permitting leases to be broken early, rents reduced or payment terms amended in the retailers' favour. This seems to have abated, but given the current pressures on the industry with competition from overhead-light retailers, Brexit, increased labour costs and falling profit margins, we wonder if there will be a resurgence of this type of activity.
Landlords though will be wiser the second time around and may not agree so easily to the retailers' demands. Or it could push through the barrier of being blatantly unfair and open the practice to legal challenge.
De-risk your supply chain
Just as a retailer planning ahead might approach its customers and landlords to strike deals, retailers must be prepared for companies in their supply chains to do the same to them. The increasing reliance on logistics companies pose a growing risk with the popularity of click and collect services and e-commerce.
Suppliers in trouble will need to show to their investors that they have taken steps to try to cut deals with their customers to ease the financial pressure. Suppliers may therefore come to their customers asking for variations to shorten payment terms, increase prices or, more aggressively, threatening to enforce any debts or contractual breaches by the customer. Clearly retailers are reliant on suppliers to fulfil their contracts with consumers so any flag raised by a supplier warning of financial difficulty must be considered seriously due to the reputational risk to the retailer, especially as these situations typically arise during peak trading periods when the retailer would be worst affected. Suppliers may also pile on pressure by saying that their investors will only continue to fund their business if deals are done with key customers.
Whilst retailers may feel boxed into a corner, there is still a negotiation to be had. For example, this could be an opportunity to settle any outstanding liabilities the retailer may have with the supplier, or to ensure that if amendments are made that the customer's deliveries will be prioritised (by agreeing to pay on delivery of each item).
What are the alternatives?
Retailers' business continuity plans usually involve identification of alternative suppliers in case the preferred supplier fails. Leaving it too late to engage with an alternative supplier though can be very costly. If that back-up supplier knows they are the only alternative able to provide the goods/service, and the retailer has left it until the eleventh hour to approach them, the cost will almost certainly increase. Again spotting the early warning signs that a supplier is in trouble and engaging with alternative suppliers early is key. Legal exits from existing supply agreements also need to be carefully navigated.
Other structural remedies can work in warehousing contracts where step-in may be an option. This is never an easy option though in reality due to the lack of the necessary expertise within the retailer to manage the warehouse, mixed-use with other customers in the warehouse and the reliance on temporary staff who will not want to continue working for a business that may not pay them at the end of the week. However, if structured correctly, a valuable supply chain can be legally protected by use of third party contractors for operational functions at the point of failure.
Retailers can ensure that key supply contracts have clauses requiring early notice of financial distress, step-in provisions and business continuity plans. The retailer should have its own continuity plans to remove single points of failure in the supply chain. Requests for deals from distressed suppliers must be dealt with quickly to ensure that the retailer obtains the best position and contact should be made with the supplier's investors to get comfort that they will not accelerate any insolvency. Watching out for competitors who are struggling and making an approach to acquire the profitable elements before the business enters administration can be very effective, but raises complex legal issues which need navigating.
No business plans to fail, but it pays retailers to make plans around failure scenarios as acting quickly is critical in these very pressured situations can have a disproportionately positive effect upon the outcome.