Everyone is all too familiar with stories of the closure of an important factory having a knock-on effect on suppliers, with job losses at the main company magnified many times along the supply chain.
This month Land Rover found itself in a bizarre reversal of the normal roles, faced with disruption of production and lay-offs because of the failure of a supplier. The sole supplier of chassis for Land Rover’s Discovery model, UPF-Thompson, had gone into receivership, and the receiver was demanding large sums of money to secure the future of the company. UPF, which has supplied Land Rover since the 1950s, threatened to cease chassis production unless the car maker paid it £35-£45m, roughly three times the annual value of its contract.
With only two days’ stock of chassis, Discovery production would have to be suspended. Finding a new supplier would take months. Some 1,400 workers would be laid off at Land Rover, and another 10,000 jobs with other suppliers could be under threat. UPF’s insolvency had nothing to do with any action of Land Rover, but was caused by an overseas business deal.
Receiver KPMG claimed it had a legal obligation to behave in this way, which it described as ‘treating Land Rover’s reliance on UPF as a valuable asset’. It was backed by a court judgment made against Ford two years ago. In that case, when Transtec, the company owned by former minister Geoffrey Robinson failed, receiver Arthur Andersen asked Ford, one of its key customers, to agree to a new contract and 60 per cent price increase.
The case went to court where Mr Justice Jacobs found in favour of the receiver, saying: ‘It is the receiver’s job to get in as much money as he can.’ The receiver was entitled to exploit a customer’s vulnerability since its prime responsibility was to raise money to pay creditors. The upshot was that any firm depending on a sole supplier could overnight find itself in the same position as Land Rover.
In the present case KPMG admits it is simply seeking to make the most out of UPF’s status as a sole supplier. A spokesman said: ‘The figure is an independently assessed valuation of Land Rover’s reliance on UPF. It is not just a notional figure plucked out of the air.’
After its Transtec experience, Ford, as Land Rover’s parent company, must have had misgivings about going to court over UPF, but had little alternative. It must have felt huge relief when, on 11 January, Mr Justice Norris rejected the Transtec precedent and awarded Land Rover an interim injunction ruling that, while it remained in business, UPF must continue to supply chassis on the terms agreed.
On the face of it this was a surprise, because the similarities between this case and the Transtec one are striking. Charles Escott, a corporate recovery partner at accountant RSM Robson Rhodes, says that receivers and administrators are sometimes justified in seeking price increases – of, say, 10 per cent – to cover overheads where continuing with a contract would otherwise incur additional losses. But the Transtec judgment went much further than this, he says. ‘The Transtec ruling crystallised the position where it would appear to be almost legitimate to make a super-profit using commercial duress.’
Nicola Mumford, a partner in the dispute resolution group at solicitor Wragge & Co which is acting for Land Rover, says there is a crucial difference, however. ‘In the Transtec case Ford applied to the court for the appointment of a provisional liquidator, on the basis that the receiver was not doing his job properly and was blackmailing them. Land Rover wasn’t seeking to overturn the receiver, but simply seeking an order to UPF to continue to supply.’
In the injunction hearing Land Rover invoked competition and contract law. It argued that, as sole supplier, UPF was abusing a dominant market position. Contractually Land Rover was able to show that UPF’s contract was on the basis of Ford’s standard terms and conditions. It was a 12-month rolling contract in which prices were agreed a year in advance, with quantities being estimated on a shorter timescale to suit demand. The judge said that the parties’ relationship was more like a joint venture than a conventional supplier/customer relationship.
This is an important point: Mumford says that by negotiating as long-term a contract with suppliers as possible customers can help to protect themselves from cases of this sort. If there is no contract, or no evidence of involvement of the supplier in production planning discussions, their case will be weakened.
‘The judge also said the correspondence made clear that Land Rover had been doing everything it could to help UPF stay in business,’ says Mumford. It had been up to date with paying its bills and agreed to pay cash on delivery for chassis supplied during the receivership. It made a goodwill payment of £1m. A further offer of £4m on account was not taken up.
In addition, the judge considered the ‘balance of convenience’ – which party would be most hurt if the decision went against them. The time Land Rover would take to re-source the chassis, the fact that Discovery production would stop in two days and the number of jobs at stake put the decision clearly in favour of the car firm.
This, though, is only the start. The interim injunction is not a decision on the issue, simply an acknowledgment that there is an arguable case. The 11 January hearing that led to the interim injunction was at short notice, and, though KPMG was represented, it did not have time to assemble all the legal arguments. At a further two-day hearing scheduled for this week, KPMG will try to get the injunction overturned, again citing Transtec and its independent valuation of Land Rover’s reliance. The car maker will seek to get the injunction extended until the case comes to a full trial, which will be some months at least.
If Land Rover’s injunction is upheld – even if a negotiated settlement is then reached before a full trial – the rejection of the Transtec judgment will allow customers in sole supplier contracts everywhere to breathe a little more easily.
Company insolvency: a beginner’s guide
‘The world of finance is a mysterious world in which, incredible as the fact may appear, evaporation precedes liquidation.’ Joseph Conrad, Victory.
The end of the line for a company. Liquidation terminates all the contracts it is involved in, including contracts of employment. It can be initiated by the courts – for example, a creditor may sue and seek the appointment of a liquidator whose job is to sort out the company’s affairs and sell its assets. Or it can be voluntary, where shareholders or directors themselves decide the company is insolvent and cannot continue.
Again, a court-driven process. Administration is effectively a moratorium, giving the company a breathing space to sort out its affairs. Usually the company itself will apply to the court to appoint an administrator on the grounds that it is facing insolvency.
The administrator is answerable to the court and has wide-ranging powers – effectively becoming chief executive – to deal with assets for the benefit of the company and its creditors. The administrator can continue with or end contracts, or sell parts of the business, but not distribute any of the funds raised. He or she has to present a plan for creditors’ approval within three months.
There are three possible outcomes. Occasionally the company returns to solvency and continues. It is more likely that it will be liquidated, after parts of the business capable of continuing profitably have been sold. Or a ‘company voluntary agreement’ may be reached. For example, the company may become solvent if creditors agree to accept 50p for each £1 of debt. In this case control of the company is returned to the original directors with the administrator keeping a watching brief.
This is more correctly ‘administrative receivership’, when applied to a whole company.
Unlike an administrator, a receiver is appointed by a single creditor. This is commonly a bank that has secured a loan through a charge on a specific asset; the loan agreement will state that the bank has the power to appoint a receiver in the event of a default.
Receivers have similar powers to administrators but their task is to realise the company’s assets for the lender. They have a secondary obligation, however, to other interested parties such as employees, other creditors and shareholders. Again the receiver cannot distribute any funds raised, except to the lender who appointed him from funds raised by selling the specific asset on which the loan was secured. A liquidator has to be appointed to distribute any surplus funds.