The Withdrawal of Trade Credit Insurance – A Death Spiral?

Trade Credit Insurance. What is it and Can its Withdrawal Lead to Insolvency? A Report from our Insolvency Practitioners

With so many insolvencies amongst high street retailers and restaurants so far this year, it is worth looking at the role that trade credit insurance can and does play in insolvency, when it is withdrawn. It isn’t often mentioned in the headlines, so Steve Illes, one of the partners at our central London insolvency practitioners’ office, looks at why it is so important and the vicious circle it can start when it is withdrawn – with specific reference to House of Fraser – and how insolvency practitioners can help.

What is Trade Credit Insurance?

When a supplier supplies a customer with goods and/or services, there is always a risk that they might not get paid if the customer becomes insolvent. There is a way to protect against this risk – trade credit insurance. Trade credit insurance is an insurance policy that ensures that a supplier is paid in the event of the insolvency of a customer, or potentially in the event of a protracted late payment/payment default by their customer.

How does it work?

The majority of policies are based on a whole turnover basis, whereby the insurer will base its premium rates on the company’s turnover and the sector it trades in. Premiums are payable either as one-off payment or via monthly or quarterly instalments.

Cover is based on the individual risk (Customer) whereby a credit limit is set. This then allows the supplier to trade insured up to this limit. Generally, the insurer will cover 90% of the credit limit and the supplier assigns their right to manage the collection of the insured invoice(s).

In the event of a claim, the supplier would assign their rights to the insurer so they could rank within the insolvency estate or where there is protracted default. The insurer can then pursue the debtor  to recover the outstanding debt.

Why Would Insurers Consider Withdrawing Cover?

Trade credit insurance can be withdrawn by insurers at any time, as was the case with House of Fraser, reported by several media outlets back in February, with this headline used by CITY A.M.

Trouble in store for House of Fraser as Credit Insurer Pulls Cover

In this case, 20 of the business’s 650 suppliers were affected by the credit insurer’s decision.  Standard terms and conditions of any trade credit policy require the supplier to report adverse information for any of their customers to the insurers when they become aware of such an event and/or the account becomes overdue for payment. It can only be assumed that 1 or more suppliers reported to their insurer and this may have contributed to the withdrawal of cover for House of Fraser.

The Effect of Withdrawing Trade Credit Insurance

Having had a dismal Christmas 2017 sales period, during which it had decided to cut the number of promotions in-store, House of Fraser also saw online sales slump by 7.5% over the festive period. It appears that this performance along with any adverse reports from suppliers may have led to the decision by the trade credit insurer to withdraw cover. For the suppliers, it means that continuing to trade would leave their most recent invoices uninsured, and funds received being applied to repay the oldest/insured debts first. It is this risk that leads suppliers to either seek a new insurer, demand upfront payments for their goods, or simply stop supplying.

The Start of a Vicious Circle

Such circumstances can easily lead to a vicious cycle for the customer/business that is in trouble. If its suppliers are not prepared to supply without insurance in case of insolvency and no-payment, then the knock-on for the customer is a potential decrease in turnover because of fewer items being stocked.

Alternatively, if the suppliers want to be paid cash on delivery, then cash flow becomes an issue for the customer, who can’t win, and the vicious circle begins, with insolvency practitioners usually appointed. In House of Fraser’s case, the result was a Company Voluntary Arrangement, with a proposal to close many stores whilst rents were renegotiated with landlords – a proposal that is facing on-going difficulties.

Are There Any Ways Out for the Customer Under Pressure?

When trade credit insurance is withdrawn, it can be very difficult for the customer business to escape its ramifications. Swift and decisive action is needed, often with the help and advice of insolvency practitioners and other professional advisers.

For the bigger corporates, with access to professional help, it may be easier to present to their insurers, bankers, shareholders and funders detailed information about the on-going viability of a business, and its turnaround plans, which will give suppliers/insurers some comfort. In addition, there is the possibility that funds can be brought into the troubled business via a refinancing package (with help and advice from the insolvency practitioner) or from a profitable parent company or subsidiary.

However, as House of Fraser, Maplin and New Look, amongst others have found, once credit insurers start withdrawing trade credit insurance, the likelihood is that some form of formal insolvency procedure is required, and that’s when insolvency practitioners are needed. Indeed, the withdrawal of credit insurance has been called a ‘death spiral’ (The Times July 15th, 2018). So far this year, Company Voluntary Arrangements have been used by several retail and restaurant chains to restructure and turn themselves around. Time will tell how successful they are.

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