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How Customers in the Automotive Supply Chain Can Prepare for Distressed Suppliers Resulting From COVID-19

Proactive Analysis and Protocols Can Reduce Costs and Better Ensure Continuity of Supply

March 6, 2020

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The extent of disruption caused by COVID-19 is unknowable at this time. However, it is likely that there will be suppliers unable to economically weather the storm. Having represented manufacturing customers and suppliers for decades, one thing is certain: even the most sophisticated entities make costly mistakes in addressing distressed suppliers without realizing they paid more as a customer than was necessary. “We only know what we know,” and preparing a customer to successfully address distressed supplier situations requires a different skill set than in representing or being a quality supplier.

Wrong moves at the very outset of troubled supplier matters can be the most costly. Immediate preparedness can reduce costs. As just one example, often a “Tier 1” manufacturer acts also as a “Tier 2” by selling product to its supplier, which the supplier then works on and sells back to the Tier 1 manufacturer. Failure to recognize that situation or have advisers that understand the resulting practical, financial and legal implications and how they relate to other customer positions can lead to losses that could have been avoided by early action.

The following are a few proactive steps to take now to better maintain continuity of supply and reduce costs:

1. Identify and categorize now which suppliers are likely to face financial distress the quickest.

Consider working from the bottom-up by first focusing on small but critical suppliers. Smaller supplier distress cases can cause great risk compared to the size of the company and can be more challenging and costly to rectify on a relative basis. Often, there is limited market investment resources and less tolerance by the supplier’s lenders than is needed by customers to work through continuity of supply.

2. Recognize and act upon the signs of trouble.

Lately, we have seen more and more companies shut their doors ostensibly “without warning” when, in hindsight, there were warning signs that were either not identified or acted upon.

For example, a failed sale process often leads to liquidation which can be extremely costly for a customer that might have to prop the supplier up until alternative arrangements are made, assuming the supplier’s lender will even work with the customers to give time to make alternative arrangements. Indeed, we have faced a number of lenders lately that simply refused to do anything other than immediately shut down and liquidate the company after a failed sale process, leaving the customers with no option but to take aggressive steps to avert shutdowns.

What can you do when you learn that a small company/good quality supplier is entering a sale process, other than say “keep us posted?” Sometimes, if customers are realistic in assessing the likelihood of a successful sale, disaster can be averted.

Other signs that may seem obvious but are often overlooked include identifying suppliers that changed lenders to utilize non-traditional financing or rely on capital from entities that invest in distressed companies.   

3. Put distressed supplier protocols in place now.

We can help you with action checklists and offer condensed training now that could help you prepare to identify and address troubled supplier situations with the goal of saving time and expense in the event these matters start hitting hard and fast.

The automotive supply chain is a small world and the motto of “what goes around comes around” has real meaning. Historic knowledge, industry expertise and relationships can make the difference in the cost of maintaining continuity of supply. Dykema’s knowledge makes it uniquely suited to help you wear your customer hat in working through this next phase of challenges.

If you have any questions about the information in this alert, please contact Sheryl Toby (248-203-0522 or stoby@dykema.com) or your Dykema relationship attorney.

As part of our service to you, we regularly compile short reports on new and interesting developments and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments are always welcome. © 2020 Dykema Gossett PLLC.