Managing Insolvency Risks within Council Procurement

By Joshua Brown, General Counsel & Compliance Manager

Setting the Scene

In the evolving economic landscape, Queensland councils are increasingly challenged in managing their procurement processes due to a rise in business insolvencies across Australia. The stability of suppliers is crucial for councils, as it directly impacts their ability to deliver essential services and complete projects on time. 

Over the past few years, the number of businesses entering insolvency has surged, with 9,996 companies facing external administration as of mid-2024—the highest level in over a decade. This troubling trend is driven by economic volatility, rising operational costs, and lingering global disruptions. For councils, understanding and mitigating insolvency risks within procurement is more important than ever to ensure operational continuity and financial stability. 

This article delves into the implications of rising insolvencies for councils and highlights key strategies for effective risk management in procurement.

What is Insolvency?

In brief, a company is insolvent when it is unable to pay its debts when they are and is a symptom of a company’s financial distress (due to internal or external factors). Common types of insolvency include (but are not limited to):

• Liquidation: The process of winding up a company where it is unable to meet its financial obligations. 

• Receivership: Process generally initiated by a secured creditor to sell a company’s assets for the purposes of paying off its debts.

• Voluntary Administration: Where a business (or its shareholders) voluntarily assign control of the business to an administrator for the purpose of avoiding liquidation. 

Insolvencies on the rise

The latest data reveals a concerning trend: a sharp increase in the number of businesses suffering from insolvency. As of mid-2024, 9,996 companies have succumbed to insolvency, reflecting the highest level of corporate distress seen in over a decade. This increase can be attributed to various factors, including economic volatility, rising operational costs, and the lingering effects of global disruptions.

The table below details the types of insolvency from July 1, 2023, to June 17, 2024:

Source: Insolvency statistics | ASIC

Managing Insolvency Risks Within Procurement:

As part of Local Buy’s pre-qualification process, suppliers are required to declare that they are financially viable against robust criteria, however supplier business circumstances can change rapidly.   It is therefore advisable that councils ensure that insolvency risks are mitigated before they engage suppliers using council specific mitigation principles. These mitigation principles should be well defined and engrained within council’s procurement policy. At a minimum, some measures that should be adopted include: 

Due diligence on suppliers

This is key. Conducting due diligence on a prospective supplier is critical to help identify if there are any tangible financial risks prior to entering into any kind of contractual relationship with a supplier. Due diligence should seek to confirm that a prospective supplier, at a minimum:

• Is currently solvent; and
• Trades profitably; and
• Has sufficient cash flow to cover its operating expenses; and
• Pays its debts on time and in full; and
• Is not subject to any current or impending legal action.

There are levels to how far due diligence can extend to, and ultimately depend on the size, value and importance of a project. 

NB: Local Buy has numerous pre-qualified suppliers that can assist councils in undertaking financial checks pursuant to our LB310 Financial Management Services Arrangement. 

Ongoing supplier monitoring 

The ongoing monitoring of council’s suppliers should not be overlooked. This enables councils to stay informed about any changes in a supplier’s circumstances that might increase the risk of insolvency. This proactive approach to managing risks during the term of a contract allows councils to mitigate potential issues more effectively, rather than discovering and attempting to manage these issues when it’s too late.

Ensuring contractual protections are in place

There are several contractual mechanisms that council may put into place at both the tender and contract levels to mitigate supplier insolvency risk.

• At the tender / request for quote stage, ensure that financial viability checks form part of the tender process (including the supplier’s subcontractors, where appropriate). 
• Ensure that there is a contractual mechanism to conduct reviews on supplier financial viability on an ad hoc basis (e.g. access to the supplier’s financial statements and other information reasonably required). 
• Structuring payment obligations around the completion of milestones (as opposed to time spent working on the project).
• Where appropriate, ensure that there are ‘step-in’ rights for council to take over the works (including subcontracts, where appropriate).
• Ensuring there are adequate set-off rights within the contract to minimise debts/monies owed or otherwise due and payable back to council. 
• Where applicable, carefully consider when title passes for goods (especially unfixed materials). The sooner the better. 
• Consider whether any security is warranted (e.g. surety bonds, parent/directors/company guarantees, retention of monies etc.).

Having robust contracts in place can make all the difference in managing supplier insolvency. However, as explored below, it is critical that councils monitor the financial viability of suppliers during the contract term to ensure that council’s right to enforce any contractual recourse is not prohibited. 

Ipso Facto Considerations 

As previously outlined, the most effective strategy for councils to manage insolvency risks is to proactively verify a supplier’s finances to highlight risks of insolvency. However, addressing insolvency where a contract is already in place can be more complex. 

Contracts typically include clauses that allow councils to take action if a supplier faces insolvency, but the ipso facto regime introduced in July 2018 complicates this. These reforms may prevent councils from enforcing actions against a supplier undergoing insolvency, particularly if the supplier has entered administration or receivership, or if a scheme of arrangement has been proposed. The same restrictions can apply when trying to act based on a supplier's financial instability due to insolvency. 

Balancing support for suppliers in financial distress while protecting council interests is delicate. It is advisable to consult with the supplier to explore possible solutions. If the council decides to exercise contractual rights related to the insolvency event itself, seeking professional legal advice is prudent.

Conclusion

In light of the increasing number of business insolvencies in Australia, it is imperative for Queensland councils to adopt proactive measures in their procurement processes to safeguard against supplier instability. The rise in insolvencies underscores the importance of thorough due diligence, ongoing supplier monitoring, and robust contractual protections to mitigate financial and reputational risks. 

By embedding these practices into procurement policies, councils can better navigate the complexities of supplier insolvency and ensure the continued delivery of essential services and timely completion of projects. Furthermore, understanding and addressing the implications of the ipso facto regime is crucial in maintaining the council's ability to manage contracts effectively in the event of supplier insolvency. 

Through diligent risk management, councils can uphold their operational integrity and public trust in these challenging economic times.

If you're interested in learning more about how your organisation can leverage Local Buy contracts to streamline council procurement, please don't hesitate to contact Joshua Brown at: E jbrown@localbuy.net.au or call our office on P 1800 524 357.