Credit insurance – the lubricant of the economy or a brake on growth?

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    As the economic crisis takes hold and the credit rating of businesses falls, insurers are increasingly willing to withdraw existing credit insurance cover of companies at short notice.  This is jeopardising longstanding trading relationships between suppliers and customers, say lawyers from Hammonds LLP.

    The importance of credit insurance to trading relationships cannot be overstated.  According to the Association of British Insurers, in 2007 UK businesses paid a total of £334 million to buy credit insurance and those policies covered the risk of £282 billion worth of sales. 

    Lucci Dammone, partner and head of the Commercial & Dispute Resolution department at Hammonds, said: “Credit insurance facilitates business and provides the lubrication that enables the economy to function effectively.  With insurance in place a supplier can deliver goods and services to customers on extended credit terms in confidence, knowing that if the customer fails to pay then the insurer will.  The customer benefits by being given time to pay the supplier’s invoice, which allows it to manage its cash flow more effectively.

    “However, insurers are now withdrawing existing credit insurance cover at short notice because the credit rating of businesses is falling.  The withdrawal of credit insurance can effectively freeze a trading relationship.  A supplier is unlikely to continue to supply to a customer who may be perceived as a bad credit risk because insurers are no longer prepared to pay the insurance that guarantees payment.  This issue has been a significant factor in the recent demise of some high profile businesses, most notably Woolworths.  It is well known that one of the final nails in the coffin of this iconic retailer was when insurers would no longer provide credit insurance to cover Woolworths’ suppliers.”

    The government is exploring the introduction of a scheme to encourage the big three credit insurers, Atradius, Euler Hermes and Coface, to underwrite credit insurance.  The scheme, which could be available to medium risk businesses whose credit insurance has been reduced but not entirely withdrawn, may see the government underwriting up to 50% of credit insurance payouts with the insurers funding the remaining 50%. 

    Dammone says: “At this point it is difficult to tell how effective this limited scheme could be in reviving the market for credit insurance, but in the meantime suppliers and customers should take steps to protect their business.”

    Some suppliers are now seeking to vary the payment terms in the supply contract by insisting that for future orders the customer pays for the goods on delivery or even in advance.  Others are looking to terminate the supply contract altogether.  “Either course of action could lead to a breach of contract and suppliers should obtain legal advice before they act,” warns Dammone.

    “Suppliers should check their contracts now.  If they can’t amend terms without breaching contracts, there are other legal options to explore such as force majeure or if the contract is ‘frustrated,’ in other words where something happens after a supplier has entered into a contract that makes the contract impossible or significantly more onerous.  The extent to which a supplier can rely on these arguments will largely depend on the terms of the supply agreement and the relationship with the customer, but seeking legal advice now may avoid contractual problems later.”

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    For further information contact:

    Nicola Woodmass, Head of Communications, Hammonds LLP, on 0121 222 3690 or email: nicola.woodmass@hammonds.com

     

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    Angelo Kakolyris +1 212 407 0148