Tight Times, Tighter Contracts: Practical considerations for businesses during tighter economic conditions

In tightened economic conditions, businesses feel the pressures of rising costs, slower payments and stretched supply chains.

These pressures often lead to issues between contracting parties including unpaid invoices and underperformance of services and in some cases, misconduct.  Businesses that prepare early are far better placed to protect their position.

Know what your contracts say

Many disputes arise because a party is not completely aware of all of its rights and obligations under its own contract until something goes wrong. Now is a good time to review your key customer and supplier agreements, and to make sure the people managing those relationships day to day understand them.

If your business provides a service, do you know exactly what you must deliver, by when, and to what standard? Scope creep and informal promises made by email or in meetings can expose you to claims for defective or incomplete performance and disputes that a contract has been varied.

If your business pays for goods or services, do you know your rights if the other party fails to perform? Your remedies may include a claim for loss and damage, calling on security (such as a bank guarantee), or the right to terminate.  Your contract will likely set out a process that must be strictly followed, such as issuing a notice and allowing the other party time to remedy the breach, before you can seek a remedy.

Rising costs prompt counterparties to look for ways to reprice or exit. Force majeure clauses are often narrower than parties expect, and a general increase in costs rarely qualifies.  If a business terminates without a proper basis, you may become the party in breach and face a claim yourself.

It is important to get early advice if your business thinks it either has a claim, or may be liable to one, before taking steps which might compromise the business’ position.

Considerations for company directors

Directors carry significant personal responsibility as they have a duty to act with care and diligence, in good faith in the best interests of the company and for a proper purpose. These duties must be kept in mind when a company is under financial strain.

Directors should monitor cash flow closely and understand whether the company can pay its debts as and when they fall due. Regular, accurate cash flow forecasts are essential, and directors should be mindful of the assumptions behind them.

Under the Corporations Act 2001 (Cth), a director may be personally liable if the company incurs a debt while it is insolvent and there are reasonable grounds to suspect insolvency. Warning signs include overdue tax liabilities, creditors placed on extended terms, dishonoured payments and reliance on informal payment arrangements.

Companies must keep financial records that correctly record and explain their transactions. Poor record keeping places the company and the directors in a weaker position in the face of a dispute.  Board minutes that show the information directors considered, the questions they asked and the advice they obtained can be valuable evidence if decisions are later scrutinised.

Directors should seek advice early to avoid these risks.

Get on the front foot with debt recovery

Unpaid invoices tend to become harder to recover the longer they remain outstanding. Act promptly and consistently and keep clear records of what is owed and when it fell due.

There are many ways that a business can seek to recover debt including by issuing a letter or demand or making a statutory demand where appropriate. It is critical that these are carefully and accurately drafted, particularly if they are later relied upon in litigation.

Before a business start any recovery action, they should seek legal advice about their prospects of success and weigh the cost of enforcement against the realistic prospect of recovery. A judgment against a company with no assets or that is uninsured has limited value.

Consider early and alternative dispute resolution

Most commercial contracts require parties to follow specific dispute resolution procedure before commencing any litigation. Check these steps and follow them carefully, as a party may be expressly barred from commencing any proceedings until it has complied with the agreed dispute resolution procedure within the contract.

A negotiated outcome often preserves more value than a commencing substantive litigation. Alternative dispute resolution such as mediation is generally confidential, quicker and cheaper than litigation, and it can help preserve commercial relationships.

Watch for fraud and misconduct

Financial pressure creates both the motive and the opportunity for fraud. Common risks include invoice manipulation, false expense claims, fictitious suppliers and payment redirection scams, where criminals impersonate suppliers and ask you to change bank details.

It is essential that every business verifies any change to payment details before making a payment to protect against this kind of fraud. Businesses should have in place policies in place that outline what steps must be taken to verify bank details and approval procedures for significant payments.

Preserve documents and protect privilege

If a dispute appears likely, take steps to preserve relevant documents, emails, and other electronic records.

Where you conduct an internal review, involve your lawyers early so that you can structure the review to protect legal professional privilege where possible. Take care when creating new documents, such as internal reports and emails, as they may later be required to be discovered in litigation.

Expect regulator attention

Regulators typically increase their focus in tighter economic conditions. If a regulator contacts your business, respond promptly, understand the scope of any notice and seek advice before providing any information to avoid unintended consequences.

How we can help

Lavan’s Dispute Resolution and Investigations team regularly advises businesses and directors on contractual disputes, debt recovery, directors’ duties, internal investigations and regulatory matters. Early advice often makes the difference between a manageable issue and a costly dispute.  If you would like to discuss how these issues affect your business, the Lavan team are here to assist.

The information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information.

Disclaimer

The information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information. The Lavan team are here to assist.