Despite persistent supply chain challenges impacting equipment availability, the equipment industry has generally performed well in the last few years, leading to positive results for most in the industry. But with high interest rates impacting demand and, in certain situations, excess inventory availability, you need to be aware of some of the unexpected risks that are more likely to pop up in your relationships with suppliers during a potential downturn.

One category of risk that is often overlooked relates to the inventory you obtain from suppliers experiencing financial difficulties. These situations typically arise with smaller or under-capitalized suppliers that may include short line suppliers, producers of specialty equipment, or international suppliers seeking to establish a presence in a new market. While many of these suppliers are very well run and have been great partners with dealers, we see more risk in these relationships for three primary reasons: 

1. a limited product line can make a supplier more susceptible in a downturn
2. equipment is often sold to dealers using a third party floor plan program, creating an independent financial obligation to another party
3. it is more difficult for you to determine the financial strength (or weakness) of a smaller, privately-owned supplier.

The following is a list of some of inventory-related risks that we see for dealers:

• Prepaying for Inventory. Some manufacturers require dealers to pay cash for inventory before it is produced. Dealers often elect to do this in exchange for discounts in the price. However, you should proceed with caution when taking this approach because your prepayment is the equivalent of an unsecured loan. This means that if a manufacturer goes under before you receive your order, there is very little chance of being repaid.
• Storing Inventory on Your Lot. Suppliers will ask dealers to temporarily put inventory on the dealer’s lot. This often occurs when another dealer is selling or closing out. If you accept the inventory with the understanding that you are not taking ownership, you need to monitor your floor plan statement very carefully to make sure that the inventory does not appear. If it does appear on your statement, your floor plan lender will often have a legal claim against you for this amount, regardless of the deal that you think you have with the supplier. This situation can occur because agreements in supplier-sponsored floor plans often say that inventory can be placed on your statement through a communication from the supplier. To help limit your risk in these situations, be sure to document in writing with the supplier that you are not taking ownership of the inventory and that the supplier is not authorized to put it on your floor plan. You should also immediately send a written notice to your floor plan provider informing it of the improper charge.
• Transfers from Other Dealers. When dealers sell or close a location, suppliers frequently try to move inventory to another dealer to avoid taking it back on their books. If you are accepting a transfer in this situation, you should make sure that there is written documentation showing the transfer of inventory from the supplier to you. This is important because the buy-back laws generally require suppliers to repurchase only inventory that was purchased from the supplier. As a result, if your transfer documentation indicates that you purchased the inventory from the other dealer, a supplier may try to use this to get out of complying with a buy-back obligation if you later decide to terminate the dealer agreement.
• Buy-Back Compliance. If you suspect a supplier is in financial trouble, it may make sense to terminate the dealer agreement so that you can use your dealer law to require the supplier to repurchase your inventory. However, a supplier in financial trouble may refuse to comply with the buy-back obligations under the dealer laws and force dealers to consider how to minimize losses. An obvious option may be to pursue a lawsuit against the supplier. Unfortunately, while a dealer’s claim may be strong, filing a lawsuit and obtaining a judgment requires a financial investment and enforcement of a judgment against a supplier that does not have sufficient assets to pay creditors with priority over your lien may lead to disappointing results. Dealers in this situation should also strongly consider retaining possession of their inventory until they have assurances that they will be paid. There are a number of reasons for this:
• If inventory is returned to a defunct supplier, other creditors may seek to claim title to your inventory.
• There is risk that the inventory will be damaged or not secured, leading to further decreases in value, especially since a financially challenged supplier may also not have appropriate insurance in place.
• If a third-party floor plan lender is involved, a dealer’s obligations to that lender are likely enforceable so retaining collateral to help offset those obligations is also critical.

Finally, while a dealer’s initial inclination may be to try to liquidate inventory immediately, another option may be to retain the inventory and see if a third party might acquire the supplier and create a more stable market for the equipment that allows it to be sold at a better price.

If you are faced with a situation involving a supplier that is defunct or on shaky financial grounds, there are no easy answers and your action plan will likely not involve a lot of great options. Because of these risks, dealers are advised to tread carefully with smaller suppliers and the best way to minimize risk will be to minimize the inventory exposure to these suppliers in proportion to your main line suppliers.

This article is intended to provide general recommendations and is not intended to be legal advice. You should always consult your attorney for advice unique to you and your business.

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