An off the cliff risk of 3PL
Risk of trading on Credit
Any trader who supplies product on credit and has been in business for a decent length of time will know the pain of a customer going bankrupt and the consequent inability to be paid for products delivered (and typically the loss of that stock). The bigger the customer, the bigger the pain. A very large customer going bankrupt can even put the ongoing viability of the trader at risk.
Terms of Trade and retention of title clauses
Traditionally traders have sought to cover this risk by means of a retention of title clause in their terms of trade. Upon bankruptcy of the customer, the trader could seek to enforce the clause and recover its goods (or so much of it as had not been on-sold during the normal course of the customer’s business) to reduce the pain incurred.
That position was complicated in Australia during 2009 by the introduction of the Personal Property Securities Act (PPSA). Unless the security interest created by the retention of title clause was registered under the PPSA then the retention of title clause in effect became unenforceable. Under the PPSA, the old adage of “possession is 9/10ths of the law” became the law of the Australian land. The trader needs to register its interest (and quickly after being created) under the PPSA so that its interest took priority relative to other creditors and so was in effect unenforceable.
Warehousing function and 3PL
Under a traditional business model, a trader would operate its own warehousing function and when its customers placed an order for products the trader’s warehouse would pick the stock and dispatch the order. For wholesale customers, orders would be aggregated (and often with minimum quantities stipulated). With a limited number of wholesale customers, this was an entirely manageable function. With many traders now also operating on-line retail stores with direct to consumer sales, the size of orders has decreased (to perhaps one sku) but the volume of orders has dramatically increased. Many traders recognise that warehousing/dispatch is not a core competency of their business and have sought to outsource this function to a 3PL provider (3rd party logistics). Good 3PL providers have the systems and resources to operate a very efficient service, often undertaking this function far better than the trader was doing itself. Appointing a 3PL provider leaves the trader better positioned to focus on the core aspects of their business.
Whilst it can make good commercial sense, there is one massive risk to entering into a 3PL contract. The 3PL provider is not just one customer who takes delivery of some stock on a promise to pay. The 3PL provider takes custody of ALL the trader’s stock, and not with a promise to pay but with a promise to provide services. This makes it even harder for the trader to have line of sight on any potential financial difficulties the 3PL provider may be having (unlike customers, who may over time become more and more delinquent when it pays for products). If the 3PL provider goes bankrupt, the trader will lose all its stock unless the trader has a security interest drafted into the services contract with the 3PL provider and promptly registers that security interest under the PPSA.
Is it worth ensuring a trader gets this right?
In the law of civil wrongs, in assessing if someone has been negligent and therefore liable to compensate another person who was harmed by that negligence, there is the negligence calculus involving 3 elements: (1) what is the probability that the harm may arise; (2) what is the gravity of the resulting injury; (3) how difficult or easy are adequate precautions? Using this as a guide to assess whether traders should bother with this:
(1) Risk of 3PL provider’s bankruptcy: Difficult to assess the risk of a 3PL provider going bankrupt, but perhaps let’s say small;
(2) The gravity of the resulting injury to the trader: potentially very significant. If a trader loses all their stock, then this will be at the least a significant set-back and a huge strain on cash-flow, but may have a domino effect, leading to the trader’s bankruptcy; and
(3) Precautions to guard against the harm: relatively simple. Some 3PL providers are setting up from overseas using a template warehouse service agreement that makes no reference to Australia’s (or New Zealand’s) PPSA regime. They don’t need to; it is not their risk. But it is relatively easy for an appropriate professional to review the 3PL contract, insert appropriate clauses and promptly register the trader’s interest in its own stock under the PPSA.