Uncertain economic times can spell big trouble for business.
In the past few years, some leading household names have ended up in an insolvency process leaving creditors short changed. Earlier this year, Wellgrain Limited, a large grain merchant in the East of England, entered administration owing in excess of £15,000,000. Creditors will do well to recover more than a few pence in the pound.
Protecting yourself against the insolvency of a supplier, or one of your own debtors, could be key to safeguarding your own business.
Insolvency procedures are primarily designed to protect the assets of the insolvent business for the benefit of all creditors.
The three most common insolvency procedures for a company are:
- A Company Voluntary Arrangement (CVA) – an agreement reached with creditors where they accept a percentage of their debt rather than payment in full.
- Administration – an administrator is appointed whose initial focus is to try and rescue the business if possible.
- Liquidation – this is a terminal process where a liquidator collects in the assets, realises them and distributes to creditors in a strict order of priority.
Although as a creditor you should get notice of a CVA proposal, you may not get any notice of an administration or liquidation until after it has happened.
If a company enters administration, an automatic moratorium comes into effect so no action can be taken against the company without the permission of the administrator or a court. That includes exercising a right of forfeiture as a landlord, or exercising any rights of security as a secured creditor.
Effect on contracts
Insolvency does not discharge a party from its obligations to perform under a contract, but a company in administration or liquidation may just not comply leaving you with a damages claim.
If a member of your supply chain becomes insolvent, their failure to deliver could have far reaching consequences for you if you have no one else available to step in.
An act of insolvency may be a termination event in a contract, but not always. If it is, think about whether you want to exercise that right or not. At a relatively early stage, administrators will want to identify key contracts and discuss the potential for future supplies. If you are a key supplier the administrators may be prepared to pay something to ensure continuity to make sure that right is not exercised. If so, that could lead to you recovering more than if you terminate and try and find someone else capable of stepping in.
As a supplier rather than a lender, it is unlikely you can insist on formal security for payment of your debt. However, there are still some things you can do.
If you are supplying goods, an effective retention of title (ROT) clause may give you a right to recover what you have supplied if payment is outstanding. A well drafted all monies ROT can capture all products supplied even if only some of the debt remains outstanding.
ROT clauses are a useful tool, but poorly drafted ones will be ineffective. Most claims that fail tend to do so because the terms are not properly incorporated or because the goods cannot be identified. Administrators review ROT claims very early on so an early notification of these claims before the administrators have the chance to dispose of the items, will maximise the prospect of the goods being returned.
This is a very good example of where a signed set of terms and conditions can pay dividends. Pointing to a retention of title term on an invoice will almost never be good enough.
A lien is a right to retain goods until services provided have been paid for. In some industries, such as the storage and haulage industries, liens are commonplace. Although some liens arise as a matter of law, they often appear in contracts as well - many industry standard terms will have them in, so check whether you have one if you trade on these.
The existence of a lien in your terms and conditions will go some way to providing you with additional protection especially if the terms also give you the right to sell the goods if they are not collected and paid for.
If you have a lien, you should consider exercising it sooner rather than later if a debt is overdue as it could be your best means of being paid. There are complexities around whether a lien can still be exercised in an administration, and whether they survive an onward sale by the owner while in your hands. Once you release the asset, the lien is also extinguished so if you are exercising one, make sure your staff are aware you are doing that.
Contracts for storage can lead to some very tricky issues, particularly with product which mixes or behaves in an unusual way.
If the insolvent company is storing product in bulk, such as oil or wheat, the challenge comes with proving your entitlement to those stored goods where they have been mixed with others. That is all well and good if there is a sufficient amount to satisfy all claims, but when there is not, the administrator or liquidator will have to try and deal with all competing claims and this can become very complicated.
If you are storing product for the insolvent company you could face multiple requests for delivery up, especially from those claiming they have purchased those goods. In those situations, one solution may be to retain everything until the competing parties resolve the matters between themselves as that avoids potentially being exposed to claims you have delivered to the wrong party. However, that might not be possible. For instance if you are storing product traded on a futures market, you may have an obligation to deliver to the party holding the relevant warrant (whether or not they were entitled to have that in the first place).
There is often no easy answer to these problems. The more you can do to make sure your own record keeping is as sound as it can be, the better position you will be in.
It is never possible to be immune from the effects of an insolvency, but it is possible to mitigate the risks. Robust contract terms and good record keeping are two ways to protect yourself but they are no substitute for effective and regular monitoring of those lingering overdue accounts. Making sure the outstanding balance does not get too large is by far the best way to make sure you are not sitting alongside one of the creditors left at the back of the queue.