
Insight
This is the second article in our two part series about the options for recovering a debt from a debtor in financial trouble. In this edition we look at the risk of a debt repayment being declared invalid as a ‘preference payment’, the issue of retention of title clauses, creditor considerations upon the insolvency of a debtor, and what else you can do to strengthen your position as a creditor.
The risk of payments being clawed back as a preference
If a debtor is in financial trouble and pays you, but not all of its other creditors, before going insolvent, there is a risk that the payment to you will be a preference and the debtor’s liquidator or trustee in bankruptcy could bring a claim against you to recover the payment.
An insolvent company or individual gives a preference if:
Examples of potential preferences include the following:
The element of desire leads to a subjective test, not an objective one. It is necessary to establish something stronger than an intention to undertake the transaction that prefers the recipient in question; the debtor must have positively wished to put the recipient in a better position.
A payment made in response to a genuine commercial imperative, such as the threat of a civil claim, service of a statutory demand, or the termination of a contract, is not intended to prefer the recipient.
When dealing with a company or an individual in financial difficulties, therefore, you should create a paper trail to show that payments to you from a trading partner are in response to genuine commercial pressure to pay a debt that is outstanding, and not simply as a favour to a friend. You should also consider what evidence you have, or may be able to obtain, to demonstrate the ability of the debtor to pay its debts at the time of and immediately after the transaction. Evidence to that end may be sufficient to demonstrate that the transaction did not take place at a relevant time.
Retention of title provisions
The aim of a retention of title (ROT) clause is to reserve rights of title (ownership) in the goods to the seller until the price is paid in full by the buyer, even though the goods have been delivered to the buyer.
Under a simple ROT clause, the seller retains title to the goods until the buyer pays the price of the goods. However, your rights can be further expanded. First and foremost, though, you need to ensure that the terms and conditions including your ROT clause are incorporated into the contract with the debtor.
Some important points to consider for your ROT clause include:
When a retention of title clause is void
A retention of title clause that is drafted too widely could be void, however, on the basis that it constitutes a charge over the buyer’s assets. A company must register all charges that it creates at Companies House. If the company does not do this, the charge cannot be enforced.
ROT clauses at risk of being construed as charges include:
In practice, registering a charge is not a realistic option, and to reduce the risk that it is held to be unenforceable for lack of registration, it would be preferable to keep these type of clauses separate from any simple ROT clause. Doing so might protect an ROT clause if a wider clause is deemed invalid.
As a result of the coronavirus pandemic statutory controls under the Insolvency Act 1986 were expanded meaning that a supplier could be prevented from exercising its rights of repossession under a retention of title clause where this is triggered by a customer’s insolvency, although this has yet to be tested by the Courts. In the meantime, care should be taken to ensure that your rights of repossession under such a ROT are not drafted to be triggered by an insolvency procedure which might be rendered ineffective.
How to enforce a retention of title clause when a customer enters a formal insolvency process
Remember that the onus is on you to prove your claim to the insolvency practitioner’s satisfaction, which may well require significant time and effort on your part. Your position will have much more force if you deal with all of these points from the outset and quickly, and have a credible case for being able to enforce your rights through the Courts if the situation cannot be agreed with the insolvency practitioner on a consensual basis.
Other creditor considerations upon the insolvency of a customer
When a formal insolvency event affects a debtor, the options open to the creditors of that debtor will largely depend upon the type of insolvency event in question.
An initial requirement is to identify any change in key contacts. In a liquidation or bankruptcy, a creditor will be dealing with the office-holder in any agreement going forward. In a CVA the directors will remain in control and will be the liaison point for the creditor.
Lodging a creditor claim
With the majority of insolvency processes, an unsecured creditor will be able to claim for the amount they are owed, and in order to lodge a claim, a creditor must first prove its debt. Where a creditor sits in the order of priority of payment will often determine the amount of debt eventually paid to them. Unsecured creditors often end up with little or no financial return.
Further, creditors will not be paid interest on the amount they are owed unless all creditors are paid in full and they have established a prior entitlement to interest.
What else can you do to strengthen your position?
It is also important to make sure your invoices contain all of the information they need to such as:
If your invoice does not contain this information then you may not be able to enforce it – although you could reissue a compliant invoice, this would obviously delay recovery.
Finally, when a debt becomes overdue for payment, act quickly, seek advice and get back to business.