Probate and Will, Trust & Estate Disputes

Publish date

14 December 2023

Pursuing insolvent debtors: Preference payments and retention of title clauses

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:

  • A payment is made to one of their creditors, a surety or guarantor for any of their debts or other liabilities
  • They do anything (or allows anything to be done) which has the effect of putting the recipient into a better position than they would have been in, if that thing had not been done
  • They were influenced in deciding to give the preference by a desire to prefer the recipient
  • The preference was given during the six months before the onset of insolvency, or two years where the preference was given to a connected person such as a director of an insolvent company, or a spouse or relative of an individual
  • They were insolvent at the time of the payment, or became insolvent as a result of it.

Examples of potential preferences include the following:

  • Paying an unsecured creditor in priority to other creditors without a valid reason
  • Paying a secured creditor whose security is insufficient to pay that creditor in full
  • Granting security to a previously unsecured creditor
  • Returning goods to a supplier when title has passed to the debtor
  • Guaranteeing another person’s debt where that person is unlikely to be able to pay the debt.

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:

  • Retaining legal and beneficial title to the goods until full payment has been received
  • Having the right to enter the buyer’s premises to recover the goods
  • Requiring the buyer to store the goods separately from those belonging to the buyer or third parties
  • Obliging the buyer to mark the goods as belonging to you
  • Prohibiting the buyer from fixing the goods to property, without your written consent
  • Allowing you to check that goods are appropriately marked and stored
  • Specifying the trigger events enabling you to enforce the retention of title clause
  • Making sure your rights do not fall foul of statutory controls that could affect enforceability.

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:

  • A clause that tries to retain title to the proceeds of a customer’s onward sale of goods you have supplied them
  • A clause that purports to retain title to goods which are inextricably mixed with other goods during a manufacturing process
  • An “all monies clause” which will preserve title over goods for failure to pay any monies under the contract (or even any monies under other contracts between you and the buyer).

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

  •  Contact the appointed insolvency practitioner to notify them of your claim to the goods supplied
  • Show that your retention of title clause applies – send to the appointed insolvency practitioner a copy of the terms that you rely on, evidence they were accepted by the customer and a schedule of the goods supplied. Provide copies of any delivery notes for the goods if you have them
  • Try to arrange to visit the customer’s premises as soon as you can, to identify and collect the goods.

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?

  • Credit control procedures – when doing business with a new customer, do you carry out company searches, searches at the register of county court judgments? Do you obtain trade, credit or other references? There is no substitute for good credit control in the first place. Keep control over missed payments and take action quickly to minimise loss
  • Written contracts – make sure you have a written contract in place. If the transaction does not warrant a bespoke contract, at the very least you should make sure you have a set of standard terms and conditions that apply. Make sure that your terms of business are as strong as possible and set out clearly what the position is in the event of the insolvency of either party
  • Are your terms and conditions effective? Common pitfalls include trying to introduce your terms and conditions once a contract has already been formed, perhaps by simply printing them on the back of an invoice, at this stage it’s usually too late for them to apply. The simplest way of ensuring your terms apply is to send your customer a copy with an acknowledgement form for the customer to sign and return before you conclude the contract
  • The battle of the forms is another common pitfall. For example, if you send your terms of business to a customer with a quote, but the customer responds with a purchase order referring to their own terms and conditions, this effectively amounts to a counter-offer by the customer. If you simply accept the order without saying your own terms will apply, you will be deemed to have accepted the customer’s counter-offer to enter into a contract on their terms. The moral of the story is to make sure to get your terms in first and last

It is also important to make sure your invoices contain all of the information they need to such as:

  •  A unique identification number (this is required if you are VAT registered, by it is good practice to do so anyway)
  • Your full company name as it appears on the certificate of incorporation, our company address and contact information
  • The company name and address of customer you are invoicing
  • A clear description of what you are charging for, the date the goods or service were provided (supply date)
  • The date of the invoice
  • The amounts(s) being charged / VAT and a total.

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.

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