Protecting Legal Rights Subsisting Prior to Insolvency

Rescue procedures involve going beyond the normal managerial responses to corporate troubles. They may operate through informal mechanisms as well as formal legal processes. It is useful, therefore, to see rescue as ‘a major intervention necessary to avert eventual failure of the company’. [1]

Central to the notion of rescue is accordingly, the idea that drastic remedial action is taken at a time of corporate crisis. The company, at such a point, may be in a state of distress or it may have entered a formal insolvency procedure. [2] Current UK insolvency regime is a shift from reactive to anticipatory philosophy. This evident philosophical shift towards a revision of insolvency role that participants in corporate and insolvency processes are becoming more encouraged and declined to see corporate disasters as matters to be anticipated and prevented rather than to be responded to after the event. [3] The law in combination with corporate and creditor practice, is moving from a focus on ex post responses to corporate crises to on that increasingly involves the ways that corporate actors manage the risks of insolvency ex ante. [4]

The enterprise Act 2002 encouraged those involved with potentially troubled companies to think about insolvency risks in advance of the final crisis _ to manage such risks ex ante rather than ex post. [5]

The main features of administration

The Enterprise Act 2002 (EA 2002) introduced a streamlined administration 2003 model to replace the original procedure. Floating charge holders lost their veto and a new out-of-court entry route into the procedure was introduced. Under the new regime, the administration may function either as a gateway to winding up, a company voluntary arrangement or a compromise or arrangement under s.425 of the Companies Act 1985, or as a stand-alone procedure which may lead directly to dissolution. Upon the appointment of an administrator or the making of an administration order by the court, existing management are displaced from their position of running the company and an outside insolvency practitioner, the administrator, takes over executive responsibilities. The moratorium formally starts from the date of granting of an administration order by the court or filing a notice of appointment with the court. The administrator is required to present a statement of proposals within eight weeks, and to invite an initial creditors’ meeting within 10 weeks after entering the procedure. The appointment of an administrator ceases one year after the date on which it takes effect, unless in accordance with exceptions. An administration now has the overriding objective of rescuing the company as a going concern. But if company rescue is not reasonably practical and/or it is not in the interests of creditors as a whole, in the view of the administrator, he can choose to achieve a better result for the company’s creditors as a whole than would be likely if the company were wound up. Where neither of the above is reasonably practical, then the administrator can just make a distribution to one or more secured or preferential creditors. When the administrator has chosen company rescue as the objective, the proposals usually include the plan to set out a CVA or scheme of arrangement under s.425 of the Companies Act 1985. The initial creditors’ meeting must be held as soon as reasonably practicable and in any event within 10 weeks. In the initial meeting, only unsecured creditors are entitled to vote. Where the initial meeting accepts the proposals that the administrator sets out, they will become the purpose of the procedure, and the administrator is not entitled to change them without the revision being accepted by another creditors’ meeting. If the meeting rejects the proposals even as revised, the court may terminate the administration, put the company into winding up or make another order as it thinks fit. [6]

If the insolvency practitioner went into the company originally at the request of the qualifying floating charge holder, and was ultimately appointed by the charge holder, it seems natural that, prior to the appointment, the debenture holder will be the client. On the plus side, the insolvency practitioner seems able to look to the debenture holder for the fees incurred in preparing the pre-pack. Objectivity may be jeopardised here if the administrator pre-packs an administration according to the wishes of the debenture holder. The Enterprise Act replaced administrative receivership with administration to ensure that appropriate duties were owed to the company’s creditors as a whole without any primacy being given to the interests of the appointing debenture holder. A pre-packed administration has the potential for holders of qualifying floating charges to retain full control over what happens to the insolvent debtor. [7]

Such as those held by floating charge holders

The Enterprise Act 2002 radically redesigned the administration procedure, first introduced by the Insolvency Act 1986, into a more avowedly corporate rescue-oriented process.

The underlying principle behind restructuring or reorganisation proceedings is that a business may be worth a lot more if preserved, or even sold [8] Under the former regime of administrative receivership the bank (party holding a qualifying floating charge [9] ) that loaned funds under the security of the floating charge operated in something of the comfort zone. It knew that if company entered troubled waters it could enforce its security quickly by appointing administrative receiver who would act entirely in the interest of the bank so as to realise assets, if necessary and settle the debt. The new administrative procedure established by the Enterprise Act replaced administrative receivership as the process for enforcing floating charges. It still placed the banks in a strong position relative to unsecured creditors [10] but it brought changes that banks would not necessarily welcome. First in contrast with receivership, it provided that administrators should act in the interests of the company’s creditors as a whole and second , it set down inclusive procedures and enforcement provisions that ensure that the interests of the creditors as a whole would be protected when the administrative will make judgment about the company’s prospects. [11]

Traditionally, [12] the main remedy available to a secured creditor has been the appointment of a receiver over the assets of a company. [13] Although designated by statute as an agent of the company, this is a very curious and unusual form of agency since the main function of a receiver is to realize the secured assets for the benefit of the secured creditor who made the appointment. Receivership was seen by many as too heavily creditor oriented and not sufficiently responsive to the concerns of other stakeholders. [14] Banks may have too readily protected their security by appointing receivers. The Enterprise Act took the administration procedure, introduced by the Insolvency Act 1986, [15] and redesigned it as a more avowedly corporate rescue-oriented procedure. Floating charge holders were barred from appointing administrative receivers in the generality of cases, but at the same time, however, “qualifying” floating charge holders were allowed to make an out-of-court appointment of an administrator [16] .

And those having a claim to property subject to retention of title

Administrators frequently find themselves in a position of having to sell or dispose of company assets on an urgent basis. Some of these assets may be the subject of valid retention of title claims that the administrators are not yet aware of or have not yet had an opportunity to investigate. Selling these assets may result in a personal claim against the administrators for the tort of conversion. [17]

In a simple commercial transaction, the customer places an order on the supplier and the supplier acknowledges that order; a contract for sale then exists and goods and payment subsequently pass. The customer treats the transaction as a purchase and the supplier treats the transaction as a sale, and property in the goods passes on delivery. The ability to retain title to goods is originated from the Sale of Goods Act 1979 (the Act), which states that property in goods sold passes when the parties intend it to pass. Thus, supplier can retain title to goods after delivery to a customer. There are, however, many suppliers that stipulate in the conditions of sale that property in goods shall not pass until those goods are paid for full. Under the Act, that is not a contract of sale but an agreement to sell.  [18] Subject to any contrary conditions, a supplier that has entered into an agreement to sell, but has retained title to the goods until payment is made, is entitled to recover its goods if the customer is unwilling or unable to make payment. In most cases, however, the supplier will not take this step and will assume, as is usually the case that payment will be made eventually.

The purpose of the insolvency law is to provide equitable and fair means by which the remaining assets of an insolvent company can be distributed amongst its creditors. By allowing the seller to retain ownership in goods which have physically passed to the buyer, the law is granting the seller ownership rights that enable him to claim his goods from the debtor company when it goes into insolvency by exercising his rights [19] under the reservation of title clause, thereby depriving the insolvent company’s liquidator from using the subject goods for Pari Passu distribution amongst the creditors.

A retention of title clause will normally be inserted into the contract of sale by the seller, ‘and if he fails so to do any later attempt at reservation will be ineffective since property will normally pass to the buyer on the making of the contract by virtue of the Sale of Goods Act 1979, s 18, rule 5’. Pursuant to s.19 of the Sale of Goods Act 1979, a supplier of goods is free to stipulate how and when title to its goods shall pass to the purchaser. [20]

When a company is insolvent its creditors are ranked in order of priority. The desire to escape from the ‘doomed category of unsecured creditors has inspired the increasingly widespread use of reservation of title clauses by materials suppliers and to achieves priority over all other creditors’.

A “retention of title” [21] clause is a clause that allows the supplier to retain ownership over the goods supplied until certain conditions are met, its a form of security against the buyer’s default or insolvency in favour of buyer. Most retention of title clauses relate to raw materials, stock in trade or livestock. [22]

English courts will in principle uphold a valid retention of title clause if it can be shown that it was properly agreed between the parties when the contract was made. Under the Sale of Goods Act 1979, where there is a contract for the sale of specific goods, the supplier can retain his right to ownership of those goods even though they have been delivered to the purchaser as long as all parties to the contract agree to this provision. For example”The seller remains owner of the goods until the price and all other sums owing by the buyer to the seller are paid in full”. [23]

When valid, the supplier’s claim to any unused goods will be binding against any trustee or liquidator subsequently appointed. If the goods were subsequently sold, a supplier would be entitled to commence proceedings for damages against the Insolvency Practitioner for interfering with goods [24] and the original supplier may acquire ownership of part of the resulting property or proceeds of the sale, but that would depend upon the existence of a fiduciary relationship. The Insolvency Act 1986 provides that when an administrator exercises his functions under Sch.B1 he does so as the agent of the company. [25] In Goldburg a trustee in bankruptcy sued the debenture holders and the receivers of a company, acting as the debenture holders’ agent, for trespass and conversion. The Court found the debenture holders and the receiver jointly and severally liable for trespass.

In the Australian decision of Barrymores Pty Ltd v Harris Scarfe Ltd (Administrators Appointed) (Receivers and Managers Appointed) [26] in which the Court stated:

“ … [T]here is no doubt that a receiver who deals with property beyond his authority may be held liable in conversion (In re Goldburg; ex parte Silverstone (No 2) [1912] 1 KB 384). A receiver is not able to sell goods which the company has brought under a contract providing for retention of title by the vendor until they have been paid for in full. [27] Where a receiver refuses to deliver up goods the subject of a valid ROT clause the receiver will be liable to the owner in conversion and exemplary damages may be awarded” [28]

It is submitted that an administrator’s liability in tort [29] has three potential bases: (i) direct; (ii) vicarious; and (iii) indirect.

Although the courts have taken the view that retention of title conditions are now common place and may not require specific treatment, however a supplier is to ensure that a customer is aware of the conditions, especially if they are out of the ordinary.  [30]

Retention of title clause can be drafted to retain ownership of the goods until payment was made for them, but goods such as any raw materials cease to be caught by it once the manufacturing process has begun, i.e. once the goods have lost their identity. For example, leather supplied in the production of handbags, once cut is deemed to have created a new product. It is possible for the supplier to retain title to the goods supplied even if they have been used in a manufacturing process provided they are still identifiable, in their original form and are easily removable. For instance, an engine supplied to be fitted to a generator does not lose its identity as an engine just because it is bolted to a generator.

Where the supplier simply retains legal ownership of the specific goods until payment is made, its claim is likely to be successful and its goods should be recoverable. If, however, the supplier retains something less that full legal ownership in the goods, (e.g. equitable and beneficial ownership) it will be establishing a charge over goods owned by the customer and that charge must be registered under section 395, Companies Act 1985. The retention of equitable and beneficial ownership results from the transfer of legal ownership to the customer and the granting of an interest in ownership by the customer to the supplier.

When goods are mixed up with other goods, or change in any way, it becomes more difficult for the supplier to trace its title in those goods as it cannot claim title to something that it never had. Where goods are destined to lose their identity almost immediately after delivery, the supplier cannot claim that the customer was holding those goods for the benefit of the supplier (which would be as a trustee or in a fiduciary capacity) and there can be no right to trace where the original goods lose their character and what emerges is a wholly new product. Thus, if it is known that goods are to be used in a manufacturing process before they are paid for, and supplier wishes to acquire rights over the finished product it can do so only by express contractual stipulation.

The position is different where goods are incorporated into something else but retains their separate identity. Where the goods can be removed without undue harm to other goods, the retention claim may succeed.

Suppliers often incorporate an ‘all monies clause’ within its conditions, so that title in the goods will be retained not only whilst those particular goods are not paid for but also while any money owe by the buyer. In such cases law does not require to identify goods against specific invoices but the goods must have remained in an identifiable and unmixed state. However, the courts have not given a great deal of attention to this form of claim and it could be argued that for a supplier to claim title to goods for which the customer has paid it would need to register a charge. Unless seller is a sole supplier or supplying a unique product, it will be necessary to identify his stock and being able to distinguish it from similar goods supplies by another supplier if claim is to be upheld. Serial numbers, bar codes and unique labelling can all be helpful in demonstrating that seller knows his stock if he is required to identify it in an insolvency. [31] The best method of identification is where the goods are marked with the name of the supplier or where their serial numbers are quoted on any unpaid invoices. [32]

The Clough Mill case

The case of Clough Mill v Martin was decided in the Appeal Court in November 1984 and raised a number of interesting, if contentious, matters. Cough Mill’s retention of title conditions provided that ownership of the yarn that it supplied remained with Clough Mill, as did the property in any goods manufactured from its yarn. The court decided that:

The court considered that each part of a clause could be treated as a separate component and that whilst some components might fall others could succeed;

The intentions of the parties were paramount and the court would do all that it could to ensure that effect was given to those intentions

In an insolvency scenario, seller wants to make sure that contract enables him to recover any goods supplied and still held in stock so long as any invoice remains unpaid by that buyer. It is important to ensure that retention of title clause covers all sums outstanding and isn’t just restricted to the goods supplied on the particular unpaid invoices.

A retention of title claim in an insolvency will also be rejected unless the administrator or liquidator is satisfied that the term formed part of the contract. Having terms and conditions in place, signed up and acknowledged by buyer will help to make a

Conclusion

Retention of title is a perfectly valid concept, upheld by courts, and supporting the right of a supplier of goods, either to obtain payment for those goods, or to recover them in the event of non-payment. From the reported legal cases, and from cases dealt with in practice, it is possible to deduce certain conclusions, although these may not necessarily be upheld in the future. These conclusions are:

A simple retention of title clause is likely to succeed if specific goods can be identified as being unpaid for;

Goods that have been mixed cannot be held by the customer as bailee because it cannot give them back to the supplier. In such circumstances, it is likely that title will have passed, and a charge will be required for the supplier to maintain any further interest;

Where goods are incorporated into something else but retain their identity and can be separated, a claim to retention of title is likely to succeed;

An all monies clause may succeed so long as legal title has been retained by the supplier; Where the supplier lays claim to the proceeds of sale, it must ensure strict adherence to specific conditions and the customer must be seen to be an agent bailee for the supplier. If the claim relates to the proceeds of sale of mixed goods the supplier will require a registered charge.