It is your worst business nightmare. You have fulfilled a large order or undertaken a substantial piece of work for a customer, delivered on your obligations but then heard a rumour that your customer is in financial difficulties and may not be able to pay you.

Can you get paid before the business goes under, and more importantly, can you get paid before the other debtors? Can you retrieve your goods rather than press for payment? Do you have an obligation to continue dealing with the business once it becomes insolvent?

Here Alan Massenhove, Head of Litigation & Dispute Resolution at Sykes Anderson LLP Solicitors looks at three quite real scenarios.

First Scenario

A shoe manufacturer has supplied between 2,000 and 3,000 pairs of shoes to a shoe retailer every month for several years. The retailer becomes insolvent. The insolvency practitioner (IP) asks the manufacturer to continue to supply shoes. The manufacturer wants to know whether they (a) have to continue to supply shoes and more importantly (b) will get paid.

BH – The shoe manufacturer may be obliged to supply the insolvent company with shoes under the terms of the contract between the two. If the manufacturer fails to do so, it will be in breach and may have a claim brought against it by the IP on behalf of the retailer. In practice, this is unlikely to happen. Most commercial contracts will contain the right to treat an event such as insolvency as sufficient to terminate the contract.

A more realistic situation is where the manufacturer wants to continue to supply shoes. If this has traditionally been the manufacturer’s biggest customer, they will endeavour to keep supplying. The question is whether the insolvent retailer will be liable to pay the manufacturer.

The answer is that it all depends on the timing of the order. If the insolvent retailer contracts with the manufacturer before the appointment of an IP, then the manufacturer will likely not get paid. If the IP causes the insolvent company to contract with the manufacturer, the payment obligations rank as an expense of the administration / liquidation. As IP’s usually ensure they have the resources to pay for any goods or services ordered in the course of their appointment, the manufacturer is likely to be paid.

Second Scenario

A web designer has designed and built a property developer’s website. The website has gone live. The web designer was paid half their £50,000 fee up front with the rest now due. The designer has chased payment and the developer has reneged on two or three promises to pay. The designer has threatened to wind-up the developer’s company unless it is paid. The designer has just heard that the developer has not paid its main contractor this month and that the developer’s bank has appointed administrative receivers.

BH – Property developers are notorious for the speed with which they go from a seemingly healthy company to financial collapse. All it sometimes takes is a small flux in cash flow for rumours to spread about the solvency of the business. Potential buyers get nervous and either pull out of purchases or procrastinate to see if they can force the price down. Contractors and sub-contractors stop work and a vicious cycle can bring things grinding to a halt. If there is a bank in the background it is usual for them to have the power to appoint administrative receivers (AR’s) to deal with any company assets over which they have security in the event that the company goes into financial difficulties. The AR will have power to sell these assets to cover the bank’s exposure. As an unsecured debtor, the web designer may think that now an AR has been appointed, they might as well write off their £25,000. Not necessarily.

The appointment of an AR does not prevent the web-designer from filing a petition to wind-up the company. The web-designer would then be in a stronger position to negotiate with the bank as to the recovery of some of his debt although there would be little point unless the company’s assets were worth at least the same as the money owed to the bank and the debt to the web-designer. The key for the web designer is to improve their negotiating position.

Third Scenario

A tiling firm is one of four similar firms supplying identical tiles to a supermarket chain to use to tile the floor of one of the new stores it is building. The contract contains a retention of title (ROT) clause. The supermarket has not paid for the tiles. It has already used 50% of the tiles in several of its new stores. The remainder are sitting in unopened boxes containing the name of the tiling firm. The supermarket chain has just entered an insolvency process. The tiling firm wants to know if they can retrieve their tiles.

BH – The answer is that they can to the extent that the ROT clause is enforceable in the first place. Assuming it is, their contractual (and proprietary) rights survive the supermarket entering the insolvency process. The tiling firm will have to identify the goods it says it is entitled to, identify the contractual ROT clause and prove that the clause covers the debt that is due.

In the scenario above, the tiling firm will probably not be able to identify the 50% of tiles that have already been laid, but if the unopened boxes are easily identifiable, it should be able to recover them.

The key is to contact the IP quickly, send copies of delivery notes, the contract, schedules of tiles supplied and visit the site to physically point out the boxes of unused tiles and perhaps point out any distinguishing features on tiles that may have been removed from their boxes but remain unlaid.

The tiling firm should be warned - the commercial value of ROT provisions in an insolvency context is limited. It can take a considerable amount of time and effort to get any recognition for a ROT clause from the IP and in most cases, the ROT clause will not allow suppliers to recover their debt, only items supplied by them (which of course is less than their debt, as their invoice will include the profit they would have made on the order).

The most important thing to remember when dealing with companies in financial difficulties is to not panic. You will often find a way out, a way to recover some of the money owed to you or to continue to trade with the insolvent company. The best thing to do is consult a solicitor or an IP.

Please note that this area of the law is a complex subject and you should not take or refrain from taking any step without full legal advice on the particular facts of your case. The content of this article is of a general nature and no liability is accepted in connection with it or if any reliance is placed on it. Sykes Anderson are not regulated to give financial advice. For more details on how to deal with businesses in financial difficulties, contact Alan Massenhove via email or call on 020 3178 3770