Dealing with a Distressed Company - How to Avoid Being Left Holding the Baby

April 17, 2009

It's official, Britain has now moved into recession. A crisis first confined to the banking sector is now also being reflected in other non-banking insolvency figures. But a company does not go from rude financial health one minute to insolvency the next; there is often a slow period of decline.

How can technology suppliers, integrators and developers protect themselves? Nobody wants to be left holding the baby in terms of unpaid invoices/undelivered goods or a broken-down supply chain when a company ultimately fails. However, it is also commercially unrealistic to sever ties with clients/suppliers who start to display signs of financial ill-health.

We look at a few tips on how you can avoid becoming a statistic.

The Warning Signs

"The cheque is in the post" famously ranks alongside "I'll love you in the morning" as one of the great (empty) promises in life. On the one hand, extending payment terms may just be a tactic employed by well-run companies using their market clout to improve cash flow. On the other hand, for other companies, sudden delays in making payments must set alarm bells ringing.

Other tell-tale signs of trouble include a change in staff (unpaid wages), failure to file accounts at Companies House (an unpaid auditor) or a notice that your debt has been factored (an attempt to improve cashflow). The following are a few steps you should be taking:

A. Credit Control

The best line of defence is to avoid unpaid debts/undelivered goods in the first place. A robust credit control policy should be a mainstay of a well run company.

You may also consider:-

1. taking out credit insurance. This is becoming increasingly popular but exclusion clauses need to be carefully reviewed;
2. setting credit limits for individual customers;
3. using the carrot and stick approach with customers – reward early settlement by discounting and punish late payment with interest;
4. registering at Companies House for their web watch service in order to monitor filings in respect of key suppliers and customers;
5. chasing down unpaid debts and making sure commercial partners know you will not be fobbed off by repeated promises to pay. If you are in a hole, don’t keep digging and don’t be afraid to call a customer’s/supplier’s bluff by putting them on a stop list;
6. insisting on payment for the remainder of the goods, if a customer questions part of an order;
7. getting to know the cheque run date(s) of key debtors. Ring them up the day before and make sure your invoice is included; and
8. insisting on post-dated cheque(s) or personal guarantees from directors/shareholders if a customer can’t pay when the debt falls due.

B. Retention of Title ("RoT")

In respect of a supplier of goods, an RoT clause should be an essential part of your terms and conditions. For tech companies who licence intellectual property, a well-drafted licence should also provide for title in the IP to return on non-payment or insolvency. Similarly, content creators or software developers should seek in their terms of engagement to get their product back (to the extent possible) in the event of non-payment. Again, a few tips to follow:-

• a well drafted RoT clause will be of little use unless it is properly incorporated into your commercial dealings. At the very outset of a commercial relationship make sure that your customer signs a copy of your terms. Make sure your terms are then included on your purchase forms/invoices and don’t accept purchase forms/invoices that include their standard terms;
• take advice on specific wording. Ideally, you should have sub-clauses which:

1. oblige the customer to store the goods separately and also to label them as belonging to the supplier;

2. include a right to enter the customer’s premises to check that RoT provisions have been complied with and/or to recover goods. It should, however, be noted that you cannot use force to enter premises. RoT clauses should be enforceable on non-payment and without having to wait for a formal insolvency event. In fact, you may have more success enforcing against a customer/supplier than against a wiry old insolvency practitioner;

3. include an all monies clause. This may allow you to recover all goods and/or intellectual property even if some individual invoices have been paid. However, the goods being claimed under an RoT clause must still be capable of identification and a supplier must be able to link them to specific invoices. The goods should also be marked with the name of the supplier, with serial numbers deployed and quoted on relevant invoices;

4. beware of the risks of including a proceeds of sale clause which tries to extend protection to the proceeds of sale when your goods are sold on. Unless extreme care is taken over the drafting/follow on procedures, the clause may be void for non-registration at Companies House. Not only that, but the inclusion of an invalid proceeds of sale clause may void the rest of the RoT provisions.

On the other hand, you need to be realistic. For example, if you are supplying raw materials which are then used in a manufacturing process, if may be impossible to identify/separate your goods. Likewise for IP businesses, it may not be commercially acceptable to retain rights against intellectual property licensed to your customers for integration in their products.

C. Know your rights

Often a knee jerk reaction of an insolvency official will be to reject claims that are lodged with them. Don’t be afraid to fight your corner and take legal advice as to the validity of your claim.
Equally, the directors may not always be able to hide behind the corporate veil of a limited liability company. If a director has made personal promises or allowed the company to continue to trade past the point where it couldn't have avoided insolvency, he may be personally liable for the company's debts.

D. Take security or otherwise improve your position

Provided you identify the valuable assets of a creditor and structure (and monitor) your security arrangements properly, there are many creative ways in which you can cut your downside risks.
But you can’t wait until it’s too late! If you have extracted security or other comfort out of a distressed company, an insolvency official may be able to challenge this if it occurred within 2 years of its demise. Transactions must not be at an undervalue or unfairly improve the position of one creditor over another (particularly when dealing with a connected party such as a relative or fellow director).

E. Keep it confidential

You may have concerns over a supplier/customer but it is not a good idea to broadcast these concerns. For example, Norwich Union were held to be vicariously liable for alleged defamatory comments made by its employees about Western Provident Association (“WPA”). Norwich Union employees were using the internal intranet to circulate emails amongst themselves alleging that WPA was in financial difficulties and that the DTI was investigating WPA.

WPA discovered that such emails were being circulated and obtained an order directing Norwich Union to preserve all of the offending emails and produce hard copies. WPA later obtained a further order allowing it to conduct a search of Norwich Union’s email records. The case was settled out of court by means of an apology and damages (reportedly £450,000 plus costs).

F. Spread your risk

If your company is beholden to one supplier, what is your Plan B if this supplier was to fail?
M&A specialists have been reporting that as the credit crunch deepens, companies are exploring opportunities for vertical integration to protect their supply chain. A distressed supplier may be receptive to an acquisition approach from a customer. (See our separate article on acquiring assets out of an insolvent company.)

G. Take advice

It may be a suitable time for suppliers, in particular, to review their terms and conditions. As well as checking their RoT clause, prudent to have the express contractual right to cease to supply a customer if he fails to pay.


Related pages:

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Tax and Incentives more

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