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ADMINISTRATION - HOW DO YOU PROTECT YOURSELF AGAINST A CUSTOMER IN ADMINISTRATION?

fEBRUARY 2009

In the current economic climate, suppliers face a situation where an increasing number of their customers are going into administration. Administration is the UK’s primary insolvency restructuring process and the UK analogue, with significant differences, of the US “Chapter 11” process. Frequently, where a customer has gone into administration, a supplier is not paid in full and only receives payment after a considerable period of time. This article provides practical advice to suppliers, who have no security over their customers’ assets, on how to deal with a customer’s administration and enforce any retention of title provisions.

This article is not a substitute for advice relating to specific situations and does not consider any insolvency processes other than administration.

An overview of administration

A company can be placed into administration by way of an application to the Court for an administration order. Administration may also be achieved by way of notice, in an out of Court procedure. When a company goes into administration, an administrator is appointed to run the company. Administrators are licensed insolvency practitioners (typically from a firm of accountants).

The aims of an administration (in order of priority) are[1] : (i) to rescue the company as a going concern; or (ii) to achieve a better result for the company’s creditors as a whole than would be likely if the company were wound up; or (iii) to realise property in order to make a distribution to one or more secured or preferential creditors.

One of the key advantages of administration is that it creates a moratorium on debt enforcement, including the repossession of goods held under retention of title arrangements, by a company’s creditors. The moratorium gives the administrator a better chance of restoring the company and saving the business. Although it is possible that an administrator will make a distribution (i.e. payment) to a supplier in respect of its unsecured debt during the course of the administration, this is unusual.

How can you minimise potential losses when your customer goes into administration?

Where a customer has gone into administration, there are a number of steps you should consider:

Terminate your contract - Unless your contract provides that termination occurs automatically on the customer going into administration, or there is a valid right to terminate the contract, it will remain in force[2] . If you continue to trade under the contract, any amounts owed to you which accrue post-administration will rank equally with unpaid amounts payable to you before the customer went into administration. In other words, where you were an unsecured creditor before the administration, you will continue to rank as an unsecured creditor in respect of goods and/or services supplied in the company’s administration. In many cases terminating the contract will be the best option for preventing any further losses following the appointment of an administrator.
Set-off - In general, you can exercise a right of set-off after a customer has gone into administration[3] .
Negotiate with the administrator - Even if you have a termination right, where you supply goods or services to the company that are essential to its operation the administrator may seek to negotiate for the ongoing provision of such goods and services. There are many issues to consider in such negotiations, including the following:

You may wish to seek a personal written guarantee from the administrator that debts incurred from the date of administration will be paid. Such a guarantee is very rarely given.
Consider negotiating a new agreement so that the administrators cannot rely on the terms and conditions of the agreement formed prior to the administration. You may wish to consider negotiating an increase in payment terms/payment in advance.
If your ongoing supplies are essential to the continued operation of the customer, debts accrued post-administration may be treated as expenses properly incurred by the administrator in performing his functions rather than just an additional debt[4] . Expenses of the administration are paid ahead of all other costs of the administration (including the administrators’ own remuneration and other secured debtors).
If the customer’s business is being sold, consider negotiating terms with the buyer, rather than the administrator, which allow you to recover some of the money you are owed. If the sale is being structured as a ‘pre-pack’ [5]and you are not a key supplier, it is likely that you will only be able to do this once the sale has taken place.

What if my contract with the insolvent company includes retention of title provision?

Where your customer has gone or is likely to go into administration, you should reassess any retention of title rights that you have under your contracts. Quick action is of the essence, whether the company is already in administration or not. In its simplest form, a retention of title clause provides that legal and beneficial title in goods supplied under a contract will not pass until some condition (e.g. payment of the full purchase price) has been satisfied. As the customer already has possession of the goods, retention of title clauses often provide that the supplier may: (a) require the goods to be returned; and / or (b) enter the customer’s premises to repossess the goods.

Act fast. If you suspect that a customer is about to enter administration, you should consider enforcing any repossession rights you may have. Where goods subject to retention of title provisions are sold prior to the customer going into administration, your right to be paid for these goods ranks alongside the customer’s other unsecured creditors.
Inform the administrator. Once the customer goes into administration, your position weakens as many of your rights, including the right to repossess the goods, will be suspended. It is crucial that you notify the administrator immediately to inform him of any goods which are subject to retention of title provisions and provide him with any evidence you have. If you do this, you increase the likelihood that the administrator will consent to your enforcement of the retention of title provisions. If consent is not given, you can apply for permission of the court to enforce these provisions.

Because you retain title to the goods even if the customer is in administration, the administrator is not entitled to dispose of your goods without your permission or the prior sanction of the court. A court will only sanction the sale of your goods if it would further the overall aims of the administration. The proceeds of the sale will be applied to satisfy the customer’s liabilities under the relevant contract.

Conclusion

If you suspect that a customer may go into administration, you should seek legal advice as to what steps you can take to mitigate your exposure. Do not continue to trade without reviewing the situation. Where you supply goods and your contracts contain retention of title provisions, you must act quickly: (a) to identify what steps are available to you to recover the goods; and (b) to alert the administrator to the fact that you retain title to the goods.

If you have any questions or would like to discuss anything in this article in more detail, please contact Jessica Stretch and Charles Claisse at Kemp Little LLP on 020 7600 8080.

[1]Paragraph 3 of Schedule B1 of the Insolvency Act 1986.

[2]Termination rights are sometimes drafted so they apply on an application to court or an order being made for the appointment of an administrator or notice being given of an intention to appoint an administrator.

[3]In any event, if an administrator is making a distribution a statutory set-off rule will come into play in relation to claims acquired before the commencement of administration.

[4]Rule 2.67 Insolvency Rules 1986.

[5]A pre-pack is a sale of all or part of a customer’s business or assets which is negotiated prior to the appointment of an administrator, the sale being effected shortly after his or her appointment.