With the rise of online shopping and the e-commerce industry, it is no surprise that a number of high street stores, such as HMV and House of Fraser, have faced difficulties in recent times. Due to the ever-growing uncertainty of the market, more and more companies are becoming insolvent. But what does it mean if a company that owes you money goes insolvent?
What is Insolvency
Under the Insolvency Act 1986, insolvency is when a business is unable to pay its debts as and when they fall due. An Official Receiver (OR) is usually appointed in the early stages of a company’s insolvency and an Insolvency Practitioner (IP) may be appointed later to deal with the assets. The appointment of an OR/IP must be included as and when any correspondence is sent out by the company, so you will be able to see that the company is within an official Insolvency process.
The IP/OR is responsible for determining the priority of creditors and distributing proceeds in accordance with strict rules. In practice, when a company becomes insolvent there is usually a limited pot of money available for all creditors. Depending on the circumstances, suppliers, contractors, consultants and lenders will have little to no protection if they are owed money.
However, certain other creditors such as employees and customers will have alternative steps available to them to secure financial support. Provided their employment contracts have been drafted to include relevant protective provisions, employees may be able to consult their employment contract and rely on it for support. Further, depending on the circumstances, customers may be able to rely on the rights set out in the Consumer Credit Act 1974, which are conferred on the basis that there are contractual obligations in place for any breach or misrepresentation made by the company to the customer.
The OR/IP will distribute proceeds according to the order of priority which, generally, is as follows:
- Fixed (secured) charge holders (i.e. those who have a charge over specific assets such as property, goodwill, shares etc)
- Fees and expenses of the insolvency process
- Preferential creditors (such as employees)
- Floating charge holders (i.e. those who have a floating charge over property that may change from time to time such as stock, cash or fixtures)
- Unsecured creditors
Most third-party customers and suppliers will find themselves ranking as unsecured creditors. Whilst customers may have other limited recourse (as explained above), this means they are likely to receive little or no repayment. How much a creditor will be able to recover their debts will largely depend on the circumstances of the case, how many claims are involved and the amount of money that can be realised. Creditors who have a right to claim must act quickly. However, they should always keep in mind the possibility of receiving nothing.
If a company you are owed money from enters into a formal Insolvency process, the OR/IP will contact a creditor if they are aware of their claim. The creditor will then have to complete a proof of debt form if the debt is more than £1,000 so that they can participate in the insolvency. Debts of less than £1,000 do not need a proof of debt form to participate; you simply give the person handling your case your contact details and confirm how much is being owed.
What if you suspect a company has become insolvent but have not been contacted? You can check whether the company is in an informal insolvency process either by searching Companies House, contacting the Insolvency Enquiry Line or checking the public notices section of The Gazette.
How to reduce risk
It is worth noting that there are a number of preventative measures that can be taken to minimise your risk:
- If you supply goods you should ensure that your terms of business clearly stipulate what happens in the event of insolvency. Insolvency itself does not automatically terminate a contract unless specifically stated in the contract. It should be made clear who has a title in the goods and who bears the risk in respect of these;
- Creditors may wish to consider allowing a contract to continue despite having a termination clause. This is on the basis that they would be seen as a loyal trading partner by supporting the company through its restructuring;
- If goods are easily identifiable, incorporating a “Retention of Title” clause into a contract ensures that goods do not pass to the company until payment has been made in full. If this clause is valid, a creditor will be allowed to recover goods from the insolvent company;
- Creditors should consider whether supplying goods by way of a lease of a licence is better. This is often the case with intellectual property such as software and can prevent the product being sold on as an asset of the company;
- Always undertake proper due diligence on all customers and suppliers. Ensure that there are proper credit limits in place which are regularly reviewed;
- Take non-payment or late payment seriously. Do not allow anyone to rack up considerable debt.
Given the current state of the market, suppliers, customers, employees etc must be alive to the potential consequences they may face in the event of a company’s insolvency. They should also be aware of where they are likely to stand in the order of priority.
Creditors should ensure that they keep up to date with the news and are proactive in making themselves known as creditors to participate in the insolvency. They should nevertheless still consider the possibility of receiving nothing and act accordingly, never allowing unpaid debts to spiral out of control.
Prevention is better than cure so you should ensure your contracts are watertight to maximise your levels of protection. In all business dealings, take sensible commercial and practical precautions.
Karen Holden is the Managing Director & Founder of A City Law Firm who practise both commercial law and litigation, having been admitted to the roll in 2005. If you require further advice or assistance, please do not hesitate to contact [email protected]
A City Law Firm Limited is a leading entrepreneurial law firm in the city of London, with a dynamic and diverse team of lawyers. It was awarded most innovative law firm, London 2016 and Business Law firm 2017. They specialise in start-up business law, the tech industry, IP and investment