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The perpetual struggle to ensure customers pay their invoices on time is disproportionately debilitating for small and medium-sized enterprises (“SMEs”), especially in adverse economic conditions when budgets are squeezed and access to finance is limited.

However you  can employ a number of contractual tactics to encourage customers to respect payment terms.

• Review your standard terms to ensure that your payment period is clearly defined and of a suitable, practical length.
• You have a statutory right to interest under the current late payment legislation, which is 8 per cent above the bank of England’s base rate for payments overdue by 30 days. SMEs should use the statutory provisions as a benchmark for their standard terms, and as leverage to negotiate shorter contractual payment periods or lower interest rates with their customers.
• Consider including provisions in your standard terms that require a fixed sum to be paid as compensation in the event of a contractual breach. You may wish to specify that, in the event of late payment, compensation of a certain amount is payable to cover the administrative costs for pursuing that payment. This type of clause is known as a liquidated damages clause.
• Liquidated damages and interest clauses are a practical way of dealing with minor breaches such as the late payment of bills without putting your long-term relationship with your customer at risk. They can be an effective means of encouraging proper performance since the financial consequences of breach are unequivocally set out. For liquidated damages and/or interest clauses to be enforceable, the sums specified must reflect a genuine pre-estimate of the wronged party’s loss and be commercially justifiable. It is wise in all instances to record the reasoning, including details of any negotiation with the other party, to justify the levels of compensation set out in your clauses.
• If payment is not forthcoming, consider other means of seeking compensation from your customers and provide for those remedies in your standard terms, such as adding a clause that entitles you to charge for instructing a debt collection agency to recover the debt. Again, you are entitled to limited compensation under statute, but this is unlikely to be sufficient and supplementary arrangements should be made.
• A “retention of title” clause will give you the right to reclaim goods delivered to your customer under the contract until full payment is received.
• Ensure your standard terms specify that time for payment is “of the essence”, so that, as a last resort, you will be permitted to terminate the contract if an invoice is paid late and sue your customer for damages. However, to ensure that such a clause is not struck out for being unfair, it is typical to allow customers a grace period to put right the breach.

Delaney -v- Chen [2010] EWHC 6 (Ch)

An appeal was made by Delaney following the Court’s decision that the sale and leaseback of a property he had purchased from the sellers at a price substantially lower than the unencumbered freehold value amounted to a transaction designed to defraud creditors pursuant to s423 IA 1986.

Delaney purchased the property from the sellers for £210,000 some £65,000 lower than the stated unencumbered freehold value of £275,000. The parties intended that whilst Delaney purchased the property from the seller, the seller would continue to live at the property and following the transfer the parties had agreed that the seller would be granted a 21 year tenancy. The tenancy was stated to be exclusive to the seller and non-assignable. It was noted by Judge Purle QC that such sale and leaseback transactions are becoming more and more prevalent as it permits the original owner to release equity from the property without having to move house.

Chen argued that the primary purpose of the transaction was to defraud creditors by permitting the sellers to put assets beyond the reach of creditors, of which Chen was one. Chen stated that the transaction was made at an undervalue pursuant to s423 IA 1986 and the Court (if it was satisfied that that there had been a transaction at an undervalue) had the discretion to restore the position to how it would have been if the transaction had not been entered into.

In order to set aside the transaction, the Court had to be satisfied that the transaction was entered into for the purpose: “of putting assets beyond the reach of a person who is making, or may at some time make, a claim against him; or of otherwise prejudicing the interests of such a person in relation to the claim which he is making or may make” (S423(3) (a) and (b) IA 1986).

At first instance, the Court held that the sale was a transaction at an undervalue made with the requisite purpose as prescribed in s423 IA 1986. The Judge ruled that there had been an undervalue of £65,000 and accordingly the transaction was void and was to be set aside with the property being transferred back to the sellers.

On appeal, the Court ordered that on a sale and leaseback transaction such as this the purchaser did not acquire an unencumbered freehold, but bought the property subject to (in this case) a 21 year tenancy. The purchaser only acquired the freehold reversion. The lower Court should therefore have looked at the value of the freehold reversion and not the value of the unencumbered property.

Evidence indicated that the freehold reversion was worth no more than £210,000, and may have been worth a lot less. Judge Purle QC accepted that: “…on my finding… £210,000 was a fair price for the reversion.” However, Chen argued that up until the point of sale, the seller had an unencumbered freehold and until the tenancy agreement had been made it could have been sold to anyone at its full unencumbered value of £275,000. As it was only sold for £210,000 there was clearly an undervalue. Judge Purle QC noted that had the sellers sold the property to Delaney for £275,000 and then entered into a 21 year lease of another property, paying a premium of £65,000, then the sale to Delaney would not have been an undervalue. Judge Purle QC went on to say that the premium element would be no different in principle from part payment in advance for any other services such as hotel accommodation: “The result can be no different in the case, as here, of a sale and leaseback where the premium value of the tenancy made up for any shortfall in the purchase price. In those circumstances, the sale at £210,000 was (on the present example) the equivalent of a sale at £275,000, with a leaseback at a premium of £65,000”. On these facts, the £65,000 premium value of the tenancy made up for any discount there may have been in the price paid by Delaney.

The Court concluded by stating that, in this case, the legal burden of proving any undervalue was on Chen and in order to do this Chen had to show that the tenancy granted to the sellers had a premium value of less than £65,000. No such evidence was provided. Accordingly, the appeal was allowed. On the evidence, s423 IA 1986 did not apply to this transaction.

Re Cornercare Ltd [2010]

The directors of C applied to court seeking permission to appoint an administrator out of court in circumstances where they had previously filed a notice of intention to appoint but the appointment had not been made within 10 business days of filing in accordance with schedule B1 of the Insolvency Act 1986.

The judge said that there was nothing to prevent a fresh notice of intention to appoint being filed and served once the time limit for appointment under the initial notice had expired.

The court held that there was no objection in principle to serving successive notices of intention to appoint an administrator provided that directors and their advisers proceeded with caution and showed a valid reason for any delay in appointing an administrator.

The court commented that, although the issue and service of fresh notices could give rise to potential abuse, the court would have adequate power to act in appropriate circumstances to restrain any unscrupulous behaviour.

B S Sandhu t/a Isher Fashions UK  v Jet Star Retail Ltd t/a Mark One) & Others [2010]

I supplied clothing to J under I’s standard terms and conditions which included an “all monies” ROT clause. The contract also gave I the right to terminate the contract if J became insolvent or entered administration. J went into administration holding stock purchased from I.

I did not terminate the contract nor did it attempt to recover any stock. Subsequently, the administrators sold the stock and I made a claim in damages against the administrators for the value of the goods, alleging unlawful conversion.

The court dismissed the claim on the grounds that the administrators acted in accordance with the established terms of contract which provided for on-sale. I had not exercised its rights to terminate the contract nor had it taken steps to identify the stock. I could therefore not prove an immediate right to possession of any of the stock.

The High Court decided that an “all monies” retention of title (ROT) clause was unenforceable by the supplier creditor because it was inconsistent with the agreed course of dealings that the goods were supplied for immediate on-sale by the debtor.

This case highlights two important lessons for suppliers who seek to rely on ROT clauses when their debtors go into administration:

• ROT clauses should be drafted to safeguard the supplier creditor’s rights where stock is to be re-sold by the debtor.
• The creditor should proactively exercise rights to terminate the contract if appropriate and, in any event, should identify stock following the appointment of administrators or liquidators.

Agilo Ltd v William Henry [2010]

H was a director of L. AMF provided L with a loan facility through its agent, AUK. H gave a personal guarantee for the liabilities of L to AMF. AMF and AUK were all parties to the guarantee.When L defaulted on the loan facility, AUK issued a statutory demand against H. H applied to set aside the statutory demand on the grounds that his obligations under the guarantee were to AMF not AUK.

The High Court upheld the first instance decision to set aside the statutory demand. The court said that it was an absolute rule that the demand must be issued in the name of the creditor.

The High Court determined that it was correct to set aside a statutory demand (under rule 6.5(4) of the Insolvency Rules 1986) because it had the wrong creditor’s name it.

Creditors must make sure that statutory demands are accurate before serving them on debtors, otherwise they may be exposed to additional costs.

A court will set aside a statutory demand which:

• Contains incomplete, misleading or inaccurate details of the debt claimed.
• Is issued by or on behalf of a party that was not a creditor at the date of the demand.

Much publicity has recently been given to the High Court case of R (on the application of Mercury Tax Group Ltd and another) v HMRC & Others [2008] EWHC 2721 (“Mercury”).

The decision in this case led to a period of some uncertainty as to execution formalities and the correct procedure to be followed where transaction documents are to be executed at a virtual signing or closing (i.e. where some or all of the signatories are not physically present at the same meeting).

The Law Society published a Guidance document setting out a non-exhaustive range of options available to parties. As the vast majority of structured finance documents are executed at virtual signings or closings, we thought it would be helpful to set out these options and their likely impact on signing procedures in relation to English law documents.

The Mercury decision

The facts of the Mercury case were not directly related to the structured finance sphere. The case revolved around a potentially legitimate tax avoidance scheme and whether Her Majesty’s Revenue & Customs should have been granted a warrant to enter the Mercury Tax Group’s premises to search for documents.

One of the side issues addressed by the courts was whether the Mercury Tax Group’s practice of transferring signature pages from a draft document to the final version was legitimate or not. In finding the document in question invalid, the judge said, in relation to deeds that “the signature and the attestation must form part of the same physical document”. In relation to all documents, the judge said that the document to be signed should exist “as a discrete physical entity (whether in a single version or in a series of counterparts) at the moment of signing”.

The potential implications of these statements on virtual signings and the practice of circulating signature pages separately from the documents to which they relate led to much discussion . It was against this background that Leading Counsel was appointed and the Law Society’s Guidance was published.

Leading Counsel’s Opinion and the Law Society’s Joint Working Party’s view

In general, the note of Leading Counsel’s consultation with the Law Society is confidential to such parties. In practice, however, although not binding on a court, Leading Counsel’s views are likely to greatly shape the development of agreed procedure in this area and provide a useful reference guide.

The consultation with Leading Counsel can be disclosed in the terms set out in the Law Society Guidance. This sets out the general view of Leading Counsel and the Law Society’s joint working party (the “JWP”) that the Court of Appeal decision in Koenigsblatt v Sweet [1923] 2 Ch 314 remains the leading authority in this area. The Koenigsblatt case established that an amendment to a pre-signed document can be binding if amendments have been authorised either prospectively or through ratification. The Mercury decision, however, should be limited to its facts and, to the extent that the decisions are inconsistent, the Koenigsblatt decision should prevail.

However, on the cautious assumption that the Mercury decision might have application beyond its specific facts and on a conservative view of the judge’s comments in Mercury, the JWP considers that contracts can nonetheless be circulated for signature using email. The Guidance is designed to provide some examples of appropriate procedures but variations on these procedures or other procedures may work as well. There are specific statutory requirements for the execution of deeds, real estate contracts and guarantees that are not applicable for simple contracts. As such, the JWP has analysed the execution requirements for each of these types of documents separately. Some of the execution options set out below will only work for specific types of documents.

The Law Society Guidance

The Law Society sets out three options for conducting a virtual signing or closing (although, as noted above other options may also work).

Option 1 – suitable for deeds, real estate contracts, guarantees and simple contracts

1. Before signing, the arrangements for the virtual signing/closing are agreed between the parties’ lawyers.
2. Once finalised, the final execution copies are emailed to the parties or their lawyers (in either word or “pdf” form). For convenience, a separate pdf or word document containing just the relevant signature page may be attached.
3. Each signatory prints and signs the signature page. There is no need to print off the full document.
4. Each party sends an email to the lawyers arranging the signing attaching: (i) the final version of the document (which can be copied straight from the execution email in item 2 above); and (ii) a pdf copy of the signed signature page. If this method is being used for execution of a deed, the arrangements should make clear when the deed will be deemed delivered.
5. To evidence the execution of the document, a final version of the document, together with copies of the executed signature pages, may be circulated to the parties. One or more additional original versions may also be created by attaching the final execution copy of the document to either pdf or original signature pages.

The view of Leading Counsel and the JWP is that the email containing the final version of the document and the signed signature pages satisfies the Mercury requirement of being the “same physical document”. The JWP also indicates that other methods will also satisfy the requirement as well as Option 1. For example, if each party prints the entire document, signs the signature pages and then returns pdf versions of either the signature pages only or the entire document including signature pages, this will also be sufficient. However, since Option 1 does not require the entire document to be printed out, Option 1 is likely to be more useful in practice.

Option 2 – suitable for guarantees (not executed as deeds) and simple contracts

1. Before signing, the arrangements for the virtual signing/closing are agreed between the parties’ lawyers.
2. Once finalised, the final execution copies are emailed to the parties or their lawyers (in either word or pdf form). For convenience, a separate pdf or word document ontaining just the relevant signature page may be attached.
3. Each signatory prints and signs the signature page. There is no need to print off the full document.
4. Each party emails its signed signature page as a pdf attachment to the lawyers arranging the signing, together with authority to attach it to the final version of the document. The level of formality required for this authority will be dependent on the circumstances.
5. To evidence the execution of the document, a final version of the document, together with copies of the executed signature pages, may be circulated to the parties. One or more additional original versions may also be created by attaching the final execution copy of the document to either pdf or original signature pages.

The only difference between Option 1 and Option 2 is at step 4. For Option 2, there is no need to reattach the final version of the document when returning the signature pages. As a result, however, the first original version of the document is created not when the email is sent but when the final version of the document is first printed out and the signature pages are added to it.

Option 3 – suitable for guarantees (not executed as deeds) and simple contracts

1. Before signing, the arrangements for the virtual signing/closing are agreed between the parties’ lawyers.
2. Before the final version of the documents are agreed, signature pages are circulated to the parties. As a matter of good practice, each signature page should clearly identify the document it relates to.
3. Each signatory prints and signs the signature page. The signature page is then returned to the arranging lawyers by pdf or by courier. The signature page is to be held on behalf of the signatory (or his lawyers) until authority is given for it to be attached to the final version.
4. Once each document is finalised, the law firm arranging the signing/closing emails the final version of each document to the parties (or their lawyers) and receives confirmation from each party that it has (or its lawyers have) agreed the final version. This confirmation should also authorise the law firm to attach the pre-signed signature pages to the final versions and to date and release the documents. The degree of formality required for such authority will be dependent on the circumstances.

As with Option 2, the first original version is created not when the email with the signatures is sent but when the final version of the document is first printed out and the pre-signed signature pages are added to it with authority. One or more additional original versions may also be created by attaching the final execution copy of the document to either pdf or original signature pages.

Option 3 is likely to be used where not all signatories are available to sign documents on the day of signing but are able to provide authorisations as applicable. This ability to sign documents before the document is final only works for guarantees (that are not executed as deeds) or simple contracts.

Summary and conclusions

It is clear that the Mercury decision and the welcome Law Society Guidance will significantly affect execution practices in the future. Parties should expect a stricter degree of formality in comparison to past practices and it should be extremely clear from the email correspondence and documents exactly which version of a document signatures relate to. Where authority is to be provided for signature pages to be attached to simple contracts or guarantees, the authority should be clear and comprehensive.

The Law Society Guidance states that each transaction should be approached according to its own facts, including the countries of incorporation of the parties, internal procedures, the content of board resolutions and whether contracts have to take effect in a particular sequence. In addition, registration requirements might necessitate a hard copy original signed version of a document to be filed. In practice, the availability of signatories will also play a part in deciding which procedure is used and there may well be a desire to simplify signing instructions where possible. For example, if a transaction contains a number of deeds and simple contracts, it might be advisable to execute all documents using Option 1. Although not strictly necessary for the simple contracts, it might be considered preferable to have one set of instructions for all the documents to minimise the risk of parties executing improperly.

We have advised on a number of post-Mercury transactions and are familiar with the various procedures and requirements. We ensure that virtual signings or closings comply with post-Mercury market practice. If you have any queries as to the Mercury case or the Law Society Guidance, please do not hesitate to contact us

Pre-pack administrations may offer the best outcome for unsecured creditors

Question

I am a trade creditor of a company with several retail outlets (Old Co) that went into administration two weeks ago. The administrator has informed me that Old Co’s business and assets have been sold to another company (New Co) that has the same directors and shareholders. I have noticed this is happening more and more frequently from talking to other creditors and reading the papers. Is there any action available to me and can i pursue the new company for my debt?

Answer

Assuming that you are an unsecured creditor, the administrator’s actions may be legal, although you are entitled to be provided with information to enable you to establish the position. You do not have a claim against New Co, and Old Co may not have sufficient sums realised from the sale of the assets with which to settle your claim.

Old Co is subject to a pre-pack administration. This means that it has been put into administration and its business and assets have been sold under a sale that was arranged before the administrator was appointed. This procedure is becoming increasingly common.

A pre-pack sale provides for a quick transfer of the business.  It can minimise loss of confidence on the part of suppliers, customers and employees and save more jobs than a normal administration.

However, such arrangements are perceived as lacking transparency.

Since the Insolvency Act 1986 nor Enterprise Act 2002 do not expressly provide for pre-packs, administrators do not have to obtain prior approval for such sales from the court and creditors.

As an unsecured creditor, you would not have received prior warning of the sale and were unable to consider the proposal. Secured creditors would have been consulted because they would need to release their security to enable the sale to proceed. The limited marketing associated with a pre-pack sale may (wrongly)  give the impression that the interests of unsecured creditors have been disregarded. The process also resembles asset-stripping, particularly where the business and its assets are sold to the original owners.

You should request information from the administrator under the Insolvency Service’s Statement of Insolvency Practice 16 (SIP 16). Under this, administrators have to explain to creditors the background to their appointment and why a pre-pack offered the best outcome.

An administrator must also disclose

• the identity of the buyer of the business or assets
• any valuation of the business or underlying assets;
• which alternative courses of action were considered;
• the consideration for the sale or the terms of payments; and
• any connection between the buyer and the directors, former directors, shareholders or secured creditors.

Creditors have a statutory right to bring an action against an administrator under sections 74 and 75 of Schedule B1 to the 1986 Act if the administrator has unfairly harmed a creditor’s interests, is not performing his functions quickly and efficiently or in the case of misfeasance. However, the only case to date in respect of SIP 16 determined that a failure to comply would not of itself be sufficient to remove an administrator from office Clydesdale Financial Services Ltd v Smailes [2009]

Where a pre-pack is subject to judicial scrutiny, the court must consider the merits of the proposal. Information must be provided to enable it to decide whether it is in the best interests of the creditors as a whole  Kayley Vending Ltd [2009]

In DKLL Solicitors v Revenue & Customs Commissioners [2007] , the court approved a pre-pack sale despite objections from the majority creditor, because it would save jobs and minimise disruption to clients.

In Re Hellas Telecommunications (Luxembourg) II SCA [2009] the court, for the first time, supported a pre-pack sale: the judge ruled that the company was clearly insolvent and there was no realistic alternative. This case concerned an investment company, but the courts may take a different approach for an operational trading company.

Potential for reform

A consideration of these authorities and further investigation may reveal a cause of action or at least satisfy you that the correct procedures have been followed. However, would your position be different but for the pre-pack sale? In the absence of any misconduct by the administrator or the directors of Old Co, if the only alternative to the pre-pack sale is a sale at a lesser value or  the company’s liquidation, you would in any event have been unlikely to recover the sums due to you so your position has not been prejudiced.

Pre-pack administrations were the subject of a consultation published by the Insolvency Service in March 2010. It invited feedback on proposals for reform, including giving SIP 16 statutory force; requiring all pre-pack administrations sales to exit into compulsory liquidation to enable the conduct of the directors and the administrator to be reviewed; and to subject all pre-pack sales to the prior approval of the court or the creditors. As yet, no proposals for reform have been formulated.