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The effective use of liens to protect against the collapse of corporate customers

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Logistics service providers need to have an effective contingency plan to deal with the prospect of their retailer customers experiencing severe financial distress, defaulting on payments, or going into administration or liquidation. Although good credit control is essential, especially given the recent disappearance of several household names in the retail sector, this article will focus on the need for the protection afforded by well-drafted contracts that give the service provider effective liens.

With effective liens in place, if (in accordance with Murphy’s Law) the worst does happen, the service provider will be far better off from a legal point of view and the risks to its own business associated with a customer’s default can be minimised. This article is written with the logistics service provider in mind, but several basic points will also apply to service providers in other sectors.

Recovery of payment for services already rendered

Service providers are usually paid in arrears, making it difficult to ensure payment for services where the customer or supplier is in financial difficulty. On the other hand, service providers have an advantage over other trade creditors, as they are often holding their customers’ goods in their possession (ie in legal terms, they are bailees of the goods). Nonetheless, when faced with a customer in financial difficulties, the service provider will need to act quickly in case the customer collapses into administration or liquidation. The main legal consequence of both administration and liquidation is the automatic triggering of the statutory moratorium, although its terms will be different depending on the insolvency procedure. Among the practical consequences of this is the competition between the creditors (both secured and unsecured) to exercise their rights over the debtor’s assets. Before releasing the goods to anyone, the service provider will need to carry out a review of its legal position to ascertain what rights, if any, it has over the goods.

Liens

Essentially, a lien is a legal right to retain possession of goods against payment of a debt due to the lien holder. To have a valid enforceable legal lien, the lien holder must be in lawful possession of the goods over which it claims the lien. In law, there are numerous different types of lien, but this article is mainly concerned with contractual liens. It would not be advisable for service providers to rely mainly on liens arising in equity or by operation of law, although these might be available as an alternative, if it turns out that the contractual lien is not enforceable for some reason. The majority of logistics service providers trade on standard terms developed by their own trade associations (eg the Road Haulage Association Conditions of Carriage 2009).

General lien

Most service providers will require a general lien, which entitles them to retain the goods in their custody regardless of whether or not the goods relate to the amount owed to them. To be really effective, the general lien should be coupled with a contractual right to sell the goods, so that the service provider will have a self-help remedy in the event of its customer going bust. The only way to achieve this is to ensure the general lien and the right to sell are incorporated into the contract between the service provider and its customer.

Specific lien

At common law, certain logistics providers, such as hauliers, will have a specific lien over the goods. A specific lien will be of limited use, as it simply entitles the haulier to hold goods that relate only to the amounts that are outstanding, not other debts that might be due. However, the major drawback of the specific lien is that it does not entitle the lien holder to sell the goods. If it turns out that the service provider does not have a valid enforceable general lien (eg because of a failure to incorporate the terms into the relevant contract or because of defective drafting), the specific lien could be useful as a fall back, albeit second-best in view of its limitations.

Exercising the lien

Life being what it is, it very often happens that by the time the logistics provider becomes aware of its customer’s financial difficulties, the customer has already gone into administration or liquidation.

Assuming the service provider has a general lien over the goods, it will need to find out swiftly what type of insolvency procedure the customer is following before taking any steps to exercise its rights. There will often be a timing issue because if the contractual right of sale has not been exercised before the commencement of the administration (and the triggering of the statutory moratorium), the consent of the administrator or the permission of the court will be required under paragraph 43 (3), Schedule B1, Insolvency Act (IA) 1986, discussed in more detail below.

The service provider will also need to consider whether to continue to provide the services or not. If the service provider decides to continue offering services, it will need to consider how best to guarantee payment for future services. The administrators have statutory powers to make any payment that they consider essential to the performance of their duties in achieving the objectives of the administration, that is, usually the sale of the business at better realisation for creditors if rescue of the business is not possible. Special care should be taken when negotiating continued services with the administrators to ensure that payment for them will be recoverable effectively as an administration expense.

Liens and insolvency: the legal position

A lien holder is a secured creditor

By s248(1)(b)(i) IA 1986, a creditor with a valid, enforceable lien is deemed to be a secured creditor in the insolvency of the debtor. It has long been held that a debenture holder is subject to the rights of a contractual general lien exercised when the lien holder lawfully acquired actual possession of the goods, albeit three days after the floating charge crystallised by the appointment of an administrative receiver.1 This shows the power of the general lien to give the holder priority over even a debenture holder with a prior registered floating charge. Given that administration has now overwhelmingly supplanted administrative receivership, the case perhaps has less validity today, but an unpaid service provider having a general lien and in possession of goods bound for an insolvent customer is undoubtedly in a strong position as a ‘ransom creditor’, if the administrator needs the goods for the purposes of the administration.

A lien is not a registerable charge

On a related point, it is important to note that although a lien falls within the definition of security for the purposes of the administration moratorium, it does not constitute a registerable charge.2 For that reason, lien holders should not accept an argument that the lien is unenforceable because it is not registered at Companies House.3

Administration Moratorium

As referred to above, the statutory moratorium triggered by the commencement of administration prohibits any steps being taken to enforce any security over the company’s property, except with the consent of the administrator or the permission of the court. In this regard see, for example, Bristol Airport plc v Powdrill [1990] (reported as re Paramount Airways Ltd [1990]), which in fact concerned the exercise of a statutory lien.4 If the administrator refuses to consent to the enforcement of the lien, the onus is on the holder of the lien to show the grounds on which it should be entitled to enforce. This requires the court to carry out a balancing act between the relative rights of the lien holder and the general body of the creditors, as referred to by the Court of Appeal in Re Atlantic Computer Systems plc [1992]. In that leading case the court referred to the underlying principle that an administration should not be conducted at the expense of those who have proprietary rights, except to the extent that it would be unavoidable. It is clear from this principle that the holder of a general lien is in a strong position as regards the administrators, which may enable it to negotiate for the payment of sums due. Assuming that there is a valid enforceable general lien, whether or not the creditor can obtain payment of all outstanding amounts will usually be a reflection of the administrator’s assessment of the importance of the continued supply to the business. Since an administrator cannot usually be compelled to pay for services and goods that are not required for the purposes of the administration, lien holders will inevitably find that there will be occasions when their lien over goods fails to ensure payment, leaving them with the distinctly less attractive option of a sale to a different party on the open market.

Although in theory administrators in exercise of their powers can agree with the lien holder that possession of the goods is to be given up in return for a non-possessory lien or other suitable security, in practice, in the case of service providers, it is much more likely that, if they want the release of the goods and the continuation of the services, the administrators will simply cause the lien holder to be paid (as in Bristol Airport).

The administration moratorium contains a specific prohibition on instituting or continuing legal process against a company in administration.5 The court has held that ‘legal process’ means a process that requires the assistance of the court. It was also held that it does not include steps such as the serving of a contractual notice making time of the essence, or the acceptance by a counter-party of a repudiatory breach of contract.6

Cross-Border situations

Where the goods are in transit overseas, the service provider will need advice as to the enforceability of its contractual general lien because in the event of a dispute over the ownership of goods, the law of the state in which the goods are situated (lex situs) may apply, rather than the law of the contract. This could result in unexpectedly altered priorities, with local creditors (such as port operators or warehousemen) taking priority over the lien.

Special care should be taken where there are cross-border issues and local legal advice is needed, as creditors could have different rights as regards liens (and also set-off and retention of title) depending on the jurisdiction. Creditors need to be aware of the interaction between different legal jurisdictions as insolvency office-holders (both domestic and foreign) might plausibly claim rights over assets that are beyond their true legal rights, often arguing that they are acting in the best interests of the creditors as a whole.

Liens over documents of title

Generally, a lien on documents is unenforceable to the extent that enforcement would deny possession of them to the administrator or liquidator.7 There is an exception to this that might prove crucial in relation to bills of lading or other documents of title, as s246 (3) provides that the prohibition on enforcement does not apply to a lien on documents ‘which give title to property and are held as such’. The words ‘as such’ in this somewhat obscure statutory provision have been held to mean ‘in circumstances which are such as to give rise to a lien’. In summary, it is a prerequisite of an enforceable lien over documents against an administrator or liquidator that they are of a kind that gives title to property (but not necessarily to the lien holder).8 This is helpful to lien holders with a general lien and contractual right of sale, as their rights can clearly extend to documents of title, without which a sale of the goods would be impossible.

Liens and third parties

The contract between the service provider and the buyer may expressly exclude any right of lien the service provider may have in law or otherwise, but if the service provider has sub-contracted the provision of the services under one of the industry standard terms, the sub-contractor itself is likely to seek to rely on the rights granted under those standard terms to retain the goods until its own invoices are paid.

Things may get more complicated where the supplier sub-contracts the transport services to a sub-contractor who in turn sub-contracts the services to other hauliers. In some instances, the service provider may not have used any of its assets to provide transport services; instead it may have used a pool of haulage companies to transport the goods. Many sub-contractors do business on terms that include a general lien in respect of charges due from their customers that gives rise to a risk that they may be entitled to exercise a lien on one party’s goods to obtain payment of a debt due from a third party. However, not all standard terms deal adequately with the right to a general lien in favour of the sub-contractor over a third party’s goods. Therefore, in each case it is essential to check that the sub-contractor’s terms contain an effective general lien over the third party’s goods and that the terms were properly incorporated into the relevant contract.

Conclusion

Clearly, the service provider itself can be held to ransom by its own sub-contractors and will sometimes face the stark choice of having to pay them before being in a position to exercise its own rights against the insolvent customer. The insolvency of the ultimate customer (or another party in the contractual chain) can sometimes lead to a complicated multi-party negotiation.

Practically speaking, nothing can replace rigorous credit control. The most efficient service providers couple that with well-drafted contracts incorporating a valid enforceable general lien and right of sale, thereby ensuring that they will stand a far better chance of recovering all sums due to them in the event of the collapse of their customer.

By Richard Baines, partner, Holman Fenwick Willan LLP.E-mail: richard.baines@hfw.com.

Re Atlantic Computer Systems plc [1992] CH 505

Bristol Airport plc v Powdrill [1990] CH 744, reported as re Paramount Airways Limited [1990] BCC 130

Notes
  1. George Barker (Transport) Ltd v Eynon [1974] 1 Lloyd’s rep 65CA.
  2. Under s874(1) Companies Act 2006.
  3. Re Hamlet International Plc, Trident International Ltd v Barlow [2000] BCC 602 CA.
  4. Para 43(2), Schedule B1, Insolvency Act (IA) 1986.
  5. Paragraph 43(6), Schedule B1, IA 1986.
  6. Re Olympia & York Canary Wharf Ltd, American Express Europe Ltd v Adamson [1993] BCC 154.
  7. 7) Section 246(2) IA 1986.
  8. 8)Re SEIL Trade Finance Ltd [1992] BCC 538. See also re Carter Commercial Developments Ltd [2002] BCC 803.
 

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