Liens and the termination of supply contracts under the new Corporate Insolvency and Governance Act
24 June 2020
The Corporate Insolvency and Governance Bill (the Bill) is being accelerated through Parliament and will soon become the Corporate Insolvency and Governance Act 2020 (the Act).
The Act, intended to give extra support to companies in financial difficulty, is likely to come into effect during July 2020. An overview of the Act can be found in our previous article.
This article considers specifically how the Act is likely to affect the rights of those in the transport and warehousing industries in relation to liens and the termination of contracts with customers in financial difficulty.
The effect of the Act when exercising a lien
What is a lien?
A lien conveys a right on a party to retain possession of goods (irrespective of ownership) until payment of carriage, storage and other charges has been made. The most useful lien for a carrier is a contractual general lien, such as clause 8A of the British International Freight Association (BIFA) Terms. This gives the carrier the right to hold onto goods until all sums due on the account have been paid up to date. Often, a contract will also set out a right for the carrier to sell the goods in its possession and retain the proceeds, if prompt payment is not made.
One of the effects of the Act is to avail companies who cannot (or are likely to become unable to) pay their debts of a moratorium, similar to the position that applies in formal administration proceedings. Once the Act is passed into law, companies will be able to file papers at Court, seeking a moratorium. They will then be protected from creditor action from the time the filing is made for an initial period of 20 days. This period can be extended by a further 20 days and then up to a year with creditor support.
During a moratorium, a monitor will be appointed to oversee (though not control) the business of the company.
The effect on liens
The relevant provisions in section A21 of the Bill (reference in final Act not available at time of writing) provide that during a moratorium, no steps may be taken to enforce any security over the company’s property, except with the permission of the Court. This is likely to include liens.
The language in this section of the Act is very similar to the language used in the Insolvency Act 1986 in relation to the rights of secured creditors against a company in administration, where a moratorium will also apply. In those circumstances, a secured creditor requires the permission of the administrator or the court to enforce its security.
The Courts have generally been supportive of creditors in this situation, taking the view that, “it cannot be right that the appointment of an administrator has the effect of turning a secured creditor into an unsecured creditor” (Re Paramount Airways Ltd. ). In our experience, administrators will usually give their permission for a creditor to exercise (or continue to exercise) a right of lien or sale during a moratorium, provided the right existed before the moratorium, in the knowledge that the Courts would probably take the same approach.
However, under the Act, there is no provision for a secured creditor to seek permission from the ‘monitor’ (see above) to enforce its security. The only formal recourse available is to seek permission from the Court. Often parties will be reluctant to incur the time and cost associated with a Court application where the sums at stake may be relatively modest. However, we expect that applications will be made and it will be interesting to see whether the Courts’ approach is consistent with the past or whether the balance is tipped more in favour of the struggling company when seeking to reconcile the interests of secured creditors and debtors.
(Finally, it is worth noting that if the customer consents to the lien being exercised, it is difficult to see that the Court would intervene but the Act does not expressly set this out as an option to the parties.)
Until further clarification is provided by Parliament or the Courts in terms of how the Act is intended to apply to liens and other forms of security, it will remain uncertain as to whether the rights of lien holders will be upheld where a moratorium is in place. In the meantime, our practical advice is:
- If a customer defaults on payment and the carrier has a right of lien, the carrier should give notice that it is exercising a lien as soon as the payment becomes overdue. They should not wait.
- If a carrier exercises a lien before a moratorium takes effect, this may assist when later seeking permission from the Court to continue to exercise (enforce) the lien.
- However, as discussed above, provided the right of lien pre-existed the moratorium, the Courts in the past have generally supported the lien holder’s rights and given permission for a lien to be exercised.
- Neither carrier nor customer will want to incur costs disputing the validity of a lien so they remain a useful tool when a carrier has possession of goods, albeit that a lienholder’s rights under the Act remain, for the time being, uncertain.
Termination of contracts
Another effect of the Act is that carriers will no longer be entitled to terminate a contract for the supply of services due to a customer’s insolvency, pursuant to the type of contractual provision that previously would have allowed them to do so. The moratorium procedure set out above will be included among the circumstances where termination of a contract is not allowed.
There is a temporary exemption to this provision for small suppliers of services. This will apply for one month after the Act comes into force.
Note however that a carrier will still be able to terminate a contract for reasons other than the onset of insolvency proceedings, if provided for in the contract. Contracts can also be terminated with the company’s consent (or that of the administrator or liquidator in formal insolvency proceedings).
Finally, a carrier will be entitled to apply to court for permission to terminate the contract if the continued supply of services will cause it hardship.
- Where contracts take the form of one-off bookings, the effect of this change in the law should not be too drastic. The carrier may have to complete the journey and deliver the goods but will then be under no duty to enter into further contracts with the customer.
- If there is a longer-term contract in place for the supply of services with doubts in respect of the customer’s financial viability in the short to medium term, it may be in the interests of the carrier to consider terminating or renegotiating now, before the Act comes into force, if it can. This will need to be considered on a case by case basis with a careful review of the relevant contractual terms.
- In relation to future contracts, parties should review the termination provisions to ensure they comply with the law whilst maximising the protection they afford within the restrictions of the new regime.
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at June 2020.