INSOLVENCY AND CONTRACTS

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1 INSOLVENCY AND CONTRACTS In-house Lawyers Group Seminar Joanna Clark DLA Piper Scotland LLP 19 March 2015

2 What are we talking about? Insolvency basics Effect of insolvency on contracts Post-insolvency challenges of contracts Some specific issues that come up regularly Points to consider March

3 Insolvency regimes (corporate) Regime Entity Purposes Administration Companies, LLPs Rescue/better result than winding up Liquidation Companies, LLPs Wind up company's affairs Receivership Companies, LLPs Repay floating charge creditor CVA Companies, LLPs Restructuring March

4 Insolvency regimes (personal) Regime Entity Purposes Sequestration (bankruptcy) PTD (protected trust deed) Debt arrangement scheme (DAS) Note: not strictly insolvency Individuals, partnerships and others Individuals, partnerships and others Individuals Note: these are the Scottish personal regimes Debt relief Debt relief Debt management/ repayments (limited debt relief) March

5 Common features: basics Appointment of Insolvency Practitioner Ingathers assets and distributes to creditors Date of insolvency crystallises creditor rights Distribution according to statutory order of priority Statutory moratorium for certain processes (i.e. no action against company or its assets with consent of IP or leave of court) March

6 Common features: priority of distribution Expenses (outlays) Insolvency Practitioner's fees Preferential creditors FC holder Ordinary creditors Non FC secured creditors dealt with separately March

7 Parties and interests Insolvency Practitioner (IP) (acts for general body of creditors) Secured creditors Unsecured (ordinary) creditors Others : owners of assets used by debtor contracting parties debtor / directors guarantors March

8 Effect of insolvency on contracts generally under Scots law Nothing in insolvency legislation that automatically terminates contracts Is there a termination clause in the contract? If not*, IP has choice: perform or decline to perform? (see Joint Administrators of RFC plc [2012] CSOH 55) Consequence of declining gives rise to damages claim (ordinary unsecured ranking) Balancing act cost vs benefit *Other party's choice where no termination clause: perform, repudiate, accept repudiation March

9 Where IP declines to perform Pragmatic vs legal analysis IP declining to perform does not have the effect of terminating the contract per se Material breach (non performance) - repudiation of the contract Repudiation accepted - contract at an end Repudiation not accepted - contract continues (can be important to preserve existence of certain types of contract, e.g. lease) Innocent party - damages claim (unsecured) Note: statutory disclaimer available in English bankruptcies and liquidations March

10 Valuation of the damages claim Claim adjudication process Theoretically, same approach court would take to contract claim Decision subject to appeal to court - rarely invoked March

11 Main grounds of challenge of preinsolvency contracts Challenge Against who Remedy Gratuitous alienation (s242 IA; s34 BSA) Recipient of transaction within 2 years prior to sequestration (5 years if associate) for no or inadequate consideration) Reduction of transaction or if not possible, other redress (Defences include balance sheet solvency at relevant date and adequate consideration) Unfair preference (s243 IA; s36 BSA) Recipient of transaction within 6 months prior to sequestration that gives recipient a preference to the prejudice of the general body of creditors Reduction of transaction or if not possible, other redress (Defences include payment of debt in ordinary course of business or where exchange of reciprocal obligations) March

12 Common issues 1: termination clauses Do you need to be able to act quickly/ pre-insolvency? Automatic or optional termination? Process? Insolvency events of default Usually comprehensive detailed list (appointments, petitions, resolutions, calling of meetings etc.) Cover off with something generic e.g. analogous proceedings in any jurisdiction March

13 Common issues 1: termination clauses (cont.) Pre-insolvency events of default E.g. balance sheet insolvency, inability to pay debts, enforcement measures taken, seeking to compromise debts with creditors etc. Section 123 IA86 often used as benchmark How do you evidence these matters in practice? Information covenants Tie up with any pre-insolvency events of default? Make non-provision of information an event of default in itself? Consider how that ties up with remediable termination process March

14 Common issues 2: retention of title Effectiveness of various types (simple, all sums, beyond) Critical factor for success: swift reaction of business to insolvency event Contractual measures (may be of limited practical assistance) Obligation to store goods separately Consent for supplier to enter and remove stock from premises Pragmatic measures Demonstrable incorporation of clause into contract (especially where standard T&Cs) Distinctive packaging and product marks Clear paperwork (statements showing detail of customer account and stock deliveries made) March

15 Common issues 3: use of trusts Trust mechanisms used to attempt to ring fence assets/ funds from insolvent estate Complex case law on what makes effective trust General requirements: Declaration of trust purposes Delivery of identifiable trust property to trustee for purposes of trust (Q: what is a sufficient equivalent to delivery?) Courts may scrutinise underlying commercial reality Registrable charge? March

16 Common issues 4: options clauses Personal right so IP may elect to perform or not (cost vs benefit) But IP cannot pick and choose which clauses to perform and which not to perform in a single contract Attempts to secure/ convert an options right to real(ish) right: Registration of standard security - blight on title IP can usually get round but may have nuisance value If invoking pre-insolvency Be aware of potential for challenge as gratuitous alienation or unfair preference Build in protections (e.g. valuation to support adequate consideration, evidence of solvency at relevant time) March

17 Consider Do you need to be able to terminate quickly and decisively? Is asset control an issue do you need title to critical assets? Do you need security for the contractual debt if so, over what and how effective is any security going to be? How and when will any rights be enforced by you? Are any practical steps required to make the stated contractual position effective? Do you need pre-insolvency warning mechanisms to enable you to take action before a moratorium sets in? Are any clauses of the contract potentially vulnerable to challenge post-insolvency? March

18 Contact March

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