Insolvency

Insolvency is a prerequisite for the availability of stoppage in transit and is one of three statutory grounds for exercising a lien or withholding delivery. Insolvency has different definitions in different legal contexts. For the purposes of the remedies under the Act, the relevant definition is at s.61(4) of the Act:

“A person is deemed to be insolvent within the meaning of this Act if he has either ceased to pay his debts in the ordinary course of business, or he cannot pay his debts as they become due” (emphasis added).

These are factual requirements and a seller needs to be sure of the position before relying on insolvency to justify action against the goods: mere suspicion of impending insolvency is not enough. Unless other facts prove insolvency, the calling of a creditors’ meeting will not be sufficient, either - sometimes creditors’ meetings are called in advance of insolvency to decide on a strategy for avoiding it.

Unless the contract says otherwise, insolvency or a declaration of insolvency will not automatically terminate the contract. A seller must therefore avoid the trap of placing itself in repudiatory breach by prematurely treating a contract as terminated. That said, depending on the terms of any declaration the buyer makes, it might be possible to treat the declaration as an anticipatory repudiatory breach by the buyer, allowing the seller to accept the breach and terminate the contract. A seller should carefully consider the legal position before doing so.

Sellers should also review the insolvency provisions in their contracts - contractual definitions of insolvency are often wider than the statutory one above.

The right to a lien or to withhold delivery

A lien is the right to retain possession of property belonging to another person as security for a debt. It is not possible for a seller to exercise a lien over goods it owns and so there is no right of lien (in the strict sense) where title has not yet passed to the buyer. To avoid putting a seller who has passed title to the buyer in a better position than one who has not, the Act includes a right of retention of delivery for those circumstances. To all practical purposes, the right of retention is the same as a lien over the goods.

The right of lien – for a seller who has passed title in the goods to the buyer - is set out at s.41. That section allows the unpaid seller to retain possession of the goods until payment or tender of the price where:

• the goods are sold without credit terms;
• the goods are sold on credit, but the term of credit has expired; or
• the buyer is insolvent.

The right to withhold delivery – covering a seller who retains title to the goods - is at s.39(2). That section states that the unpaid seller has, in addition to its other remedies, “a right of withholding delivery similar to and co-extensive with his rights of lien or retention and stoppage in transit where the property has passed to the buyer.”

To exercise rights of lien or retention, payment of the price must be due or the buyer must be insolvent. Where goods are sold on credit terms, the rights will not exist until the credit term has expired.

The possession of goods is the key to exercising a right of lien or retention. A seller who gives up possession of the goods cannot later exercise a right of lien by regaining possession: sellers must often think quickly and carefully to ensure they retain possession and their right of lien, especially where goods are on a ship sailing to the buyer’s destination. The matter of possession is not always simple. A seller might retain possession even though the buyer has controlled access to the goods. Further, s.41(2) of the Act makes clear that a seller can exercise a lien over goods even if only in custody of them as the agent or bailee¹ of the buyer, provided there is no waiver of the right of lien. These nuances make a careful examination of the facts important before a right of lien is exercised or assumed to have been lost.

Where a seller delivers part of the contract goods, the right of lien or retention of the balance remains unless there is evidence that the seller has waived that right. If a contract is for delivery in instalments, for example a long term supply agreement, the seller’s position depends on whether the instalments are divisible. Where a contract provides for a separate price to be paid for each instalment, it will usually be regarded as divisible. In those circumstances and unless the contract says otherwise, a seller can normally only exercise a lien over an instalment of goods for which payment has not been made and so must deliver a paid instalment even to an insolvent buyer. If the payment of the price is not clearly linked to a particular instalment, the contract might be seen as indivisible so that the seller may exercise a lien over any instalment of the goods in respect of any part of the price that is unpaid.

A seller will lose the right of lien if possession of the goods is lost. Section 43 provides that the lien is terminated when:

• the seller delivers the goods to a carrier for the purposes of transmitting them to the buyer, without reserving a right of disposal;
• the buyer or its agent lawfully gains possession of the goods; or
• the right of lien or retention is waived.

Importantly for international sales, the right of disposal is deemed reserved where a seller takes a bill of lading from the carrier that is made out to the seller or its order, because such a bill of lading gives the seller constructive possession of the goods it represents. In those circumstances, a seller who loads goods onto a ship for carriage to the buyer should not lose its right of lien as a result. The right will be lost, however, if the bills of lading are endorsed and delivered to the buyer, even where payment has not been made.

As a result, a FOB seller will not normally lose its right of lien by loading the goods on board the carrying vessel. However, if the buyer owns the vessel or is a demise charterer of it, so that it has total control over the ship, there might be an argument (i) that the goods were not delivered to a carrier (but rather to the buyer) so that (ii) the buyer has possession of the goods and the right of lien is lost.

Because the exercise of a right of lien will not by itself terminate the sale contract, unpaid sellers must ensure they continue to perform their other obligations under the contract or else they risk being in breach themselves.

The right of stoppage in transit

Section 44 provides that, where the buyer is “insolvent” (see s. 61(4), detailed above), an unpaid seller who has parted with possession of the goods may stop them in transit and retain them against payment of the price.

For the right of stoppage to exist, the goods must be “in transit” to the buyer. A seller might have to act fast to stop the goods before the transit is ended. The goods do not need to be moving to be considered “in transit”, provided the period of transit is continuing. Section 45 states that the goods are in transit:

• from the time they are delivered to a carrier for the purposes of transmission to the buyer until the time the buyer or its agent takes delivery from the carrier; or
• until they are delivered to the buyer.

Where goods are loaded onto a ship chartered by the buyer, it is a question of fact in each case as to whether the master of the vessel takes possession of them as a carrier only or else as the agent of the buyer. In the latter case, the transit will end when the goods are loaded and the right of stoppage will end with it.

Again, a FOB seller should not face difficulties as a result of loading the goods onto the carrying vessel, unless the vessel is owned or demise chartered to the buyer, in which case there might be an argument that transit ended on loading when the goods were delivered to the buyer. The transit will not end as a result of loading the goods into the buyer’s vessel if the seller has reserved a right of disposal by taking a bill of lading in its name and to its order (see above).

Where a seller makes a part-delivery, the right to stop the rest of the goods in transit remains unless there is evidence that the seller intended to give up possession of all of the goods (s.45(7) of the Act).

As to the exercise of the right to stop the goods in transit:

• the seller can take actual possession of the goods or notify the carrier that they are not to be delivered to the buyer;
• separate considerations will arise as between the seller and the carrier: the seller will be responsible for freight costs incurred in getting the goods to an alternative destination. The carrier’s lien for unpaid freight will also take precedence over the seller’s right to possession of the goods.

As the buyer’s insolvency is a prerequisite of the right to stoppage in transit, it is essential for the seller to ensure the buyer is insolvent within the meaning of the Act before exercising the right.

Stopping the goods in transit will not terminate the sale contract by itself. Again, therefore, unpaid sellers must ensure that they continue to perform their other obligations under the contract to avoid breaching it.

The effect of an on-sale

Under s.47, an unpaid seller’s rights of lien, retention or stoppage are not affected by any on-sale or other disposal of the goods that the buyer has made, unless the seller assented to it.

However, if a document of title (such as a bill of lading) is lawfully transferred to a buyer, who then transfers it to a third person taking it in good faith and for valuable consideration:

• the unpaid seller’s statutory rights are defeated if that third person is a buyer; or
• if the third person takes the document of title by way of a pledge (e.g. a financing bank), the unpaid seller’s statutory rights are can only be exercised subject to the rights of the pledge holder.

The unpaid seller’s right of re-sale

The rights of lien, retention and stoppage are often precursors to the seller re-selling the goods to a new and solvent buyer. The seller will want to realise the value of the goods as cost-effectively as possible, perhaps by finding a buyer able to take delivery at or near to the original location.

Depending on the circumstances or if the contract terms allow it, a seller may have the ability to terminate the sale contract and re-sell the goods. A seller who terminates a contract or re-sells the goods without the right to do so risks being in repudiatory breach of the contract itself – termination should always be carefully considered in light of all the relevant factual and legal circumstances.

There is a distinction between the ability of a seller to give a new buyer good title to the goods and the right of the seller to sell the goods from under the original buyer. A seller might successfully transfer good title to the new buyer, but still face claims for breach of contract from its original buyer.

Under s. 48(2), where an unpaid seller who has exercised the right of lien, retention or stoppage re-sells the goods, the new buyer will get good title to the goods as against the original buyer (even if title has already passed to the original buyer from the seller). This allows the seller to satisfy its obligations to the new buyer, but will not protect the seller from claims its original buyer might make for breach of the sale contract.

To avoid claims from its original buyer, the seller will either need to have an express contractual right of resale, or else rely on the statutory rights of resale under s.48(3). Unless a contrary intention appears from the contract terms, the time of payment is not normally of the essence of the contract. Care is therefore needed before the goods are re-sold, unless the contract clearly allows re-sale after a particular period of time.

Section 48(3) addresses this by allowing a seller to re-sell the goods where (i) they are perishable in nature, or (ii) where the unpaid seller has given notice to the buyer to pay the price within a reasonable time and no payment has been made within that time. What is a reasonable time will depend on the circumstances, in particular on how quickly payment can actually be made (e.g. it might not be reasonable to demand payment within 24 hours before banks are closed for a weekend in the buyer’s place of business).

A seller who re-sells the goods may be entitled to damages from the original buyer, including for the difference between the resale and contract prices or the costs of effecting the resale.

A re-sale of the goods will terminate the original sale contract. If title has already passed to the original buyer under that contract, it will re-vest in the seller so that the seller passes good title to the new buyer.

Interplay with contractual remedies

Depending on their terms, expressly agreed contract provisions might override, supplement or amend the statutory remedies discussed above. The starting point for any seller should therefore be to consider the contract fully.

1. Event of default provisions

Contracts, especially longer-term contracts, often contain default terms that define a range of insolvency events as defaults. Those terms will frequently allow the seller to terminate the contract or any deliveries under it if the buyer suffers an insolvency event (However, please refer to a recent client alert, 'The UK’s Corporate Insolvency and Governance Bill – implications for firms in the commodity markets'). It is important to ensure the requirements for an insolvency event in any clause are met. Even where there is no insolvency, default clauses might enable a seller to terminate the contract or suspend deliveries where there is a failure on the part of the buyer to pay any sums due to the seller when they are payable.

A seller must ensure it complies with any procedural requirements set out in the clause, such as serving correct notices and allowing any cure periods to elapse. Failure to do so may expose the seller to a claim for breach of the contract. Sellers should also consider whether, by relying on a contractual clause, they are cutting themselves off from statutory remedies or from claiming damages at common law, which will depend on often complex analysis of the relationship between the contract default terms and the common law.

2. Retention of title provisions

Terms allowing a seller to retain title to the goods until the buyer has made payment, even after delivery, are commonplace in sale contracts. From the seller’s perspective, the terms should ideally allow the seller to re-take possession of the goods prior to an insolvency event if payment is late. The effectiveness of the contract provisions will depend on their terms and the practicalities of re-taking possession, particularly if the goods have been processed or used to manufacture other products.

Retention of title terms should be considered alongside statutory remedies and might affect them, for example by preventing a lien where ownership remains with the seller. In such case, the seller should consider what other statutory rights might remain open to it, such as the right to withhold delivery or to stop the goods in transit.

Depending on the insolvency law applicable to the buyer, once an administration or liquidation of the buyer’s business has begun, it might not be possible to exercise rights over goods in the possession of the buyer under a retention of title clause.

Key takeaways

Apart from agreed contract terms, which must always be analysed as the starting point to ascertain what rights the seller has or does not have, an unpaid seller has a number of statutory remedies affecting the goods. Those remedies might be amended or overridden by the contract terms in place. Where available, the remedies will allow a seller to retain or regain possession of the goods and possibly to re-sell them to a new solvent buyer.

Except for the right of stoppage in transit, insolvency is not a requirement for the exercise of the statutory remedies, but it is one of three grounds on which a seller may exercise its right of lien.

Aside from examining contract terms, an unpaid seller should consider the practical position very quickly after the time for payment has passed or concerns about the buyer’s liquidity have arisen:

• The value will normally be in the goods. The availability of remedies, practically and legally, will often depend on who possesses the goods and in what capacity.
• Where necessary, is the buyer demonstrably insolvent?
• Is there a right of resale and if so can the seller pass good title to a new buyer?
• If there is a re-sale, will the original buyer have claims against the seller and if so, will the buyer or the liquidators be in a realistic position to start proceedings to pursue them?
• What are the required procedural steps? Can a notice be given to allow re-sale of the goods?

Lastly, unpaid sellers should take great care before attempting to terminate a contract, to avoid a claim from their purchaser for wrongful termination or repudiation of the sale contract.

Remedies Available under Trade Terms

The table below sets out the contractual remedies available in the case of an insolvent counterparty pursuant to standard terms in the agricultural, energy, cotton, oil and coffee industries.²

Contract	GAFTA3	FOSFA4	ICA Bylaws and Rules	BP 2015 GTCs	European Standard Contract for Coffee
Definition of Insolvency	A party will be able to rely on the insolvency provisions if its counterparty suspends payments or notifies its creditors that it is unable to meet its debts or has suspended payments. The GAFTA provisions also apply if the counterparty convenes a meeting of its creditors; proposes a voluntary arrangement; has an administration or winding up order made; has a receiver or manager appointed; convenes a meeting to go into liquidation; or becomes subject to an Interim Order or Bankruptcy Petition.	The definition of insolvency contained in FOSFA contracts is identical to that contained in the GAFTA contracts.	A party can rely on the  close-out provisions if its counterparty enters into an arrangement with its creditors; appoints an administrator or receiver; presents a petition for its winding up or is adjudged by the President of the ICA to be imminently subject to one of those events.	The BP GTCS include a wide definition of insolvency. A counterparty will be deemed to have undergone an insolvency event if it makes an arrangement with its creditors; becomes insolvent; is dissolved; institutes insolvency or bankruptcy proceedings; presents a petition for its winding up or liquidation, provided such petition is not withdrawn, dismissed, discharged or stayed within 15 days; has a secured party take possession of substantially all of its assets; appoints an administrator, liquidator, receiver, trustee or similar official over all or substantially all of its assets; or undergoes any analogous proceeding under any applicable law. This definition includes a situation where the counterparty is unable or fails to pay its debts or admits in writing it is unable to pay its debts as they fall due.	To rely on the insolvency provisions, the counterparty must either be insolvent or bankrupt or have passed a resolution to become the subject of liquidation, receivership, moratorium or equivalent proceedings. Additionally, if the counterparty has failed to make a contractual payment, it will be deemed insolvent.
Notices	The affected party is to  notify the non-affected party of the occurrence of an insolvency event forthwith, but the non-affected party will still be able to operate the clause if it learns of the insolvency event without a declaration having been made.	N/A	In the case of one of the above events occurring, the non-affected party may send a written notice of closure to the other party. Either party may request a Declaration of Findings from the President and must give the President full written details supporting their request, including a copy of the written closure notice.	To enforce the provisions, the non-affected party must notify its counterparty either orally (confirming such notice in writing) or in writing.	N/A
Remedies	The contract is closed-out at the market price and the difference between the close-out price and the contract price will be paid by or to the affected party as applicable. If the affected party does not give notice of the insolvency act, the non-affected party may at its option declare the contract closed-out at either the market price on the first business day after learning of the insolvency event or at the market price on the first business day after the insolvency event occurred. If it is proven the affected party gave notice within 2 business days of the act of insolvency, the contract is closed-out at the market price ruling on the business day following the date on which notice was served.  In all cases, the non-affected party has the option of ascertaining the settlement price on the closing-out of the contract by re-purchase or re-sale.  The difference between the contract and re-purchase or re-sale price will be the amount payable or receivable under the contract.	If an insolvency event occurs, the contract shall be immediately closed-out. The close-out price shall be either the current actual or estimated market price for similar goods or, at the option of the non-affected party, a price ascertained by the re-purchase or re-sale of the goods. The difference between the contract price and the close-out price is the amount the non-affected party shall be entitled to claim or be liable to pay under the contract. If either party is dissatisfied with the price obtained on re-purchase or re-sale, the close-out price will be determined by arbitration.  If there is no re-purchase or re-sale and the parties cannot agree on the close-out price, there will be an arbitration to set the close-put price before a sole arbitrator appointed by FOSFA and subject to the right of appeal under the arbitration rules.	Once the relevant notices have been served, the President will appoint an arbitrator to determine the date of closure of the contract and the price at which it will be invoiced-back to the seller.	Section 68 designates an insolvency event as an event of default. If an event of default occurs, a non-defaulting party may terminate the agreement, suspend deliveries (if the non-defaulting party is the seller), terminate an individual cargo if the agreement covers the delivery of multiple cargoes or set-off amounts due against the defaulting party’s liabilities under the contract or any other contract between the parties.	The relevant provisions apply equally to ‘shipped’ ‘delivered’ and ‘spot’ cargoes. Once a counterparty is insolvent or deemed insolvent, in accordance with the contractual definition, the contract shall be deemed to be discharged at the market price and the owing party must pay any damages immediately. If the parties have concluded additional contracts between themselves, those contracts shall also be deemed to be discharged at the market price. Similarly, any damages shall be paid immediately by the owing party. Any amounts due between the parties under the insolvency clause shall be set-off against each other prior to settlement of the contract.

Related Client Alerts

Please also refer to our recent client alert, 'The Impact of COVID-19 on International Trade'.

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1. A bailee is a person who holds property belonging to another person and an arrangement by which that occurs is known as a “bailment”. For example, a warehouse keeper is a bailee of the property belonging to others in its warehouse.
2. The Refined Sugar Association and Sugar Association of London Rules do not contain separate insolvency provisions.
3. All GAFTA contracts contain the same insolvency provisions.
4. All FOSFA contracts contain the same insolvency provisions.

Client Alert 2020-410