Increases in late payments of invoices, dishonoured payments and post-dated cheques are all indicators that a debtor may be experiencing financial hardship or possibly headed for insolvency (if they are not there already).
Once a person or company is declared insolvent, their creditors must go through the process of proving their debt in the bankruptcy or liquidation, in order to recover any outstanding monies owed to them and typically only recover a fraction of what they were owed.
So what is a creditor to do? The first inclination of many is to quickly and aggressively recover whatever they can, before the ship goes down. However, this is often not the best course and may lead to further unnecessary legal disputes down the track.
Why creditors need to tread carefully around a financially troubled debtor
Once a debtor becomes insolvent, a liquidator or trustee in bankruptcy is appointed to manage their affairs. One of their main tasks is to scrutinise the company’s financial records in order to determine whether payments made just prior to the insolvency were authorised and identify any “voidable” payments.
Yes, certain payments made prior to the company entering liquidation or bankruptcy can be voided and clawed back from a creditor by the liquidator or trustee. This means that a creditor who managed to coerce payment of their debt prior to the debtor ‘going under’ can face costly recovery proceedings from the liquidators for repayment of such amounts. The creditor will then be forced to prove their debt in the insolvency like all the other creditors, and receive their outstanding debts at X cents to the dollar.
What payments can be clawed back?
Creditors are commonly affected by ‘preference payments’. This is a payment made by the debtor:
- within 6 months prior to winding up or bankruptcy;
- while the debtor was ‘insolvent’ (unable to pay their debts when they fall due); and
- where the person to whom the funds were paid received an ‘unfair preference’ by receiving the payment.
It’s possible for a creditor to defeat a preference claim by a liquidator by proving that the payments were received in good faith and that neither they nor a reasonable person in their position had any suspicion that the debtor was insolvent at the time of the payment. In any event, it is typically a stressful and costly process.
What to do if you suspect financial trouble
Creditors can avoid unnecessary legal dramas at the outset, by taking the following action when faced with a debtor who is struggling to pay bills on time.
- Attempt to determine the debtor’s true financial position. Raise your concerns with the debtor personally or make independent enquiries with regulatory bodies.
- Get legal advice on how you can bolster your supply terms to better protect you. For example you may be able to include some form of security such as a retention of title clause. (Only unsecured debts can be the subject of preference claims.)
- Seek legal advice from an experienced insolvency lawyer on the most efficient way to go about recovering your debts.
Are you looking for a debt collection agency? Please contact with us at 1300 668 699 or visit our office in Sydney, Melbourne, Canberra.