Almost all business owners will tell you that chasing payment of overdue accounts is a tiresome yet inevitable part of running a business. Often these debtors who fail to pay their accounts on time (or at all!) are customers or clients making the process even more sensitive. So, for business owners, gaining a better understanding about the debt recovery process really can make life a lot easier as well as easier to avoid.
This guide will provide business owners with a list of actions to follow when faced with debt recovery, and explain the pros and cons of the options available to them as part of the process. It is not intended as a substitute for legal advice but can be used to review your current debt recovery and avoidance strategy.
Step 1: Define the legal right to seek payment
For a commercial creditor (your business), the first step in seeking recovery of a debt is defining the legal right to seek payment of that debt. To do this, go back to the source of the debt, i.e. the contract or agreement which gives rise to an obligation by the debtor to pay you a specified sum of money. Consider the following:
Do you have a legally binding contract with the debtor?
In order to recover monies from a debtor, you will need to establish that there is legally binding contract in place. To be legally binding, a contract must
contain four essential elements:
- an offer to enter into the agreement
- acceptance of that offer
- intention to create a legal relationship
- consideration (usually money).
A contract will not be legally binding if it entices someone to commit a crime, is illegal, or is entered into by someone that lacks capacity (such as a minor or bankrupt), or if it arises out of misleading or deceptive conduct, duress, unconscionable conduct or undue influence.
What is the form of the contract?
The law recognises that contracts can come in many different forms. They can be verbal (spoken), written or a combination of both.
Written contracts will often comprise a standard form or bespoke agreement, or a letter stating the terms of the agreement. Written evidence of a contract may also include other communications such as emails and text messages.
A written contract is easier to prove and so will always be preferable over a verbal contract. If you can produce a signed copy of the contract it will also help to prove that there was an agreement and what are the terms. However, whilst signed agreements are definitely preferable, a legally binding agreement may still be enforceable even where one or more parties have not signed written terms.
What are the payment terms under the contract?
The terms of the contract should establish when the debtor was required to pay. If the contract is silent on this point then ask, were any verbal undertakings by the debtor? If not then payment terms may have been implied between the parties. Even previous payment history may provide an indicator of this.
Step 2: Determine exact amount of debt
It goes without saying that business owners should always take care to ensure that the amount which is sought is correct and matches the terms of the contract. Any errors in the amount sought will likely add further complication and increase delays in the recovery process.
What amounts can I claim under the contract?
When determining the amount of the debt, look to the terms of the contract and if applicable, take into account any agreed variations. Ensure that you have also met your obligations under the contract (such as the provision of goods or services) which then triggers the contractual right for you to seek payment.
Consider whether there is any contractual right to seek payment of interest/costs/liquidated damages (note the law requires that liquidated damages must be reasonable and not in the nature of a penalty). Finally, double check all figures! It is surprising how often and easily errors can occur when undertaking calculations.
Is there a dispute about the debt?
Sometimes a debtor may refuse to pay because there is a dispute in relation to the debt. If this happens, consider the following:
- Is the dispute genuine and does it have merit?
- Does the contract include a process for dispute resolution and if so, have the parties followed that process?
- What steps (if any) have been taken to try and resolve the dispute?
- Is there anything further that the parties can do to try and reach a resolution?
Where a debtor has raised a genuine dispute about the debt, then you should always try and respond appropriately. This may bring about a resolution and result in payment. Even if the parties cannot agree, a discussion about the dispute could still help to better define the issues in contention.
Step 3: Consider options for recovery
You have now established your legal right to payment of the debt, the next step is to consider the available options for recovery. These include:
- Sending a letter of demand. Before commencing any recovery action you should start with a formal letter of demand. This letter may be relied upon in any later court proceedings so it is usually beneficial to engage a solicitor to prepare it. This also will give the letter greater persuasive force, and help ensure that it does not contain errors.
- Engaging a specialist debt collection agent. Debt collection agencies will act on your behalf to collect the debt or in some cases, they may even agree to buy the debt from the creditor. Agencies can be useful when the debtor’s location is not known. The downsides are that agencies will often charge the creditor a sizeable fee, will pay little or no regard to client relations and may render the creditor liable if their debt collection practices are in breach of the law.
- Serving a statutory demand. Where the debtor is a company, and the amount of the debt is over $2,000, a statutory demand will require that the debt be paid within 21 days. A statutory demand is a statutory instrument under the Corporations Act. If the debtor fails to pay the debt or raise a genuine dispute about it then the creditor can apply to the Court for an order to wind up the company on the basis that it is insolvent. Whilst a statutory demand is intended to be part of the liquidation process (rather than a debt recovery tool), it can work to place substantial pressure on a debtor to pay the debt in order to avoid liquidation. There are complexities and particular requirements for statutory demands, as well as significant costs considerations. It is therefore best to seek legal advice if considering making a statutory demand against a company debtor.
- Considering the creditor’s rights in respect of any security or other legal interests. Such rights may arise for example where the creditor holds a security interest under the Personal Property Securities Act, is entitled to exercise a lien over property or may be able to sell unclaimed goods and apply the proceeds of sale to the outstanding debt.
- Considering whether there any other available options/solutions which the parties are prepared to agree directly between themselves in order to resolve the debt. A commercial agreement of this kind gives the parties the flexibility to negotiate terms which are acceptable to them, therefore avoiding unnecessary costs and helping to preserve business relations. Some common options include agreeing on a payment plan, or exploring options for potential set-off of the debt by way of a contra deal. However the sky is the limit and the parties should be encouraged to think broadly and commercially when exploring viable options for resolution. Just remember that if an agreement is reached then it should be properly documented in writing. This will not only give the parties a clear record of it, but will also help ensure that they are clear on their respective obligations.
- Commencement of Court proceedings. The creditor can apply to the Court seeking an order that the debt be repaid, as we all as other orders such as for return of goods, interest and costs. Whilst court proceedings can often be effective, they are costly, time consuming and offer no guarantee of success. For these reasons, litigation is usually the last resort after all other available options have been exhausted.
Whilst debt recovery is generally a fact of life for business owners, you can help to minimise the risk of default and better manage the debt recovery process by taking the following steps:
- Ensure that you have written contracts in place which have undergone proper legal review;
- Implement robust credit policies and procedures, taking into account the need for credit reference checks and upfront payment; and
- Consider what, if any, security interests may be available to secure the debt.
If this article has raised any concerns for your business, or if you need help with debt recovery, get in touch with Karina McDougall for a complimentary initial discussion on 1300 565 846 or via email email@example.com