When a customer goes bust

It can really hurt when one of your customers go bust. You are left with outstanding bills and wondering if you will get paid. While you wait to find out if your debt is going to be cleared, your cash flow will suffer.

In Australia, company insolvencies can take a number of forms but are essentially defined as a company's inability to pay all their debts as and when they fall due. On average 24,000 individuals and 10,000 businesses become insolvent each year, although according to the Australian Securities and Investment Commission, approximately 50 percent are avoidable.

When your customer goes bust, it can be frustrating and confusing not knowing where you stand. Safeguard your cash flow by ensuring you have a basic understanding of insolvency in Australia.

Type of insolvency

In order to understand where you sit when your customer goes bust, it is worthwhile knowing a little bit about each type of insolvency. If you know what type of insolvency your customer is under, you will better understand your rights and what steps to take to recover your money.

1. Voluntary administration

As the name suggests, voluntary administration is a voluntary action by the directors of a company which is suffering financial troubles. The directors or a secured creditor appoint a voluntary administrator to take charge of the company's assets; essentially to provide the company time to resolve its future. During voluntary administration, creditors can vote on the future of the company at 'meetings of the creditors'. Depending on the votes from the meeting, at the end of voluntary administration, the company will likely enter a deed of company arrangement, go into liquidation or will be returned to the directors.

While under voluntary administration, there are a number of restrictions which apply to you:

  • a creditor cannot begin, continue or enforce a claim without consent of the administrator or the court
  • a secured creditor cannot enforce their charge over company assets, except in limited circumstances.

If your customer enters voluntary administration, you can notify the administrator of your claim by completing a 'proof of debt' from (available from the administrator). When making a claim, attach copies of all relevant information (invoices and supporting documents). However, be aware that you will not be paid during the voluntary administration period, only once the company enters a deed of company arrangement or liquidation.

Any debts accrued from the voluntary administration are paid from the available assets or are covered by the voluntary administrator. As such, you can continue to supply the customer and it is recommended you do so. It is much harder to collect payment from a company which is winding up but it will need to have suppliers in order to survive. However, if you do decide to continue supplying, ensure you receive a purchase order as advised by the voluntary administrator.

2. Receivership

A company goes into receivership when a secured creditor appoints a receiver to collect and sell sufficient assets to pay a debt owed to the creditor. As such, the receivership only relates to the single creditor taking the action and therefore the receiver has no obligation to advise other unsecured creditors of their appointment; although, they often will. Once the debt is repaid and the receiver has completed their duties, the receivership ends and unless another external administrator has been appointed, the company will return to trading as normal.

As the receiver sells the assets to cover the charge, the company can continue to trade. Therefore, as with voluntary administration, you can continue supplying the company. Just ensure you have an authorised purchase order and it is advisable to request cash on delivery rather than providing a credit account, at least until the receivership ends.

The receiver has no obligation to pay unsecured creditors for outstanding invoices. However, if the company owes you a large amount, you can still commence or continue legal action.

3. Deed of company arrangement

A deed of company arrangement (DOCA) is a binding arrangement between a company and its creditors dictating how the company's affairs will be dealt with. A DOCA aims to increase the chances of the company continuing to trade and the ability to pay creditors rather than winding up the business. The terms of the deed will determine the order in which creditors are paid.

During voluntary administration, you will have had the opportunity to vote at the 'meeting of the creditors' on the future of the company. Even if you voted against the proposal, or didn't vote at all, a DOCA binds all unsecured creditors.

To make a claim, you will need to provide the administrator proof of your debt and complete a claim form. You should ask the deed administrator to confirm receipt of your claim and advise you if they require further information. It is possible the administrator will reject your claim, in this instance contact the administrator as soon as possible as you may have a limited time to challenge the decision.

4. Liquidation

Liquidation is the winding up of a company's affairs, including the termination of the company's assets and operations. The proceeds are distributed among its creditors with the remainder paid to its shareholders. There are three types of liquidation:

  • court
  • creditors voluntary
  • members voluntary.

The liquidator will advise all creditors of the liquidation and provide a deadline to make a claim (at least 14 days after notification). The notice of liquidation must be published in a daily newspaper in each of the states where the company operates. To make a claim, you will need to submit your proof of debt forms. Be sure to ask for a receipt of your claim.

As with a DOCA, your claim may be rejected and you will have a period in which you can appeal the rejection. Seek legal advice if you are unsure.

Available funds are distributed in a pre-determined order, starting with the costs of liquidation and finishing with unsecured creditors in the final category. In all cases, you can reduce the risk to your business and cash flow if a customer becomes insolvent by taking it one step at a time.

  1. Remove the customer's credit limit - at least until you know what the situation is and you know what the risk would be.
  2. Establish what the customer owes you.
  3. Gather documentation to support your claim.
  4. File a claim, even if it is a small amount. It is better to get a small recovery than none at all.
  5. Keep the return receipt with a copy of your claim in a safe place.
  6. Read everything you are sent carefully.

Remember that each situation is unique so it is advisable to seek the advice of a professional (financial counsellors, registered trustees, accounts or lawyers) if you are unsure.

While there is little you can do to avoid a business from becoming insolvent, you can take some simple steps to prevent the pain in the first place:

  1. Before supplying credit to a customer check their credit report - visit dnb.com.au for more information.
  2. Implement a solid accounts receivable policy which ensures that invoices are issued promptly and provides guidelines for chasing overdue accounts.
  3. Monitor your customers' risk and payment profile on a regular basis so you know if or when their financial position changes.

This can be achieved by using a monitoring system which alerts you to changes when they occur or it could involve ordering a credit report on each of your customers at specific intervals (at a very minimum this should be done annually).

 

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