Recognising and dealing with insolvency in your customers

Top Tips

1. Identifying and managing financial difficulty in your customers or clients is essential to minimising economic risk in your own business.
2. In addition to preliminary protective measures at the commencement of a trading relationship, continued monitoring and attention to your customers’ financial performance and business practices can reduce exposure and potential losses.
3. Be proactive in your account management: enforce payment terms, chase outstanding amounts, or negotiate settlements, and be prepared to escalate recovery processes in order to protect your interests.

In our seventh episode, we looked at key indicators of insolvency in your own businesses and options on how to manage that situation. In our eighth episode in this series, we discuss the warning signs of insolvency to look out for in your customers or clients, and what steps you can take to best insulate your business from the impacts of your customer’s financial distress or insolvency.

Identifying financial distress in customers

Financial hardship in an entity that buys your goods or services can have significant, adverse effects on your business and could be fatal to your operations. Failure of your clients to pay your invoices will invariably have a downstream effect on your revenue. Therefore, being able to identify deteriorating financial conditions or insolvency in your customers or clients is a key business management skill.

There are numerous indicators of financial distress in your customers, some of which include:

• Payments well outside terms, particularly where there is a negative change in the payment performance (for example, a customer that used to pay on time has become delinquent with payments), or payments in round-sums or amounts that do not correlate to invoices issued.
• Seeking extensions of time to pay or reductions of invoices, or disputing invoices to avoid payment in part or altogether.
• A communication breakdown with the customer, potentially involving your contact person going “missing”, or a change in key personnel.
• ASIC searches shows significant changes, including registration of judgments and increased credit checks on the client company.
• Increased reporting of insolvencies in your industry, including of parties you know to be upstream to your customer.

Practices that can minimise risk

There are certain practices that a company can implement to safeguard its interests and minimise risks against the potential consequences of customer insolvency, both at the commencement of the relationship and then as trading continues.

Preliminary protective measures:

• comprehensive initial checks on customers, particularly when extending credit
• ensuring contract terms (particularly with respect to payment) are robust and fit for purpose, and
• taking security, including registering any security interest on the PPSR (see Episode 6 of our series).

Ongoing management:

• maintaining complete records, utilising accounting software that monitors payments where possible
• invoicing regularly so that delinquency in payment is more easily identifiable
• continued monitoring of payment performance and active engagement with customers throughout the relationship, and
• regular checks on the financial health of customers (for example, by way of ASIC and PPSR searches).

Proactive management and recovery

As an informed business owner, you are best placed to diagnose the difference between a simple missed payment of an invoice here and there, and a significant and bigger financial problem in your customer. If you are concerned that it may be the latter, this should be met proactively by pursuing debt recovery measures as quickly as possible, to avoid deterioration that impacts your business, and these may include:

• Enforcement of security: if your terms of trade allow it, you may be able to enforce against any security your customer has given for performance of its payment obligations.
• Letter of demand: normally the first step in recovering a debt, often a letter foreshadowing more substantive action if the debt is not paid can result in prompt payment and avoid any further delay and cost.
• Statutory Demand: this is a formal demand that can be issued on a debtor company where there is no dispute about the debt being claimed. Once served, the debtor has 21 days from the date to either pay (or provide security for) the debt in full or file an application in court to have the demand set aside, failing which the company is deemed insolvent under s 95A of the Corporations Act and can be the subject of winding up proceedings.
• Legal proceedings: if there is a dispute about the debt, or the debtor isn’t a corporate entity, it may be necessary to commence court proceedings with the view to obtaining and enforcing a judgment against the debtor.

What if the customer is actually insolvent?

Despite taking all proactive measures to insulate against it, customer insolvency might sometimes be simply unavoidable. In some cases, the insolvency might be the result of you taking measures to enforce your debt.

Where your corporate customer goes into external administration (most commonly, liquidation or voluntary administration), or your individual customer becomes bankrupt, any claim you have for outstanding payments becomes a claim in that administration. In those circumstances, you will be entitled to, and should, lodge a proof of debt notifying the administrator of the quantum and detail of your claim. This will give you the right to participate in meetings, to vote on what action is taken by the administrator, and to receive a dividend (share) of any assets that are recovered.

Conclusion

Recognising and dealing with insolvency in your customers can be difficult and time-consuming, but it is an essential element of protecting your interests, ensuring you are paid for the goods or services you provide, and minimising losses.

While debt recovery action can be daunting, it is wise to seek advice as soon as a customer has stopped making regular payments or once a debt becomes outstanding so your business doesn’t suffer the consequences of non-payment.

In the next part of our series, which will recommence in February 2024, we will move on to discussing breakdowns in shareholder relationships and exploring the different avenues to resolution.