What to do when dealing with a customer or supplier of questionable solvency.

14 March 2022

Times can be tough for businesses. Given COVID-19 lockdowns, tight border restrictions, increasing costs of materials and labour shortages, we are seeing more businesses facing financial distress. As a natural progression, a number of businesses are having to transact with others facing financial difficulty.

If you find yourself dealing with a supplier, customer or counterparty of questionable solvency, below are some options you may want to consider:

Proof of solvency

Request a statement from the directors or principals, giving assurances that the business is solvent and will be able to pay debts as they fall due. That assurance can provide you with some confidence before you commit to any transaction. Such assurances can generally be relied on and the Courts (where companies are involved) have ruled that directors may be held personally liable for misrepresentation if making assurances of solvency without carefully examining the company’s current and future financial position.

Register a Security

It is common commercial practice to supply goods, machinery, or other assets to a business, invoicing them at a later date. If you are at all worried that the business that you are dealing with may not be able to pay the invoice when it falls due, you can register a security over the goods supplied on the Personal Property Security Register (PPSR). This can ensure that if the business is wound up, and you have not yet been paid, you will be able to claim the return of the goods before they are included in the business’s inventory when liquidating the business. It will also give you an enhanced claim in any proceeds of liquidation of the business.

To be able to register a security on the PPSR you will need consent to do so from the business that owes you the money. That might be included in your terms of trade, or it could be a specific consent from that customer. You will also need to make sure that you have the legally correct name of the business/customer to register the security against.

Seek Payment up Front

You may also wish to seek either all, or part, payment up front for goods or services to be delivered. Requesting payment in advance of delivery, or contemporaneously with delivery, reduces the risk of non-payment. It may also act as an early warning if a customer is unwilling or unable to make an initial payment.

Compromising as a Creditor

If you are a creditor of a business that is in financial distress, the business may reach out to you in attempts to negotiate the amount of debt owing or extend the time to pay the debt. Businesses will often use this tool if they are insolvent (or nearing insolvency) but can restabilise their financial  position by restructuring their debts.

As a creditor, whilst agreeing to reduce the debt you are owed will result in a loss, it may be beneficial in the long run. If you have had or are likely to have a long term relationship with the insolvent business, throwing them a lifeline and agreeing to accept a lesser amount, and/or an extended time for payment, may prevent that business from being wound up, keeping the doors open to you for future business opportunities.

Compromises by a creditor can be made informally or as a commercial agreement, binding only the creditor and the distressed business. Compromises can also be made formally under the Companies Act where all creditors vote on the proposed terms of the compromise, binding all creditors if passed by a majority.

Norris Ward McKinnon is experienced in dealing with all matters outlined above, and we welcome the opportunity to discuss these with you.

Tom Corkill is part of our Corporate & Commercial team at Norris Ward McKinnon.

Corporate & Commercial Team