In brief - Well drafted trading and credit terms can
help your company avoid bad debts
Seeking director's guarantees, following your credit
policies and including recovery costs, interest clauses, general
security and retention of title clauses in your trading terms can
help you manage cash flow and prevent bad debts.
Company liquidation often due to poor management of cash
According to the Australian Securities & Investments
Commission's report Corporate Insolvencies: December quarter 2014, in the
second quarter of the 2014-2015 financial year, over 2,000
companies entered external administration. A major cause for
companies entering external administration is poor management of
the company's cash flow, in particular its accounts
receivables. In addition to the risk of liquidation, lack of cash
flow can lead to other problems such as:
An inability to meet statutory obligations such as taxation
liabilities and employee superannuation contributions
Inability to pay creditors on time (and the imposition of
interest and other charges and penalties)
Poor credit rating
Unwanted demands or court summons from creditors
An increase in doubtful and bad debts
Diminution of the company's value
Although there are often factors outside the control of the
company that lead to its debtors being unable to pay their debts as
and when they fall due, there are certain factors that a company
can control, such as its trading terms.
Companies that spend time drafting proper trading and credit
terms will enjoy more liquidity and fewer headaches when they have
to recover their debts.
Seek director's guarantees and indemnities
Director's guarantees and indemnities are standard practice
in many industries. A director's guarantee and indemnity is a
legal undertaking, by the director of the company, that the
director accepts personal liability for the debts of his or her
company. Guarantees can also provide security over the
director's property if drafted correctly.
In order for a director's guarantee to be effective,
companies must ensure that the terms of the guarantee and indemnity
are clear and reasonable and, if the guarantee seeks an interest
over the director's private property, that the terms comply
with the real property legislation in the particular
Include recovery costs and interest clauses in your trading
A company wishing to pursue its creditors for debt should be
able to recover its enforcement costs and charge interest for the
period the debt has been unpaid. A good credit application includes
indemnity provisions for the company's enforcement and recovery
costs and a fair and reasonable amount of interest to be charged
for overdue invoices.
Without such provisions, companies that are required to commence
legal proceedings will be without grounds for seeking indemnity for
their legal costs (which will result in the company's net
return from the debtor being reduced) and will be forced to seek
the default interest rate provided by legislation (which is often
set at cash deposit rates). It is also important that these types
of provisions are worded correctly so a court will not consider the
interest clause to be a penalty.
Include general security and retention of title clauses
If a company wants to register an interest over its
customers' personal property, over goods sold on credit or over
hire equipment, it must ensure that the security clauses in its
trading agreements (or the clauses in its separate security
agreements) comply with the Personal Property Securities Act.
Strictly follow credit policies and enforce trading terms
Debtors do not always pay their debts simply because a document
obliges them to. A company must apply its internal credit policies
and enforce its credit terms strictly to obtain the maximum benefit
This includes ensuring that credit agreements are signed by the
proper person or entity, that customer signatories have authority
to bind their companies, that credit ceilings are enforced and
trading halts are imposed when necessary.
By implementing these features in your business, you may prevent
bad debt from being incurred and avoid having to write off debts
due to lack of debt recovery options.
When determining if a DOCA is to be terminated, public interest can, and often will, outweigh any benefit to creditors.
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