Australia: What to do when your customer becomes insolvent

Last Updated: 17 October 2018
Article by Catherine Ballantyne

It is an unfortunate reality that your business can be severely affected when one of your customers become insolvent. Special Counsel Catherine Ballantyne outlines some strategies for minimising your exposure to risk in such circumstances.

It is an unfortunate reality that your business can be severely affected when one of your customers become insolvent. It can be financially crippling on your business and emotionally stressful for you. Although you cannot control the financial viability of your customers, there are a few strategies you can implement to minimise your exposure when your customer is in financial distress.

In the beginning

It is important at the start of a new business relationship that you implement some strategies which can minimise your exposure if your customer is insolvent:

  1. Perform a credit check prior to agreeing to supply your goods or service. If they have a bad credit history request funds upfront or cash on delivery.
  2. Ask for a personal guarantee from the director (if you are dealing with a corporate entity) and perform a property search to see if the director owns any property in their personal name. This allows you to seek payment from the director personally if an administrator or liquidator is appointed to the corporate entity.
  3. Have your paperwork in order – whether it is a contract or your standard terms of trade, ensure that it is current and able to be relied upon if enforcement is required to procure payment.
  4. Be aware of the Personal Properties Securities Act – seek legal advice as to whether you are able to register your interest on the Personal Properties Securities Register ("PPSR") and ensure it is done correctly and as soon as possible.
  5. Ensure that your PPSR interest is registered over the correct entity – In many cases if you are dealing with a trading trust, you need to be careful that you are securing the trust's property and not just the assets of the corporate trustee. This is because a corporate trustee often does not have any assets of its own. It is a common mistake to register a security interest over only the corporate trustee and not on the ABN of the trust.

Once you are trading

You should constantly be vigilant throughout your business relationship to ensure that you keep your exposure to a customer's insolvency in check:

  1. Invoice often so that if your customer is under financial stress you are aware of it sooner rather then later.
  2. Be firm about your terms of trade – do not allow outstanding amounts to get out of control and be prepared to stop supply if payment is not forthcoming.
  3. Keep your paperwork up to date – ensure that any personal guarantees cover all amounts owing and that PPSR registrations are current and do not need to be updated for new equipment or new security interests.
  4. Be prepared to take legal proceedings – although it may not be palatable, sometimes the only way in which to be paid is to have your lawyers commence legal proceedings.

Once your client is insolvent

Once an administrator or liquidator is appointed to your customer there are some important tricks to be aware of:

  1. Seek advice to confirm if you are a secured creditor – secured creditors enjoy priority over unsecured creditors pursuant to the Corporations Act and your registration on the PPSR if registered correctly will usually afford you the rights of a secured creditor.
  2. If you are a secured creditor do not file a proof of debt with the administrator or liquidator. In some circumstances, submitting a proof of debt and voting in creditors meetings based on this proof of debt can be deemed as surrendering your security and becoming an unsecured creditor. You need to write separately to the liquidator / administrator to make them aware of your security.
  3. If you are an unsecured creditor ensure that you submit a proof of debt with all of the relevant contracts, terms of trade and invoices attached to ensure that you are able to vote at creditors' meeting and receive any dividend payable by the liquidator.
  4. Stay informed – make sure that your contact details are current, read the administrator's or liquidator's reports carefully, asks questions and attend creditors' meeting. This will assist you in knowing what return you are likely to expect, allow you to vote whether to accept any deed of company arrangement proposed and be aware of any Court proceedings the liquidator has filed.
  5. Be aware that any payments you have received from your customer in the 6 months prior to company being placed into administrator or liquidation could be attacked by a liquidator as an unfair preference. If this occurs seek legal advice as to the strength of the liquidator's claim and the best strategy when negotiating with the liquidator.

In summary

Although a customer's insolvency cannot be avoided, if you follow these tips you place yourself in the best possible position for recovery.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Madgwicks is a member of Meritas, one of the world's largest law firm alliances.

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