UK: How To Avoid... Bad Debt, Credit Risks And Missing Out On Debt Recovery

Last Updated: 19 March 2012
Article by Cassandra McCarthy

In the third of our new series of articles on "How to Avoid..." common legal problems, Cassandra McCarthy looks at the steps that you can take to avoid bad debts and credit risks, and provides some practical advice about how to recover debts.

Key Points to Remember:

How to Avoid... bad debt, credit risks and missing out on debt recovery:

  1. Know your client
  2. Obtain signed Terms of Business
  3. Take steps to recover the debt
  4. Consider Insolvency or Court proceedings

In the current climate it is commonplace to see credit periods being extended by businesses. Debt is also turning into bad debt, which cannot be recovered due to the debtor being insolvent. This article looks at the practical ways in which you can avoid bad debts. If a debtor is not settling his debt, you will need to assess whether it is a situation where the debtor will not pay or cannot pay. This article provides you with helpful tips and guidance on how you can decide whether it is worth pursuing the debt and if so how you can recover the unpaid invoice.

1 – Know your client

It is important to first assess whether you should take on a new customer. You should consider whether they had a previous supplier and if so establish why they left that supplier - for example, was it because they were unable to pay their invoices and they are now shopping around for a new supplier to obtain more credit? It is always worthwhile carrying out credit checks on a potential new client. This will give you an initial view of the company and its financial position. As the market is competitive in the current climate any new client is an attractive prospect, however, do not be blinded by this. Take the time to do the initial research into the customer, as they may not actually be a worthwhile proposition.

2 – Obtain signed Terms of Business

We strongly advise that you have Terms of Business in place. You need to make sure they are clearly and comprehensively drafted. If they are not, then they may not be worth the piece of paper they are written on. You need to ensure that they cover your business needs and clearly deal with payment terms and expectations. The Terms should set out concisely your rights of remedy in event of default of payment.

Companies often have Terms of Business but for them to be enforceable they need to be incorporated into the contract. You should take all necessary steps to bring the Terms to your customer's attention, such as notifying them of the Terms in advance of an order; placing them on your website; or having them on purchase orders. It is best practice to obtain a signed acknowledgement from the customer, acknowledging that they have read and understood the terms. For more advice on how to successfully incorporate your Terms of Business, see our earlier article How To Avoid... Disputes over your Terms and Conditions.

A clause which should be considered and which may help you to recover goods or their proceeds of sale in the event of a customer becoming insolvent is a Retention of Title Clause (also known as an ROT Clause or Romalpa Clause). You should however seek advice on the drafting of an ROT clause, as if worded incorrectly it will not be enforceable.

Further terms that should be considered include terms relating to:

  • Payments on account for services
  • Deposits for goods

We recommend that you seek assistance with the drafting of Terms of Business, to ensure that all recommended terms are included and are fully enforceable. Our Commerce and Technology Team have extensive experience in drafting tailor-made Terms and Conditions to meet your business needs. Please contacMark O'Shea of our Commerce and Technology Team if you would like further details.

3 – Take steps to recover the debt

It is vital that you act quickly if you suspect that a customer may be having financial difficulties, as any delay can potentially mean the difference between recovering an overdue payment and being saddled with irrecoverable bad debt. Do not expect your customer to tell you if they are having problems, as they will often be in denial themselves regarding how bad things have become. If even one invoice is overdue then you should consider very carefully whether it is in your best interests to continue to supply the customer with goods/services.

It is also recommended that you have an internal procedure in place to recover bad debt, which should include:

  • An initial phone call to the debtor from your Credit Controller. You can often gauge the position of the other side with such a call, especially in relation to whether it is a matter of them not being able to pay as opposed to not being willing to pay (which may happen if, for example, they are getting more pressure from their other creditors).
  • A 30 day letter – this letter can simply state the sum that is overdue and that payment is required immediately.
  • A 60 day letter/letter before action – before court proceedings are issued you must send a letter before action. If you do not you could be penalised in relation to costs later (i.e. even if you were successful in your claim, the court may not award you your legal costs). The letter should give details of your claim, for example, how much is due, when it was due, what services/goods were provided and what invoice the claim relates to. It would normally be best practice to send a copy of the invoice too.

Interest can be claimed either in accordance with your Terms of Business, or if there is no interest provision in the Terms, under the Late Payment of Commercial Debts (Interest) Act 1998.

4 – Consider Insolvency Proceedings or High Court/County Court Proceedings

If the above steps do not work, then you will need to decide whether you wish to take the next formal steps to try to recover the debt.

If there is a genuine dispute between the parties or there is a counterclaim then High Court or County Court proceedings should be considered (depending on the amount in dispute). If there is no genuine dispute over the debt, then insolvency proceedings may be more appropriate.

County Court / High Court proceedings

If you have decided to issue County Court or High Court proceedings, you will need to commence formal proceedings by issuing a Claim Form and Particulars of Claim at the Court. The parties will have to follow the Court's Civil Procedure Rules throughout proceedings.

Claims up to £5,000 are allocated to the small claims track unless there are complicated legal issues. The relatively informal procedure for small claims is designed to allow parties to conduct litigation without the need for solicitor's. Legal costs are not therefore usually recoverable for small claims.

For claims over £5,000 it is advisable to instruct solicitors to obtain assistance with the conduct of the claim, in particular to ensure that the correct procedures are followed.

If you are successful in obtaining a judgment against the debtor from the Court, you will then still need to enforce the judgment. This is why it is important from the outset to assess whether the defendant is good for their money. A judgement will be all but meaningless unless the debtor has assets against which the judgment can be enforced.

Insolvency Proceedings

When issuing an application for a Winding Up Order against a company or Bankruptcy proceedings against an individual, you will need to demonstrate that the company/individual is unable to pay their debts as they fall due. You can usually achieve this by sending a Statutory Demand to the debtor. If the Demand is not satisfied within 21 days, the debtor will be deemed insolvent and it will then be open to you to either issue a Winding Up Petition or Bankruptcy proceedings. For more information about establishing that a debtor is insolvent, see our article Off Balance? The test for Creditors just got harder.

At this stage it would be advisable to carefully consider whether there is any realistic prospect of recovery before you embark upon insolvency proceedings. As an unsecured creditor it is likely that once the company is Wound Up/individual is declared bankrupt, you will only receive a nominal amount, if anything, in respect of the debt owed. You would have to bear the costs of issuing the insolvency action, but you may not necessarily receive anything back, and you would not be put in a better position than any other unsecured creditor just because you commenced the insolvency proceedings. If you reach this stage, you may need to focus on taking steps to avoid throwing good money after bad. The threat of insolvency will usually force a debtor to settle the debt if it is feasible for it to do so, but if it doesn't then you may be facing a Pyrrhic victory.


Prevention is always better than cure, so it is vital to get to know your client in the first instance and assess how much credit you give. Ensure that you have safeguards, such as having your Terms of Business signed, which should clearly set out your rights to remedies in the event of non-payment. As soon as you suspect there is a problem with payment, do not give any further credit and take the first steps to recover the monies owed. If you are then in the unfortunate position where payment is still not made, you may need to consider issuing either County/High Court proceedings or Insolvency Proceedings to recover the debt.

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.

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