What to do when your customer goes bust
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It’s a familiar story. There have been rumours going around the market that one of your customers is in trouble, you have tried speaking to them and have either not been able to get hold of them or have been fobbed off with vague reassurances, but despite your best efforts they haven’t paid you.
Then, you get a letter from a firm of accountants referring to a creditors’ meeting containing some basic information about time and place and a proxy form but it doesn’t help you very much.
You conclude that is the end of the story isn’t it? There’s nothing coming back, you are wasting time, there’s nothing you can do so time to move on?
There are things you can and should do.
And that is where this Galen Partners Business Guide can help you.
What should you do when a customer goes bust?
Receiving such a notice means it’s time to take urgent action that is critical to your business.
Too many businesses become passive creditors – just ready to accept whatever outcome happens without ever understanding or becoming involved in the process.
So what can you do?
Understanding the processes and how to look after your interests
The first stage is to understand the basics of the process, the procedure, who the key players are, where you rank, and what rights you have as a creditor in each.
Typically there are three procedures that you might be notified of, Administration, Company Voluntary Arrangement (‘CVA’) or Liquidation, and each of these has its own specific rules, time scales, intended objectives and likely outcomes.
While in reality the scope for the insolvency practitioner (or IP) and creditors to influence the outcome is typically far greater for example in a CVA (which should involve an element of negotiation between the parties), than in a liquidation (which should involve the most cost effective collection and realization of the business’s assets); it is never the case that the procedure is completely beyond your control.
However, to achieve the best outcome for your business from the situation, you do need to be an active creditor, which means taking basic steps to ensure you:
- minimise your exposure,
- maximise your recovery,
- minimise your business risk, and
- exploit any opportunities that may occur.
This short guide is intended to help you with each of these steps and to act as a remedial actions checklist in the event of customer failure.
1 Minimise your exposure
The first thing to do when you have a potential bad debt is to take all appropriate and available steps to minimise the size of the problem. This will be a mix of:
- activating precautionary measures which you already have in place (after all, if you don’t action them, there’s not much point in having them is there?); and
- complying with the requirements of the process to formalise and protect your claim.
So the specific actions required are:
- Check your terms of business to see if they give you any pre-emptive rights in these circumstances that can help you minimise your exposure or achieve a payment. Examples of this would include checking to see if you have any form of rights, security or leverage such as Retention of Title clauses, Personal or Cross guarantees, or Liens that you can exercise; and then taking the necessary steps to enforce these.
It is a good point of principle to check regularly your terms of trade and if they haven’t been updated for some time you should arrange to do so. Failing to give yourself the maximum ability to recover a potentially bad debt due to out of date or poor contractual terms can be an expensive mistake.
- Check your commercial position. Will you be in a position to obtain a ransom payment from any successor business to enable you to recover your loss?
- Make any insurance claim you can. Do you have the debt insured or is it factored? If so what are your obligations re notification and have you complied with them?
- Make sure your claim is recognised in the insolvency. Ensure you complete the necessary proof of debt form(s) and provide the necessary supporting information within the prescribed time limits to avoid your claim being rejected.
2 Maximise your recovery
The second step is to ensure that you get the best return possible on your claim.
To do so you need to ensure you understand the process involved and what it is intended to achieve which broadly are:
- Company Voluntary Arrangements are intended as a mechanism for rescuing a salvageable business and should be thought of as a negotiation, so understand what is being proposed and decide what you think is achievable.
- Liquidations are intended to simply wind up the affairs of a completely failed business and payout whatever can be recovered.
- Administrations sit somewhere in the middle in that their first objective should be saving the company but in practice they are often simply used as a mechanism for selling on an insolvent company’s business and assets to new owners.
In Administrations and Liquidations the IP also has a duty to investigate and report on the director’s conduct and can have wide powers to seek to reverse transactions that took place in the period leading up to the insolvency if these were not in the creditors’ interests.
Where in any doubt, take advice.
Having formed a basic understanding of the procedure being used and its relative merits you should be able to apply this knowledge to the specifics of the particular matter.
The recovery available to creditors is derived from the simple mathematical formula:
Total gross realisations – costs = sum available to creditors
So to get the best result and the highest distribution you want to see
- all the available assets are collected by the IP;
- the IP achieves the maximum realization;
- at the lowest cost.
Inevitably in an insolvency the balance between these elements will be a practical one on which the IP has to exercise their professional judgement over the cost effectiveness of any recovery action they may think about taking.
By understanding the position and the likely returns under different scenarios you should be in a position to assist the IP to maximise realisations and avoid unnecessary cost.
There are also a number of fundamentals which you can influence to improve the management of the process:
- Ensure the right IP is proposed and appointed. The IP is statutorily charged with the duty to work for the creditors, not the directors or the bank. Find out what you can about the IP, talk to him/her if possible before the creditors’ meeting to form an opinion on how supportive and co-operative they are likely to be of the creditors as a whole and satisfy yourself that they will act in your interests.
- Make an active choice of IP. Attend the creditors’ meeting; don’t just give your proxy to the chairman of the meeting as they will be the Directors’ nominee. Do you want to leave the choice of IP to them?
- Inform the IP. Use the meeting and any creditor enquiry form received to ensure the IP is made aware of any relevant questions or information that may be of help to them.
- Ensure the IP then acts in your interests. Following their appointment you will want to make sure that the IP does act in your interests and you can influence this through forming and joining a formal creditors’ committee to assist and supervise the IP’s work in:
- pursuing recoveries (so long as cost effective to do so);
- ensuring proper investigation is done (subject to costs); and
- controlling costs.
If a creditors’ committee is not formed you can as an individual creditor seek a regular and active dialogue with the IP to achieve these goals.
3 Minimise your business risk
So far we have concentrated on the insolvent company and what you can do to improve your prospects of recovery. But it is equally important to focus on your own business at such a time and ask yourself the key questions:
- what does this irrecoverable debt mean for your business; and
- what do you need to do?
There are fundamentally two areas of impact; the immediate and medium term effects on cash flow and sales.
There will be an immediate impact on your cash flow as a result of the irrecoverable debt. You will need to re-visit your cash flow forecast (if you have one), or create one if you don’t, to fully assess the impact. This is not as big a task as it seems so don’t be put off by incorrect perceptions which can be overcome with a little assistance.
It is important as part of the forecasting exercise to ensure you don’t make unrealistic assumptions. In particular, be very careful about any forecast you make concerning the size and timing of any dividend from the insolvency.
Sales will also be affected by the loss of a customer. The extent depends on how much business was transacted with the now insolvent company.
If the business is looking to trade on through a CVA or administration or someone is looking to purchase the business from the IP there is both an opportunity available and a decision to be made about such trading.
There is also a need to assess what impact the lost (at least in the short term) sales will have on the business and develop strategies to replace the lost turnover.
A business plan which allows time to reflect on the business and its future and to evolve strategies to reduce future business risk is fundamental to the future decision making process.
Where the customer failure is going to have a significant impact on the business you will need to communicate the news, together with your plans for dealing with it to your key stakeholders, such as your bank, at the earliest opportunity.
Initially it is sensible to make them aware of what has happened and reassure them that you are managing the situation.
Subsequently, dependent on the need for support that may be required, it may be necessary to enter into more detailed conversations such as:
- arranging additional short term facilities from your bank;
- seeking time to pay from HM Revenue & Customs;
- agreeing extension of credit terms with suppliers;
- finding equity investors to invest further capital; or
- speaking to directors and employees (and their families) regarding a pay cut.
If you find yourself having to take the above steps then consider seeking expert professional business restructuring help to review your position and to assist you in agreeing and then implementing a plan.
4 Exploit any opportunities that may occur
Finally, it is always worth asking yourself whether the failure of the customer might in fact open up an opportunity for your business.
Obviously the prospects of this will vary enormously from case to case and will be determined by a wide range of factors, not least the nature of the value chain involved and your relative positions in it.
But at a minimum the two questions you should be asking yourself are:
- Is there an opportunity to buy the failed business in whole or in part?
If so, is this something it is sensible to pursue?
A sound business plan, access to appropriate finance and some sensible due diligence will be needed to ensure you are not going to be compounding the felony and send good money after bad.
Properly advised and financed however this might be a fantastic business opportunity to move up the value chain and capture more of the available profit.
- Alternatively is there a way of going straight to the insolvent company’s customers?
Buying a business is always a risk and this is particularly the case in respect of one that has already failed.
So it may be that while you want the sales opportunity you don’t want the business as such. If so you need to look at how you can best arrange to exploit this opportunity.
Conclusions and key points
Don’t simply give up when you hear about an insolvency.
Be active in looking after your interests, not passive.
There are things you can and should do to:
- minimise your exposure (some of which you need to think about in advance);
- maximise your recovery;
- minimise your business risk; and
- exploit any opportunities that may occur.
If you don’t have the relevant technical insolvency or restructuring expertise, get good advice.
- understanding the initial letter,
- understanding what action to take and when, or
- planning the future for your business as a result of these events
we are uniquely placed to help.
Our bespoke Meetings Service provides, for a fixed fee of £500, advice before the meeting, attendance and participation at the meeting on your behalf and a subsequent written report to enable you to understand and influence the outcome of the insolvency and plan the future for your business.
One of the most common concerns for any recipient of ‘the letter’ is that the Insolvency Practitioner is an unknown and, unfortunately, this often casts doubts on their professionalism. A perception exists that the IP is ‘in the directors’ pocket’ and therefore will not be acting in the best interests of the creditors. Whilst this is rarely true it is an understandable conclusion to draw.
A call from a firm of solicitors to one of our partners recently raised just such a question.
Notice had been received of a creditors’ meeting in a part of the country where the firm had no coverage.
Initially the solicitors were merely seeking to obtain some comfort by asking whether we had experience of working with the IP involved. We did know the IP in question and so we were able to reassure the solicitors on that count.
We were then asked if we would speak to the IP prior to the meeting as the solicitors’ client was facing not only a very significant (7 figure write-off) but also major operational difficulties as a result of the liquidation.
Over a 24 hour period through a series of emails and phone calls we were able to establish a better understanding the position and to report back to the solicitor.
There were however, still a number of unanswered questions which were causing major business difficulties for the client, and as a result we recommended that we attend the creditors’ meeting on their behalf in order to address the director of the failed company.
So we went to the meeting and as a result were able to get answers to these questions which both helped our client and the IP himself by bringing to light information he was not aware of, and which should enhance the level of realisations in this case.
Additionally we were able to ascertain that a crucial machine part which our client had not been able to get hold of, and which was fundamental to resolving their operational difficulties with a major piece of capital equipment, was within the director’s control.
We reported back to our client, made arrangements for the part in question to be delivered to our client so they could restart their machines, and, in the absence of a creditors’ committee, reached agreement with the IP to meet at 6 weekly intervals for the first 6 months of the liquidation to enable us to keep our client updated.
And all this took place within 72 hours.
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