Pursuing insolvent debtors : what are your options?

This is the first instalment in our two part series about some of the main options for recovering a debt due from a debtor in financial trouble. We will identify legal and commercial processes that can be used, and highlight some steps that might improve your chances of recovery.

Debt recovery options

When a debt arises, what are the recovery options for a creditor to consider? Typically, these can include:

Writing-off the debt
Negotiation with the debtor
Starting formal insolvency proceedings against the debtor
Court proceedings.

When should you consider writing-off a debt which is owed?

Whilst admittedly not the most outwardly desirable option, it is always open to you to write-off a debt which is owed. This may be preferable where, for example, the cost of recovering the debt outweighs the amount which is owed, or where your due diligence, or instincts, suggest that the debtor is simply not good for the money. However, it might also be appropriate where the overall commercial relationship you have with the debtor is more valuable than the recovery of the debt in issue.

What is the best way to negotiate a settlement?

Pursuing a negotiated settlement has the potential to be both more cost and time efficient than starting a formal litigation process. It also has the benefit of giving you some measure of control over the outcome, the effect which the debt recovery activity has on you, your team and the commercial relationship between the parties.

If the debt arises from a written contract, you need to check whether or not the contract contains any clauses that deal with (amongst other things) any prescribed dispute resolution process that need to be followed. Does the contract provide for informal meetings, discussions, or more formal processes such as mediation, before any legal proceedings can be commenced? You may be contractually required to negotiate in good faith, even if your preference is to take legal action.

Issues to consider include the following:

Whether the contract, and the clauses that cover disputes, apply to the debt in question
Whether there are any time frames or notice procedures that must be followed
Are the dispute resolution clauses mutually exclusive, or do they provide a mechanism for escalating matters to another tier, or to an independent process such as mediation?
What the governing law of the contract will be
Which court (if indeed it is a court) will have jurisdiction over the dispute if the parties cannot resolve it themselves
How does the debt impact on any ongoing obligations or relations under the contract?

Even if the contract does not contain any relevant clauses, or you do not have any terms set out in writing, it may still be possible to engage in settlement discussions with the debtor. The forum for negotiation is flexible and can be conducted in person, verbally over the telephone or in writing including email.

It is also worth remembering that negotiations can still take place after legal proceedings have been commenced. Indeed, the vast majority of cases are settled out of court before the case reaches a final hearing.

The “without prejudice” rule

When working towards a negotiated settlement you should consider the merits of making your correspondence ‘without prejudice’.

Provided any correspondence labelled (or agreed to be) ‘without prejudice’ is made in a genuine attempt to settle the matter, it is privileged and cannot be put before a court as evidence should the matter reach litigation in the future. The rule applies equally to written exchanges and to in person/telephone/video discussions; you simply need to open a conversation with a statement which makes clear that your discussion is ‘without prejudice’. However, there are different types of without prejudice privilege and the rules can be confusing, so if in doubt, seek advice.

Also, if the debtor owes multiple debts, for example debts that relate to the supply of different goods and / or services under separate contractual arrangements, be clear about which debt is the subject of the negotiation. It will be in the debtor’s interests to ensure that any correspondence agreeing a settlement sum for a debt, or enclosing payment of the settled sum, is stated to be ‘in full and final settlement’ of all debts, which may not be in your intention.

Insolvency proceedings for debt recovery

Insolvency proceedings are not intended to be used for debt recovery. However, in practice, the threat of insolvency proceedings may be sufficient to persuade some debtors to settle their debts.

The type of insolvency proceedings that may be suitable will depend on whether the debtor is a company, a partnership or an individual / sole trader.

Has an insolvency procedure already been started?

Before commencing insolvency proceedings you should check whether an insolvency procedure against the debtor has already been started, perhaps by another creditor. If you commence insolvency proceedings while another action is pending, you may be at risks on costs, i.e. you could be ordered to pay the debtor’s costs of responding to your action.

You can check the position by carrying out online searches, including reviewing information available via the Gazette and GOV.uk websites. However, your legal representatives should be able to conduct more through checks and given the risks and the complexities, it would always be sensible to seek legal advice if you are considering commencing insolvency proceedings.

If an insolvency process has already been started by another creditor, you could consider contacting the petitioning creditor to determine the progress of the petition. It may be that you can appear at the hearing to support the petition. Alternatively, if the petitioner decides not to proceed with the petition, perhaps because their debt is finally paid, you may be able to apply to be substituted as the petitioning creditor.

Insolvency proceedings against a company or partnership

If you are owed a debt by a company or partnership, the process is started by issuing a winding up petition at court.

The court will decide, at a court hearing of that petition, whether to make a winding up order. There are various grounds on which a company may be wound up, including that the company is unable to pay its debts. A company will be deemed to be unable to pay its debts (satisfying one of the grounds on which it may be wound up) if a statutory demand for a debt of more than £750 is served on a company and the company fails to pay the debt within 21 days.

Note, however, that it is not always necessary to issue a statutory demand before presenting a winding-up petition.
It is just one method of demonstrating that a company is unable to pay its debts, but it is usually the most straightforward way of supporting a petition.

If a winding up order is made an independent insolvency practitioner (a liquidator) is appointed to gather in and realise the debtor’s assets, and distribute the proceeds to the creditors (each creditor is invited to submit a proof of debt to the liquidator). Upon conclusion of the administration proceedings, the debtor will be dissolved and it will no longer exist.

Insolvency proceedings against an individual

If you are owed a debt by an individual or a sole trader, you may issue a bankruptcy petition against that individual. This process is started by issuing a bankruptcy petition at court.

Conditions for presenting a creditor’s bankruptcy petition include:

The amount of the bankruptcy petition debt, or the aggregate of the petition debts, must be equal to or exceed £5,000
The petition debt must be for an unsecured liquidated sum, payable either immediately or at some certain future time
To be liquidated, the petition debt must be a specific amount which has been fully and finally ascertained and is unsecured. If a debt is subject to an account or a claim for damages that requires further adjudication it will not be liquidated
The debt or each of the debts, must be a debt which the debtor appears either to be unable to pay or to have no reasonable prospect of being able to pay. This will be deemed to be the case if a statutory demand has been served and has not been paid within 21 days.

If a bankruptcy order is made an independent insolvency practitioner (a trustee in bankruptcy) realises and distributes an insolvent individual’s assets among their creditors. The ability of a bankrupt individual to trade and take credit is restricted. An individual’s bankruptcy usually lasts for one year, although the realisation and distribution of assets by the trustee in bankruptcy may take longer.

Advantages and disadvantages of the threat or commencement of insolvency proceedings

There are a number of potential advantages and disadvantages to commencing, or threating to commence, insolvency proceedings. These include:

Having served a statutory demand, a creditor is not obliged subsequently to commence insolvency proceedings; sometimes just the threat of insolvency proceedings can lead to a prompt settlement of the debt owed
Exercise caution; if you serve a statutory demand on an individual debtor for payment of a disputed debt the debtor can apply to the court to set aside the statutory demand and have you pay their legal costs
If you serve a statutory demand on a company debtor for payment of a disputed debt the company debtor can apply to the court for an injunction to prevent you following through with a winding up petition. If they secure an injunction, again, you would be ordered to pay their legal costs
Similarly, it is an abuse of process to commence winding up proceedings against a company, or to issue a bankruptcy petition against an individual, for a debt that is genuinely disputed. If you issue a petition for a genuinely disputed debt, the debtor can apply to court to have the petition dismissed, and secure an order for you to pay its costs
Insolvency is a class remedy for creditors. This means that once you have issued a petition, even if you are repaid in full, another creditor may pursue the proceedings causing the company debtor to go into liquidation or the individual debtor to be bankrupt, which may not have been your aim
Even where you are successful in pursuing insolvency proceedings, there is likely to be a substantial delay before a dividend is paid to unsecured creditors. The dividend paid to unsecured is often only a few pence in the pound.

For these reasons, commencing or threatening to commence insolvency proceedings is not without risk and it will not be an appropriate step in every case.

Court proceedings to recover debt

If a debtor is not already in, or about to go into, insolvency, your quickest and most effective means of securing payment may be to pursue a civil claim through the Courts, particularly if liability to pay the debt is not contested. A range of enforcement options could then be pursued.

However, you need to bear in mind that if the debtor enters into a formal insolvency process such as compulsory liquidation or bankruptcy, a moratorium will come into force meaning any claim will be suspended. Permission from the Court will be required to continue your claim and this is unlikely to be grated if you are pursuing a debt. The Courts are more likely to grant permission if you are enforcing a property right.

Therefore litigation can be risky and you need to ask:

Does the debtor have enough money to pay the debt plus legal costs?
Does the debtor have other assets you could enforce against?

If so, then suing could be a good option. However, if the debtor is already insolvent / about to go insolvent, there is probably little to be gained.

Also bear in mind that recovery of your legal costs in pursuing a debt claim will be limited; the court will decide what is recoverable. That will usually be strongly influenced by the procedural track to which your claim is allocated, which will, in turn, largely but not exclusively, depend on the financial value of the claim.

Terminating a contract with a debtor in financial trouble

Terminating a contract is not an option to be taken lightly by any business. There are potential consequences of termination which you must also factor into your considerations, such as:

What impact will terminating the relationship have on your business more generally?
Do you have a contractual right to terminate the contract?
Does the contract provide for any alternative remedies for a creditor not receiving payment for goods or services, such as the right to call upon a bond, guarantee or letter of credit?
Does the contract provide the right to cease or suspend deliveries, or include terms such as retention of title provisions?
What notice periods need to be complied with?

The important point to note is that failure to pay monies due under a contract may not automatically gives rise to an immediate right to termination.

Also, there is no automatic right to terminate where a counterparty is in financial distress. However, often contacts will include a clause that provides a right to terminate for an insolvency event. The definition of ‘insolvency event’ will be contract specific, and so it is important to consider whether the debtor’s situation really does fall into that particular contractual definition or not. However, bear in mind that there are statutory controls on contractual clauses triggered by insolvency events for certain contracts.

For further information on this issue and terminating contracts more generally, please see our separate article on this topic.

Reviewing and re-negotiating contract terms

Where a contract does not provide a right of termination, or, as an alternative option, it may be beneficial to review and/or re-negotiate the existing terms of trading. Strategies for reducing a creditor’s contractual exposure to the risk of further financial difficulties in its trading partners include:

Negotiating an exit which is otherwise not provided for in the contract
Achieving savings through contractual provisions such as benchmarking or ‘most favoured customer’ clauses
Achieving value through contractual provisions such as for continuous improvement, exclusivity, price review and minimum purchase obligations
Achieving security through payment terms and retention of title, guarantee or other security provisions
Re-negotiating individual contract terms such as price, term and notice period etc.

If re-negotiated terms are reached, it is important to clearly document what has been agreed, in writing.

Keep a look out for part two of this series where we look at preference payments, retention of title provisions, creditor considerations upon the insolvency of a debtor and more top tips for improving the chances of recovering a debt.