There is a mistaken belief when a business (the creditor) is owed money by a debtor and makes an application for the offending debtor to be declared bankrupt that bankruptcy is the panacea for getting paid. The reality is that bankruptcy is the last port of call and if the debt recovery process is incorrectly pursued there may be possible legal and cost ramifications for the creditor.
The marine industry is possibly one of the last bastions where business is done on a gentleman’s handshake. However, in today’s economic reality a handshake may not provide enough legal security to secure payment. In an industry where costs are high and profit margins are squeezed if bad debts are numerous not only is cash flow interrupted but there are increased costs to the business.
Before delving into the murky waters of bankruptcy, listed below are some practical suggestions of how a business may avoid increased costs, bad debts and strengthen its ability to make a successful legal claim in the event of a bad debt.
Protecting from bad debts
- Before any transaction has occurred, follow up that verbal agreement with well drafted, signed contract. A verbal contract, while being legal and the norm in the marine business, may be difficult to prove and most importantly increases legal costs in litigation.
- Terms and conditions such as COD and progress payment clauses in the contract may assist in limiting exposure to bad debts.
- If your business is supplying goods and/or services to a company a contract should include personal guarantees from the company director/s. The reason for this is that a company may itself be asset poor whereas directors and their spouses often co-own property. However, the asset status of the directors should be ascertained before accepting a personal guarantee.
- A business can also gain security, for goods and service sold to the company on credit, in the form of fixed and floating charges that are registered over a company’s assets. The effect of this is that if the company declares itself bankrupt then the business’s secured interests will be paid before an unsecured interest.
- If the debtor is a sole trader or partnership, then provided good contracts are in place, debt recovery can be relatively simple. However, again it must be stated that if the debtor/s do not have any assets then the recovery of owed money may be unrealistic.
- In the situation where a debtor has property and owes a substantial amount of money to a creditor then the debtor may agree to secure a mortgage over its property in order to keep supplies flowing to their business.
- If goods are being exported then a secure payment system utilising banks is even more important.
It must be impressed on the reader that these suggestions will not stop bad debts from occurring but may assist in limiting them and assist in the claims process. As all circumstances different legal assistance early on should form part of a business’s business plan to limit bad debts and avoiding costly litigation.
Before Bankruptcy – the claims process in a nutshell
The claims process for the creditor, after invoices are sent and terms of payment are ignored, should start with a carefully drafted letter of demand. It may be the case that this letter of demand is sufficient and results in a payment agreement between the parties. However, where no initial agreement is reached it should be noted that even after the matter has been listed with the court that mediation will more than likely form part of the legal process. Therefore, if the debtor offers an olive branch it should be seriously considered.
After all else fails, legal action is commenced with a statement of claim and where the debtor does not reply with a defence within the prescribed time default judgement may be awarded. Otherwise the matter continues on culminating in a hearing with judgement being awarded to the successful person. The next step is the actual debt recovery process, which often utilises the sheriff and may result in a garnishee of income/wages or the sale of assets. How this final process is best conducted is a question of investigation into the debtor’s financial circumstances and should have been a question considered before any legal action was commenced. The purpose of these processes is to show that the debtor is in fact insolvent and unable to pay their debts and only then should bankruptcy be considered.
Limited debt recovery action may be taken through the Consummer Trader and Tenancy Tribunal (CTTT) or alternative debt recovery action may be commenced under the Admiralty Act at great expense to the debtor/owner of vessel with a warrant being nailed to the mast and the vessel being arrested.
It is important to note that legal action may also be taken against the director/s of a company if their company trades while insolvent. It is often the case that bankruptcy follows a corporate collapse and regularly in these instances the directors transfer all available assets to spouses or family members. If this occurs, in certain situations, assets may be clawed back by the trustee in bankruptcy.
The Purpose of Bankruptcy
There are two actions in filing for bankruptcy. Either the debtor may enter bankruptcy through the filing of a debtor’s petition or a creditor files a creditor’s petition. In both of these scenarios a central theme is that the debtor needs to be insolvent and unable to pay their debts. However, be warned if bankruptcy proceedings are commenced purely as a debt recovery process and a debtor can show that it is solvent, able to pay its debts and there was also a plausible reason for not paying the original debt, the court has the power to look behind the original judgement, stop the bankruptcy action and in some cases award costs against the creditor.
Newly proposed laws support the central theme of bankruptcy as previously discussed. The proposed laws lifts the minimum bankruptcy claim to $10,000 and encourages the parties to enter into early discussions to resolve payment of the debt. Such agreements will require full disclosure of a debtor’s total financial situation (previously on occasion not done) otherwise failure to disclose may result in the debtor facing imprisonment.
Bankruptcy Procedure in Brief
There are two bodies that are involved in bankruptcy. The first being Federal Court of Australia and the Federal Magistrates Service (the Court) who are responsible for challenges to bankruptcy notices, the issuing and hearing of creditor’s petitions for bankruptcy and other applications in relation to bankruptcy matters. The second being ITSA (Insolvency and Trustee Service Australia) who are informed of certain matters in relation to Creditor’s Petitions.
Be warned, the Courts take the bankruptcy process very seriously and final sequestration orders often fail on technicalities such as where the creditor has failed to fulfill its legal obligations to the letter of the law or where incorrect interest is claimed. After a bankruptcy notice is served on a debtor an “act of bankruptcy” is committed when the debt stated in this notice is not paid within 21 days of service. Service is often difficult and costly as it should be personally served with substituted service having to be approved by the court. A creditor must serve the Bankruptcy Notice on the debtor within six months of issue, however this time may be extended.
After service of the bankruptcy notice on a debtor is successful, a debtor may avoid bankruptcy by entering into a Part X agreement to pay the creditor through an agreed payment plan.
If the debtor does not comply with a Bankruptcy Notice within 21 days of service (and the notice has not been set aside) the creditor may proceed to make application to the Court for a creditor’s petition to be issued. To support this the creditor must swear an affidavit regarding the amount of debt that was owed initially and that the amount that is still owing.
After the final sequestration order is made ITSA is notified and the bankruptcy/Trustee takes control of all the assets. The proceeds from the sale of these assets goes toward paying the trustee, tax department, workers and secured creditors followed by unsecured creditors. The chance of getting all your debt paid becomes slimmer the further down the list of creditors one finds themselves.
Often a creditor is left with no other option than to take bankruptcy proceedings against a debtor. However, bankruptcy proceedings should not be entered into lightly. Often bankruptcy is used as strategic tool to get the debt paid such as where directors are threatened with bankruptcy they may pay sooner as they can not hold their office if declared bankrupt. However, at the end of the day to take this action a creditor should have clear legal advice that can assist the creditor to make a commercial decision. The commercial questions to be considered are:
- Do I write-off the debt as there are no debtor assets to sell or
- Do I spend a considerable amount pursuing the debt with the hope that there will be some money left from the sale of assets to pay my legal costs and the debt.
Marcel Vaarzon-Morel of Vaarzon-Morel Lawyers was a shipwight of 18 years before becoming lawyer and has had considerable experience in drafting contracts, debt recovery and bankruptcy proceedings. If you require his assistance in these or other legal matters he can be contacted by phone: 02 4929 1174 or emailed at firstname.lastname@example.org