How to recognise an insolvent customer?

Author: Nikas Borneika, attorney-at-law at METIDA

VC125186_editIt is probably hard to find a business that has never had any debtors. The experience of entrepreneurs is different. Some succeed in recovering their debt without greater inconvenience (e.g. by sending a reminder), others fail to do so without court intervention. The third, and the saddest case, is the debtor’s bankruptcy, which usually means that the debt will not be recovered.

What should be done with late payments and how to identify related risks? These and other issues relevant to entrepreneurs will be discussed in this blog.

When is a company considered to be insolvent?

Insolvency is a state when the company does not fulfil its obligations (it does not pay its debts, does not carry out pre-paid work, etc.) and the company’s overdue liabilities (debt, work not performed, etc.) exceed half of the value of the assets recorded in its balance sheet. When a company becomes insolvent, the law obliges its director to apply to the court for instituting bankruptcy proceedings.

What signs show that the customer may become insolvent?

The mere fact that the customer has overdue obligations does not necessarily mean that it is insolvent. Maybe the company simply has temporary financial difficulties. On the other hand, financial difficulties may indicate that the company is approaching insolvency and therefore, in the event of a delay in settlement, it is important not to wait and learn the reasons for such a delay. Maybe the customer does not pay because they are not satisfied with the quality of the goods or services. However, in any case it is important to collect and track information about the customer’s financial status.

A lot of information which helps to assess the company’s financial situation is publicly available. The website of the Register of Legal Entities shows any changes in the company’s management (e.g. shareholders, directors) and whether the financial statements have been submitted in time. On the website of SODRA (the State Social Insurance Fund Board) you can check if the company has any debts to SODRA and how many people it employs. Delayed submission of financial statements, social security arrears and constant or sudden decrease in the number of employees may be a sign of more serious internal problems.

Very important information can be obtained from the Register of Property Seizure Acts. If the data indicate that the company assets are subject to any restrictions, it means that the company already has creditors who have failed to reach agreement with the customer voluntarily. Of course, it is important to analyse grounds for such restrictions. It is often the case that property seizures (interim measures) are later eliminated after finding that there is no ground for them.

The customer’s behaviour is also a good indicator of their financial situation. If the customer cooperates, explains the reasons for delay in payment and promises to pay off debt, the customer may have only temporary financial difficulties. However, if payment requests are ignored (not responding to e-mails, returning mail, not answering calls), this is a very serious signal that the company’s financial situation will not improve and the company is at risk of insolvency.

When is it worth going to court to recover a debt?

If the information collected raises some founded suspicions that the company’s financial difficulties are not temporary, you should apply to the court for the award of the debt without any delay, requesting the court to seize the debtor’s assets for the period of the proceedings. It is an effective means to protect yourself against situations where the company assets are wasted and later are no longer sufficient to settle with creditors.

Are there any alternative (out-of-court) ways to force a debtor to pay?

If the information collected shows that the situation is not that bad, it is worth using other remedies established by law to avoid litigation.

One of the most effective remedies is the suspension of counterparty obligations, in particular where cooperation between the parties is continuous (e.g. suspending the provision of goods, works, etc.). Since the payment for the goods or services is a material condition for the seller or the service provider, it is a ground to terminate the contract following the procedure established by law or the contract. It would help to avoid bigger debts in the future.

To save the commercial relationship, you can set an additional deadline for the performance of the obligation or request the customer to secure the delayed obligation or subsequent payments with a security or pledge (mortgage).

If a customer is declared bankrupt, are there any ways to fall in a higher class of creditors? What protects the creditor’s interests in the bankruptcy proceedings the best?

Creditors’ claims are divided in classes in accordance with the criteria established by law: by entities and the nature of legal relationships. It is not possible to put the creditor’s claim in a higher class of creditors.

A mortgage or a pledge would ensure a special status of the claim in this case. Such claims are satisfied with funds received from selling or transferring the pledged company assets. The creditor’s claim secured by a pledge or a mortgage does not fall into the class of other creditors’ claims since the pledgee (creditor) is a privileged creditor and their claim must be satisfied with the funds from the pledged assets out of turn.

It follows from this that the creditor’s interests are most effectively protected in the bankruptcy proceedings, if the parties have agreed to secure the debtor’s obligation by a pledge or a mortgage. In all other cases, creditor’s claims are prioritised in accordance with the criteria established by law, where business entities are at the bottom (after employees and the state).

What to do, if the customer who is late or not able to pay is a foreign company?

Foreign companies are more troublesome since it is more difficult to collect information about the financial situation of such companies. Moreover, the bankruptcy proceedings differ across countries, which makes it tricky to predict the creditor’s situation if the foreign entity becomes insolvent. In case of foreign customer’s insolvency or delay in payment, the assistance of a lawyer in that country is usually a must.

As an alternative, to minimise the risk of foreign customer’s insolvency, you can use trade credit insurance. It protects the seller or service provider from any bad debts. However, this insurance is quite expensive and therefore companies usually assume any possible risks arising out of cooperation with foreign partners.

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