Recent statistics released by ASIC show that 7,942 Australian businesses entered into external administration during the 2022-23 financial year.
This represented an increase of nearly 50% compared to the previous year, and one that was particularly felt in the construction, accommodation, food services and retail sectors.
With such a significant escalation in the number of businesses entering into administration, and an expectation of continued high inflation, it is likely that we will see many more insolvencies in the coming months.
This means there is a high probability that if you are a business owner or operator , you either have encountered, or will encounter, an insolvent customer.
Whilst you cannot foresee or control the financial stability of your customers, there are several strategies you can implement as part of your internal processes that occur at each stage of the lifecycle of a working relationship, in order to minimise the risk your business may face from a customer insolvency.
Stage 1: Early prevention is key
The most complete protection against customer insolvency is to supply your goods or services only on a strict payment-on-delivery basis. However, for most of us that is not a practical possibility. Therefore, it is important to conduct a thorough due diligence process on any new customer prior to the commencement of any new working relationship. This enables you to identify and manage any possible areas of risk in a proactive manner before it can detrimentally impact your business.
A thorough internal due diligence process may consist of the following undertakings:
- Credit check. Perform a trade credit check via a credible credit reporting agency in order to ascertain company and director information such as credit defaults and judgements. If the credit history result is negative, this enables you to get on the front foot and establish a less risky and more suitable payment arrangement such as upfront payment or cash on delivery.
- Ensure your paperwork is in order. Whether it is a contract or standard terms of trade, it is imperative to ensure that it is current, clear and relevant so it can be relied upon in the event enforcement is required to procure payment.
- Contractual options. Use trade credit agreements, which consist of personal guarantees against the company directors and include retention of title clause and security interest provisions with respect to the materials supplied. These clauses can help to protect you by providing you with a right to retain your interest in the goods in the event the other party defaults on your agreement.
- Register your PPSR security immediately and solidify yourself as a secured creditor. If you supply goods before you are paid for them, the PPSR is one of the primary risk management tools that can help protect your business against unexpected issues such as disrupted cash flow or asset loss that may arise as a result of insolvent customers. The PPSR legally defines the priority of security interests, with a ‘first in, best dressed’ principle. Read more about the PPSR here.
As at June 2023, more than 1.4 million businesses, representing 56% of all Australian businesses and 2.1million consumers accessed lines of credit and purchased goods through the PPSR asset registrations. The growth recorded shows that the increasing awareness and use of the PPSR is a benefit to Australian consumers and businesses alike.
Stage 2: Remain alert at all times
Once your new relationship has commenced with a new customer it is essential to maintain a consistent approach to risk management.
On a regular and systematic basis (e.g. every month) conduct a customer review to recognise potential “red flag” indicators of insolvency which may include:
- Repeated late payments;
- Sale or repossession of assets;
- Other contractors and suppliers complaining of late or non-payment;
- Change in employment status or reduction in employees; or
- Issues with payment for materials and supplies.
Invoice promptly and regularly. Not only does this help your business cashflow, it also quickly and efficiently identifies repeat late payments, as these will be appear as “visible bumps” in an otherwise streamlined invoicing process.
Three tips for a streamlined invoicing process:
- Invoice often. This helps you recognise a customer under financial stress sooner rather than later.
- Stick to your terms of trade and stop supply or suspend work upon non-payment. This prevents the compounding of outstanding amounts.
- Keep all paperwork up to date. Ensure all PPSR registrations and contracts are current, including updated scope of works.
Stage 3: After the end
Once you have completed a project, or the supply of goods or services as agreed, issue any relevant tax invoices promptly and follow up with subsequent payment reminders if the customer fails to pay within terms.
As most of us will know, some customers always pay late, and have to be prodded – they are not non-payers, just slow payers. However, slow payment is a signpost to financial distress, so watch this carefully. It may be that in fact this customer is on the path to insolvency.
Stage 4: Insolvency
A business is insolvent when it cannot pay its debts as they fall due.
An insolvent business may first appoint an administrator, in the hope of restructuring before it is too late – but it usually is too late. Alternatively, a secured creditor, usually the bank, may appoint a receiver to take control of the business assets.
However it starts, in most cases the outcome is liquidation.
Liquidation involves the appointment of an independent and qualified person, a liquidator, to control the company and wind up its affairs. The liquidator is tasked with selling off any assets the business has in order to satisfy as many of its debts to its creditors as possible.
There are two main types of creditors:
- Secured creditors. These parties hold a security interest such as a mortgage in some of the company’s assets. The Personal Property Securities Register (PPSR) registers any security interests over personal property; and
- Unsecured creditors. These parties have no security interest in the company’s assets and include customers, trading partners and employees.
If you are a secured creditor, it is essential to notify the liquidator and provide them with the details of your debt.
Whilst there is no assurance that you will receive the monies that you are owed, your chances are significantly higher if you have taken the correct steps in becoming a secured creditor as the priority order of payments when a liquidation occurs are as follows:
- Liquidation costs including the liquidators’ fees (subject to the rights of any secured creditors);
- Priority creditors such as outstanding employee wages and superannuation;
- Priority creditors such as outstanding employee leave payments and retrenchment pay; and then
- Unsecured creditors.
The liquidator must pay each of these categories in full before they can move onto the next category. If there aren’t enough funds to pay a complete category, then the liquidator distributes the remaining funds among creditors on a pro rata basis, which means you may only receive payment for a portion of the debt, or nothing at all if there are no funds available.
As with all things in life, when is comes to business there are no guarantees. However by implementing a few proactive measures at each stage of a working relationship, you can simultaneously help minimise the risk of exposure your business has to customer insolvency, as well maximise the chance of being able to recover any outstanding monies in the event of a customer liquidation.
If you have any questions or would like to find out more about how to protect your business, feel free to contact us at Antcliffe Scott, we’d be more than happy to help.