Customers who don’t pay their bills are one of the occupational hazards of running a business. The wise business sets its prices at a level which allows it to carry a reasonable level of bad debts. But this really only applies to small debts. If a big debtor doesn’t pay up, your business could be wrecked. There are two situations: the customer who can’t pay, and the one who won’t. This guide deals with what to do and how to prevent the situation in the first place.

First actions

First, you want to discover if you are dealing with a debtor who genuinely cannot pay, or one who has cynically decided not to pay. With the latter, you need to go in hard and fast. With the debtor who has a problem, however, there are some other avenues to be explored first, because driving them over the edge with hasty legal action could ruin your chances of recovering anything.

If the debtor can’t pay promptly, try to avoid pushing them into the situation where they decide they might as well not pay at all. Obviously, this will depend on what it is you do for them – if you provide a service or goods which are not crucial to their business, refusing to provide any more will not make an impact.

However, where you are providing something important, cutting off their supplies may make them fold or go elsewhere. And, since word tends to get around, the new suppliers are likely to demand payment in advance or on delivery, so what little money they do have may not come your way.

On the other hand, you should not continue supplying someone who cannot pay at all, even part payments.

Restructuring the debt

The starting point for all debt collecting is the chase letter, and this should be sent immediately the debt becomes overdue. It says something on the lines of: ‘We note that our invoice (reference number and date) has not been paid. Our terms are x days. Please let us have payment by return.’

If this doesn’t work, call and find out why. This may require some subtle handling, but if you can manage it, they may confide in you. Try saying something like: ‘I get the impression that you may be in trouble. I don’t want to make it worse at this stage by taking legal action. Can we talk about it and see if there is a way we can help each other?’ Knowing that someone cannot pay is usually not the whole story. Often the situation is that they cannot pay the whole bill in one go right now.

The situation may be temporary – they might just have a short-term cash-flow problem – in which case you might consider restructuring the debt so you can continue to supply them while they gradually reduce the amount they owe you on an agreed monthly schedule including interest. This has another advantage: by agreeing the new repayment structure (and you will want to get them to do this in writing after consulting your solicitor) they are admitting the debt exists, and can’t dispute it later, if you do have to take them to court.

Pre-legal action

If your customer refuses to respond to your initial letter, or to take your phone calls, you or your solicitor should send a ‘seven-day’ letter. This would say something like: ‘Despite our reminder of [date], you haven’t paid our outstanding invoice (reference number and date). Please do so within seven days or we will take legal action.’ And if the payment has not been received within that period, you may have to consider whether to issue a claim in the court to recover payment.

Alternatively, there are firms of debt collectors who will take over collection for you, though, in general, they are less interested in collecting one single large debt than a sequence of smaller debts.

Taking legal action

If you cannot agree to a phased repayment of the debt, the next stage depends on these factors:

• Whether or not the debt is disputed.
  
• The size of the debt.
  
• The status of the debtor (sole trader, partnership, limited company).

The size of the debt

The size of the debt determines which court you use, and, possibly, whether you use solicitors.

• For debts up to £5,000, you can use the small claims procedure, and deal with the matter yourself.
  
• For debts between £5,000 and £50,000, you can use the County Courts.
  
• Above this figure, you have to go to the High Court.

The status of the debtor dictates exactly whom you sue. It may seem obvious that it will be the organisation to which you have addressed the invoices, but in the case of a partnership or a limited company it is essential that you put the correct name on the court documents.

• With a sole trader it is easy – use their name, their trading name if that is different, and their business address.
  
• For a partnership, you also need to know the partners’ names. There might be a trading name or, if there are many partners, you may need to quote the names of the managing partners. You will also need the partnership’s business address.
  
• For a limited company, you should check that the name of the company has not been changed and that you have the company’s registered address. You can check this at Companies House.

Doing it yourself

To start a ‘small’ claim or a county court case, you will need the correct forms, which you can get from your local county court. Cases can start in the court in whose area your address falls but the debtor may be able to transfer the case to his or her local court.

The court offices have booklets on procedures as well as the relevant forms and details of their fees. The staff are helpful, although they are not allowed to give legal advice.

Submit the completed forms to the court office with the appropriate fee. The court will issue and deliver a claim form. If the debtor does not defend, you can apply for a summary judgement and then go on to enforce it.

Using professional help

Although the exercise becomes more costly if you take legal advice, the larger the debt, the more sensible it becomes to do so. Debt collecting through the courts is not always straightforward, and the amount of work and expertise required can make it worthwhile to pay an expert to do it properly, leaving you free to spend your time and energy on running your business. However, be sure to choose a solicitor who has experience of commercial debt collection.

If you win your case, you should be awarded your costs by the court unless it is a claim under £5,000. However, the whole thing is pointless if the debtor has no funds to pay you at the end of the day. This is another reason for spending a little money on enquiry agents before you embark on legal proceedings.

Interest on late payments

It’s worth remembering that the Late Payment of Commercial Debt Act gives all businesses the right to claim interest on late payment of commercial debts. Further information can be obtained by visiting www.payontime.co.uk.

The outcome of legal action

The point of taking legal action is to obtain a judgment – an order from the court telling the debtor to pay, but you still have to collect your money. When it comes to enforcing a judgment, if the debtor still won’t pay, you can ask the court bailiffs to seize the debtor’s property to be sold on your behalf. You can initiate procedures for liquidation (for limited companies), or bankruptcy (for individuals) without obtaining judgment, but the debtor may argue that the debt was disputed or is otherwise incorrect and halt that procedure. This can be avoided by getting a court judgment first.

You can also ask the court to make an order that the debtor’s bank (if they have a credit balance) makes payment to you.

Debtors can prevent bankruptcy or liquidation by proposing a voluntary arrangement. This stops everyone from enforcing judgments, but provides for all debtors to be paid something. This may be preferable to bankruptcy or liquidation which are costly procedures, leaving little for payment to creditors.

Use formal terms and conditions of trade

You can make the whole issue of collecting debts much simpler by having a set of formal terms and conditions that you spell out to your customers at the order stage. Ideally, each customer should sign a copy of these to show that they accept them. These terms and conditions should include how and when you should be paid, when ownership of your product passes to the customer, how any defects or disputes will be dealt with, and interest due on overdue debts. Having all this clearly spelt out beforehand – and agreed by the customer – makes it much easier to collect debts later.

Recovering your goods

One course of action, if you haven’t been paid for goods supplied, is to try to recover your goods. This will only work if your terms say that ownership of the goods does not pass to the buyer until they have been paid for in full.

This retention of title clauses will only work if:

• You can locate your goods – and they haven’t been sold on.
  
• They haven’t become part of another product.
  
• They are not perishable e.g. food.
  
• They can be identified as yours.
  
• The clause is well drafted – legal advice is essential.

Providing services

To protect you against non-payment, you could request part-payment before you start, or at stages during the job. If your debtor can’t pay, you can reserve the right to stop work. This could reduce your loss.

Avoiding large debts

What can you do to protect yourself?

• Find out about your customers.
  
• Ask your bank to make a status enquiry with your customer’s bank.
  
• Check them through a credit reference agency.
  
• Find out why they have come to you – is their usual supplier refusing to give them any more credit?
  
• Get part payment in advance, or consider stage payments.
  
• Consider credit insurance – it can cover you against bad debts.

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