The colloquial “cash is king” is a testimony to the importance of a healthy cash flow in a business.
By Paul Crosland, partner at Webber Wentzel
Even though most business transactions are digital today, the concept still applies when debt collection comes into play. In fact, debt collection plays a crucial role in managing a business’ finances as it helps recover the money that is rightfully owed to the company, which again maintains its financial stability.
There are a few important aspects to consider around debt collection: how to avoid it, how to do it efficiently and effectively, and what cost(s) are involved.
Prevention is better than cure: mitigate the risks
There are measures that could help lessen the risks associated with bad debts. Most importantly, ensure that a contractual relationship is in place (whether it is based on a separate contract or standard trading terms) and that is fit for purpose. Conduct credit checks and asset searches on companies that will be afforded credit, as this can help to establish whether the company has substance behind it and that it will not simply be an empty shell, should it default. Then, consider putting in place at least one of the common forms of security that is fit for purpose, often used by professional lenders.
Debt collection: what to consider
- Who to collect from – Companies and the individuals behind them (shareholders, directors, and employees) have separate legal personalities. In the context of debt collection, this means that the individuals are not automatically responsible for the debt of a company that defaults on its payment obligations. Only when there is fraud on the part of directors, or it can be proven that they have traded recklessly (that is, incurred further debt when the company’s liabilities exceeded its assets), can a court go beyond the veil of separate legal personality and hold directors personally liable. However, such a remedy is often difficult to achieve, as the burden of proof to establish claims of fraud or reckless trading is high.
- Establish the existing contractual terms in place – When faced with a situation involving a bad debtor, first establish the applicable contractual terms and whether the contractual relationship in place is a specific contract and/or a standard terms and conditions contract in any of the documents (for example, purchase order, quotation, or invoice). Then, consider:
- what the terms say about when the debt is due (credit terms);
- what the rights/obligations on non-payment are;
- what interest and legal costs claimable on non-payment will be;
- whether the contractual terms impact the typical dispute resolution process, for example, is there an obligation to first refer the dispute on non-payment to an alternate dispute resolution process (such as negotiation between company principles or mediation); and
- whether there is an arbitration clause in the agreement and how that applies when the debt is not disputed.
Options for legal debt collection
- Action proceedings (typically through a court summons)
- A standard letter of demand from the company itself or its attorneys precedes a court summons. This letter details the existing contractual framework with the established debt in relation and demands any amounts outstanding (like any default interest and certain costs, depending on the contractual terms) from the debtor. Usually, a time is allowed for the payment of debt, either in terms of the contract, or it is determined based on what is practical in the circumstances. If this is not provided for in the contract, demands for payment usually provide for one week, failing which, a threat of the commencement of a court process is made. The seriousness of receiving a letter of demand from attorneys is often enough to result in payment, but this is not always the case.
- If there is no response to the demand, or the demand raises some form of dispute that cannot be resolved by negotiation between the parties, a summons for the claim is issued. The court that will have jurisdiction over the matter will depend on several factors, such as the contract terms, the quantum of the claim, as well as the location of the debtor’s registered or business address.
- If the summons is not defended, it will result in a default judgment against the debtor. However, if the summons is defended, the debtor must detail its defence in the form of a plea, and then a full trial process will continue.
- After the plea stage, the company has an option to apply for summary judgment against the debtor if the plea does not offer a bona fide defence to the claim and the matter is merely being defended to delay the case. Such an application is decided by the parties’ filing affidavits and by arguing a motion in court.
- Turnaround time: a default judgment is typically the quickest process and takes several weeks to obtain. A summary judgment will be longer but is also a relatively quick process. A full trial can take anywhere between 18 months and three years to complete and is, therefore, a less desirable option when it comes to standard debt collection practices.
- Once a court order is obtained (either by way of default judgment, summary judgment or a judgment following a full trial process), the process moves into the execution phase, which includes that:
- a sheriff of the court can (by using a warrant/writ of execution) first attach the movable property of a judgment debtor. If the movable property is insufficient to cover the order, the sheriff can attach any immovable property of the judgment debtor, and
- then the attached property is later sold by the sheriff on auction, with the proceeds paid to the judgment creditor. If the sheriff cannot find any property (movable or immovable), then the lack of assets is sufficient grounds to apply for the liquidation of the judgment debtor.
- Application proceedings (for liquidation)
- In application proceedings for liquidation, a Section 345 Notice (also referred to as a statutory demand) is sent to the debtor in accordance with section 345 of the old Companies Act (as certain provisions of the old Companies Act still apply in relation to insolvent companies). This letter contains the same details as the standard letter of demand, but a period of 21 days is allowed for the payment of the debt.
- If the debt is not settled within this time period, the debtor is deemed to be insolvent and this is sufficient grounds to apply to a court to have the debtor wound up.
- If the demand is ignored, an application can be filed with a court having jurisdiction and an order sought for the company to be placed under either provisional or final winding up.
- Turnaround time: As the application process is done by way of affidavits, it is quicker than the action proceedings and it can result in a liquidation order within several months.
- A final liquidation brings about the end of the company, which makes the threat of a liquidation a useful tool in the debt collection process. It is also helpful to establish whether the debtor company is trading as a going concern, as this will inform the strategy surrounding the threat of liquidation. If the debtor company is trading, it will have much to protect and will likely want to avoid being placed into liquidation. This is especially the case for companies that hold certain regulatory approvals or other rights (such as mining rights) which would lapse upon final liquidation. To the extent that a debtor company is not trading or has no assets to protect, it may just ignore the threat of liquidation and allow the process to proceed, thus rendering this form of debt collection strategy largely ineffective.
- A final liquidation is ultimately value destructive as the debtor company will cease trading and all creditors will then be ranked as ordinary, preferred or secured. This means that the ordinary creditors (those that are not preferred by way of statute or do not hold any form of recognised security) face the distinct risk of not receiving anything for their claim.
Cost(s) of legal debt collection
Legal debt collection can be a costly exercise, depending on the complexity and the duration of the selected process. Although successful litigants can claim back legal costs from the opposing party, the quantum of those costs will not equal the amount paid to their own attorneys. To claim back legal costs, a litigant goes through a taxation process, when the costs which are claimable are detailed in a bill of costs, prepared with reference to tariff amounts contained in the respective court rules.
The bill of costs is then considered by a Taxing Master, who will alter the bill and, if necessary, add VAT, and an amount for drawing/taxing the bill. Therefore, the Taxing Master determines the final amount and the bill of costs is endorsed. The taxed bill of costs has the power of a court judgment for the final amount. It is important to note that the tariffs contained in the court rules are largely out of date and not in line with the amounts charged by legal professionals, which means that the amount a successful litigant can expect to get back from an opposing party on a taxation is about a third to a quarter of the amount paid to its attorneys.