What businesses should know about the legal debt collection process

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Debt collection plays a crucial role in managing a business’s finances because it helps to recover money that is rightfully owed to the company, thereby maintaining its financial stability. In this article, Paul Crosland, a partner at Webber Wentzel, discusses important aspects of debt collection: how to avoid it, how to do it efficiently and effectively, and what it costs.

Prevention is better than cure: mitigate the risks

There are measures that could help to reduce the risks associated with bad debts:

  • Ensure that a contractual relationship is in place (whether it is based on a separate contract or standard trading terms) and that the contract is fit for purpose.
  • Conduct credit checks and asset searches on companies that will be afforded credit. This can establish whether a company has substance behind it and that it will not be an empty shell if it defaults.
  • 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 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 proved 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 the directors personally liable. Such a remedy is often difficult to achieve because the burden of proof to establish claims of fraud or reckless trading is high.

Establish the existing contractual terms

When faced with a bad debtor, first establish the applicable contractual terms and whether the contractual relationship 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).
  • The rights and obligations on non-payment.
  • The interest and legal costs that will be claimable on non-payment.
  • Whether the contractual terms impact the typical dispute resolution process. For example, is there an obligation first to refer the dispute on non-payment to an alternate dispute resolution process, such as negotiation between company principles and mediation?
  • Whether there is an arbitration clause in the agreement, and if so, how it 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 relating to the established debt and demands any outstanding amounts (such as any default interest and certain costs, depending on the contractual terms) from the debtor.

Usually, 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 the contract does not provide for this, 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, and 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. If the summons is defended, the debtor must detail its defence in the form of a plea, and 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.

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 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 (by way of default judgment, summary judgment, or a judgment following a full trial process), the process moves into the execution phase, which includes:

  • 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.
  • The attached property is sold by the sheriff on auction, with the proceeds paid to the judgment creditor. If the sheriff cannot find any property (movable or immovable), 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 it allows for 21 days for the payment of the debt.

If the debt is not settled within this 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.

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 helpful to establish whether the debtor company is trading as a going concern, because 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 particularly 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 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 because the debtor company will cease trading and all creditors will be ranked as ordinary, preferred, or secured. This means 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.

Costs of legal debt collection

Legal debt collection can be an expensive 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 that 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 considered by a Taxing Master, who will alter the bill and, if necessary, add value-added tax 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.

Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article does not constitute legal advice that is appropriate to every individual’s needs and circumstances.