Claw-back of debtor payments in liquidations or bankruptcy

Reminder to creditors – make sure you don’t have to pay back repayments from your debtors!

Jim owned a company which supplied commercial machinery parts to a number of manufacturers. He noticed that one of his customers, who manufactured metalwork machinery, was sometimes a bit ‘slow’ to pay for the parts after they had been supplied, but they were a long-standing customer so he didn’t want to make a big deal about it.

After one chase-up, his customer did repay a sizeable chunk of the debt owing, but after that Jim received no repayments for about three months. He carried on supplying goods, assuming that his customer would pay ‘when they were ready’.

Out of the blue, Jim received a letter from liquidators advising that the metalwork machinery manufacturer had been placed into liquidation. The liquidator also advised him that it wished to recover the repayment made to Jim’s company by the manufacturer.

Jim sought advice about whether he could object to the repayment being set aside but was told that, unfortunately, his prospects were not good. He realised that, in hindsight, he had ignored some of the ‘signs,’ and should have put more robust credit management practices in place.

Jim’s tale serves as an important reminder to creditors about voidable insolvent transactions. When a company goes into liquidation, any payments or repayments the company has made over the two years before liquidation (if the company was unable to pay its due debts at the time) are at risk of being set aside.

The reason behind this is that the liquidator’s role is to ensure that all creditors share in the available funds on an equal basis. Therefore, the liquidator can ask the court to set a repayment aside if it gives a creditor more towards the satisfaction of a debt than they would have otherwise received in the liquidation.

If you had debts repaid within six months of the liquidation, it is up to you to prove you don’t have to pay them back.

So, how do you avoid this happening to you?

Obviously, no-one wants to be in Jim’s situation. While you cannot completely remove the risk, there are some basic credit management steps you can take to protect yourself/your company:

1. Register your security interest! If you are supplying goods on credit, a relatively simple step to take is registering your security interest on the Personal Property and Securities Register. However, it is still important to get advice about whether your interest will take priority over other creditors, which is where the wording of your terms of trade becomes important.
2. Have terms of trade in writing and make sure all customers have a copy. The wording of your terms of trade is particularly important to limit your exposure or risk to a customer. For example, if you can set credit limits and stop credit (only accept cash) once this limit is reached, you may limit the amount that can be clawed back by a liquidator.
3. Get personal guarantees from directors (or other suitable persons).
4. Send out statements to all customers that owe you money each month.
5. For those that do not settle their account within the agreed payment terms, the customer must be closely monitored to avoid the debt becoming seriously overdue.  Don’t delay… make the time to call and ask for payment.
6. Also, be aware that it is worthwhile “screening” new customers to make sure they can pay.  Do not be a victim of those unreliable, late-paying, customers that often shop around for an easy target. Look for a clean credit history and a demonstrated ability to pay. Remember the old adage, “If it seems too good to be true, it probably is”.

And what if it does happen?

If you receive a notice from a liquidator proposing to set aside a repayment from an insolvent debtor, it is very important to seek advice. This is because if you do not object to the notice within 20 working days, the transaction will be set aside automatically.

Basically, if you did not reasonably suspect that the company was or would become insolvent, and gave value in exchange for the transaction, you may be able to persuade the court not to set aside the repayment. However, it would be hard for someone like Jim to say that they did not realise a company was in trouble when it was persistently late in its repayments.