VIDEO: Safeguarding Your Business - Protecting AgainstTrading with an Insolvent Company

In the ever-changing landscape of business, it's crucial to make informed decisions to ensure the success and longevity of your own company. One area that demands careful attention is trading with other businesses, particularly those that may be at risk of insolvency.

My name is Jessica Diep and I’m a Commercial Partner at Maclarens Lawyers.

Engaging in transactions with companies that are in financial distress can pose significant risks to your operations, financial stability, and reputation.

So, what happens when you deal with a company that becomes insolvent?

If a company you are trading with becomes insolvent there is a strong chance that you will face potential losses.

Once insolvency proceedings have commenced, as a creditor, you may need to lodge a proof of debt with the company’s administrators and liquidators in an attempt to recover the debt owed to you. The insolvency proceedings will typically provide a mechanism for creditors to submit their claims within a specified timeframe.

After the company has had a liquidator or administrator appointed to it, and the liquidator has exhausted its attempts to recover funds of the Company, the liquidator will consider all of the claims for money owing and distribute available funds to creditors according to the priority of their claims. 

Certain creditors have priority over others in the distribution of assets.  Secured creditors, such as those with registered security interests, usually have the highest priority. Employees' entitlements, such as unpaid wages and superannuation, also receive priority. Trade creditors will typically be unsecured creditors who have a lower priority, or in other words will only receive a proportion of available assets after the secured creditors have been paid out.

In some cases, an insolvent company may attempt to restructure its operations and debts and carry on rather than finalizing the liquidation and deregistering. This could involve lengthy negotiations with creditors to modify repayment terms.

So, what steps can you take to protect yourself against dealing with a company that becomes insolvent?

There are multiple steps you can take to protect your business when entering into agreements or trading with other companies.

1. Depending upon the nature of the arrangement, research and due diligence can be vital.

Before entering into any trade agreement, take the time to conduct background checks, review financial statements, and assess a company’s creditworthiness by obtaining credit reports. If you are looking to enter into a partnership with another business, an experienced commercial lawyer will be able to conduct the necessary due diligence to provide peace of mind.

2. Protect your business by securing contracts and collateral to mitigate the risks associated with trading with a financially unstable partner. Establish clear and comprehensive agreements that outline payment terms, timely delivery schedules, and dispute resolution mechanisms.
3. Consider including specific clauses that protect your interests, such as retention of title or security interests in assets.

The Personal Property Securities Register (PPSR) is a register that allows businesses to register their security interests in personal property. You must comply with strict timeframes and procedures for registering your interests or you will either lose your priority rights or be forced to commence litigation in the Supreme Court to undo the damage caused by your inadvertence or lack of legal knowledge. By registering your security interests on the PPSR, you establish a public record of your claim on specific assets or property. This, in time, registration establishes priority in case of competing later claims. If another party later attempts to claim the same property, your registered interest will generally take precedence over unregistered interests.

If you have a security interest registered on the PPSR, you have a better chance of recovering your assets or being compensated from the proceeds of the sale of those assets.

4. Collateral, such as personal guarantees or bank guarantees, can sometimes provide an additional layer of protection against potential insolvency.
5. Investing in comprehensive business insurance policies can also provide an additional safety net when trading with companies at risk of insolvency. Explore options such as trade credit insurance, which covers losses resulting from non-payment by customers due to insolvency or default.

So, are there any warning signs that might indicate a company is in financial distress?

It can be difficult to ascertain whether a company you are trading with is in financial distress and at risk of insolvency, or whether they have a temporary cash-flow issue. Often you are only made aware of their troubles when it is too late.

Warning signs of financial difficulty could be that they are paying invoices late or only after considerable chasing and their payments are dishonoured.  Such behaviours indicate financial distress and may result in the destressed company committing unfair preferential treatment towards the loudest creditor in order to stave off insolvency for as long as possible. If you are that loudest creditor and you are not a secured creditor, you should seek legal advice early before you raise your concern about any financial woes. I always advise my clients to focus entirely on your own debt collection procedures. This is because defending an unfair preferential payment claim requires you to have received the payment in good faith without any reason to suspect that the debtor was insolvent. 

You should have a company policy in place for how to deal with a debtor if your discussions with the company fail to resolve the issue. You will need to consider whether to cut your losses early or whether, and for how long, you are prepared to be lenient with the debtor. In either case, you should seek legal advice early.

How can Maclarens help?

By implementing proactive measures you can help to safeguard your business.  At Maclarens, we can work with you to prepare general contracts, credit applications, terms and conditions, and payment schedules that will minimise potential risk to your business.  We can also provide assistance in registering security interests on the PPSR and ensuring your business is protected as much as possible.

In the event that you do suspect you are trading with a company that is in financial distress we can also help to recover payment from the company in question - before the commencement of insolvency proceedings – and represent your business in any disputes or negotiations with debtors or their administrators.

Contact Maclarens for more information – we would be happy to help.