DEBTORS AND CREDITORS

PSYCHOLOGY OF DEBT ADMINISTRATION.

Never apologise to your customers for requiring debts to be paid. Never allow your dependence upon a particular client’s business to cause you to back away from requiring payment on time.  Allowing accounts to balloon means that you become an indirect financier. This means that you borrow more, assuming you cannot finance the debt out of cash flow, and the customer needs to borrow less, until one day your banker refuses more credit and your business is in difficulty.  If your demand for payment is not met, then you should take recovery action and immediately stop supply.  Any customers who do not pay on time are unworthy customers in which case you would be much better off if you severed relationships and spent your time more productively finding replacement customers.

If you cannot immediately find replacements, then you may be well advised to gear your operation down to a size commensurate with the customer base which you have. You may be surprised to find how profitable a smaller operation can be.

THE CUSTOMER (DEBTOR)

When a business supplies goods to a customer a contract is entered into whereby the customer agrees to pay an agreed price for the goods on or before a certain date. If the time for payment is not stipulated, there is an implied condition of the contract that the time allowed would be reasonable.

If a customer is given time to pay the debt due under the contract, the debt only becomes due for payment when the time given has expired. This simply means that you cannot sue for the money until the debt becomes due for payment.

THE SUPPLIER (CREDITOR)

This is an important relationship although its importance is not apparent to some.  Of the supplier creditors, there are those whose supplies are essential to the operation of the business and those whose supplies are only incidental. Of those suppliers of essentials, there are those whose goods or services cannot be obtained from alternate sources.  To lose any of them can be devastating. This situation could arise if the supplier were taken over by a competitor, had gone out of business, or more importantly had severed relationships with your business.

Any relationship with a creditor is important, because it is a part of the network of commercial relationships and a breakdown in one can lead to a breakdown in the network.

The length and quality of the relationship of your business with a supplier is important, especially if you need an extension of credit for say 30 or 60 days, or even more, to see you through a difficult time or a growth phase. Without that credit limit you would be financing those purchases through the bank and paying dearly for the privilege.

THE LANDLORD

The relationship between the proprietor and the landlord arises out of a contract which is usually in the form of a lease. It is desirable to try and negotiate a short term lease with a number of options for renewal rather than a longer initial term. If it becomes necessary to cancel the lease then the shorter the lease the less it will cost to pay out the rent through the end of the term of the lease.

If the premises are highly relevant to the business then you should have options to renew the lease included in the agreement. If you find your business in default and the landlord seeks to evict you, it is open to you ( if the rent can be bought up to date)  obtain an order from the court for relief from the forfeiture of the lease.

PROFESSIONAL ADVISERS

All too often the professional advisers are avoided, possibly because of an apprehension that the costs of their services will be high.

Relatively speaking, it is smarter to obtain advice of the preventative kind sooner rather than later. It is when the professionals are called in for remedial advice that the expense will be felt.

BANKING RELATIONSHIP

THE CONTRACT

The legal relationship between a banker and a customer is expressed in a contract which is invariably in writing. Such contracts contain a promise by the bank to lend money, to establish a line of credit or to provide some other finance facility such as a bank guarantee. The customer on the other hand promises to repay the loan with the agreed amount of interest, or to maintain the credit line within agreed limits and ultimately to repay the amount then due.

Contracts with a bank (mortgages, charges, guarantees, etc.) have in addition what are known as “all money clauses” and it is very important to understand what they are. We tend to think that a mortgage, only secures the facility which is mentioned in the mortgage; when the truth is that it secures all other monies owed by the borrower. It will for example secure an unsecured loan, a line of credit on a credit card, and moneys due to the bank under a leasing arrangement etc. In fact if you have given a security to your bank for one facility then you have effectively given it for all financial accommodations.

ARE ANY ASSETS PROTECTED FROM THE BANK IN THE EVENT OF DEFAULT

The short answer is, no! As previously mentioned the bank can exercise its rights over the security which you have given, not just the direct borrowings giving rise to the security, but for all other monies owed.

MORTGAGES OVER COMPANY’S ASSETS (CHARGES)

A Charge over the assets of a company will normally be similar to those contained in mortgages over real estate. The remedy most employed by banks that hold such securities in the event of default by the borrower is to appoint a receiver or a receiver and manager. A Receiver is normally empowered to take possession of the assets of a company and to sell them for the benefit of the bank. A Receiver and Manager may carry on the business of the company primarily for the benefit of the bank. If this happens (which is unlikely), the unsecured creditors and owners may benefit as well. Banks as holders of a charge may also appoint and administrator, normally with a view to a reconstruction of the company’s finances/business.

Charges are usually both fixed and floating. A fixed charge operates over those assets (land, machinery, etc.) which cannot be sold or dealt with without the bank’s consent. A floating charge operates over those assets which are normally sold without the consent of the bank because they come and go everyday in the ordinary course of business activity e.g. stock and debtors.

A charge usually provides that in the event of a default by the borrower, the floating charge will become fixed, whereby not even the stock can be sold without the consent of the bank and “the debtors”, as collected must go to the bank. This will have the effect of paralysing the business operation and is usually a prelude to the appointment of a receiver or an Administrator, whereby the bank can preserve its position over all the assets.

A charge is of course, a form of security for a bank and entitles the bank to be the first to be paid in the event of default,

GUARANTEES

Guarantees are contracts between a lender/bank, borrower and a third party (the guarantor). The guarantor promises to pay the lender if the borrower does not.  The guarantee can limit the amount for which the guarantor will be responsible or alternatively the liability may be unlimited. The guarantor may be required to give security to the lender/bank, sometimes in the nature of a mortgage over real estate. The mortgage has similar conditions as does a mortgage between a lender/bank and a customer/borrower. Also the lender/bank has similar rights and powers. The obligations of the guarantor are activated by the default of the customer/borrower. Once a guarantee has been given it is almost impossible to opt out of, because the lender/bank will normally have assessed its preparedness to lend upon the basis that the additional security of the guarantee was available to it. A guarantor, who is concerned about possible risk such as the diminishing value of the bank’s security over the business assets or the business’s financial situation, may insist that the business pay out the bank. This may involve court action to compel the business to sell the security. This can be the case when the business is owned by a number of persons or a company owned by others. In other words guarantees are easy to get into but difficult to get out of and the risk is mostly taken without the prospect of any benefit to the guarantor.

Such a situation arises even in the case of a guarantee given by the directors of a company, particularly companies in which the directors have a proprietary interest. It is most important to understand the exposure in such a situation and to protect one self. If the company is placed into liquidation then the obligations under the guarantee will almost certainly come to life and the bank will call upon the guarantor to pay the debt. If a guarantor does pay then he/she takes over whatever rights the bank had over the company (i.e. a charge or mortgage of property) so that the guarantor would be entitled to repayment from the company {as a secured creditor)of the amount which was paid to the bank. If there are other guarantors then the one who paid is entitled to have the co-guarantors contribute.

What then can be done to give the guarantor more protection in such circumstances? A guarantor in those circumstances should insist that the company gives, as security to the bank, a charge over its assets as well. Then in the event of the failure of the company the bank may either appoint a receiver or a receiver and manager to recover their money from the company. This can be achieved either by trading on or by selling the assets. The money so recovered is paid, to the bank to cover its debt before the other creditors of the company are paid. If the bank has to take action against the guarantor it should only be for any shortfall. If the guarantor pays the bank then he/she will be entitled to the same rights against the company as the bank had including the benefit of the charge or mortgage. The guarantor then has the right to seek reimbursement of the money paid by him or her to the bank by selling the company’s assets or appointing a receiver and trading on.

Banks have tended to prefer real estate mortgages, given by guarantors as they are less complicated and are better understood by the bank’s officers. It is in the interests of the guarantor to be aware that the company should give security to the bank as well.

A further protection for a guarantor is for he or she to take a charge over the company’s assets to secure the right to be indemnified.