What happens if a client files for bankruptcy?
Having a client declare bankruptcy is a risk that all businesses face. But what are your rights if you find yourself with a customer who cannot pay due to bankruptcy? Is it still possible for you to recover your debt?
What is bankruptcy?
Bankruptcy occurs when an individual or a company seeks relief from the courts from their financial troubles, through filing for bankruptcy to discharge their debts. A trustee is then appointed by the Government to manage the bankrupt estate and work out how to distribute any assets the debtor has, after establishing the priority that creditors should have.
If you are listed as a creditor, the trustee will notify you and let you know if you are likely to receive any funds from any liquidation of assets of the debtor. To attempt to recover your outstanding debt, you will need to lodge a proof of debt with the trustee, detailing what you are owed and the circumstances.
The likelihood of you receiving any money back will depend on how many creditors are involved and whether your client is likely to have any tangible assets available which the trustee can liquidate to distribute proceeds to creditors.
The more creditors there are, the less chance you will receive your money back. And if you’re dealing with a small client, it is unlikely they will have the assets necessary to liquidate for cash.
It’s very important to stop any collection activity to avoid violating the Bankruptcy Act 1966 (Cth) and potentially being sued. However, you are permitted to contact the trustee (or the solicitor who informed you of the bankruptcy) in order to find out more detail and ask any questions you may have. At this stage, it’s advisable to seek professional debt collection advice to ensure you follow the correct process and procedures.
Take preventative measures
Because of the difficulties in obtaining payment when a client becomes bankrupt, we always recommend taking a proactive approach to avoiding bad debts in the first place.
This includes carefully vetting new clients by conducting credit checks and seeking out trade references in order to determine their business history and the likelihood of them becoming bad debtors. If they check out, make sure you clearly communicate your terms of trade to them, spelling out that they will be liable for collection costs, including the fees of a professional debt collection agency if necessary.
If you have any doubts about potential clients, but still want their business, ask for deposits, upfront payments, or put retainers in place before doing any work or providing any goods.
Keep an eye on the payment behaviour of existing clients, too. If payment behaviour changes, such as taking longer and longer to pay bills, this can be a warning sign. You could also consider providing clients with discounts for early payment – for example, 3% discount if paid within 10 days; 2% in 30 days, and net regular terms for 60 days. In business, patience is really not a virtue: we strongly suggest you approach your debt collection agency to take over once you have sent out no more than three payment reminders.
Ultimately, the best defence against bankrupt clients is ensuring you undertake your due diligence before offering credit. Don’t delay if you see any payment red flags and protect your cash flow by seeking the assistance of a professional debt collector.