It is a complex and costly process for a factor to try and force payment of an outstanding invoice through the courts. This post details the intricacies involved in this process and the options available to the factoring company when opting for legal recourse.
Late Payment of Commercial Debts (Interest) Act 1988
Many factors when they are compelled to take a debtor to court for an overdue payment will put in a further claim for interest and compensation under the Late Payment of Commercial Debts (Interest) Act 1988. The factoring agreement will have assigned all bought debts to the factor. The factor will assert its statutory rights under the 1988 Act that this transference is just and that it has the right, but not the obligation, to claim interest for the overdue days and compensation. As the days pass after the due date of an unpaid invoice, the interest accrued increases, putting pressure on the debtor to pay now and avoid more cost later. This is a point of leverage for the factor if it is in negotiation with the debtor over payment. The interest rate set out in the Act is 8% above the base rate for lending.
The factor, as mentioned, is also entitled in law to claim compensation for the late payment. The compensation is set as follows:
- For debts of £1,000 or less, £40
- For debts between £1,000 and £9,999, £70
- For debts of £10,000 or more, £100
In practice, the seller will often want to maintain good relations with its debtors and for this reason it will instruct the factor to not claim interest and compensation. The seller will not want to lose customers, and if its products or services are vital to the debtor then it is clearly in the buyer’s interest to pay promptly. If there is a breakdown in relations between the seller and buyer then the factor will assert its legal rights to statutory payment of interest and compensation.
Large companies will often prefer their own accounting systems to that of their suppliers. It is not uncommon for large companies to operate self-billing. This is where the company keeps its own records of delivery, credit notes and payment. They send out payments from calculations that are internally generated often with no reference to outstanding invoices that the supplier has sent. This becomes problematic for a factor seeking payment for an overdue invoice especially in the situation of many small transactions being conducted by the seller and buyer with multiple instances of rejection of goods and deductions being claimed against credit notes. This is a problem for factors that has not been definitively solved. Some factors try to insist that their client provide delivery notes and other documentation that contain the reference numbers the debtor is using.
Self-billing cannot be avoided as the larger company will claim they have better systems in place than their suppliers; and if the suppliers want their business, then it is their way or the highway.
Another tactic of a large business is to insist upon trading that includes a non-assignment clause to prevent the assignment of the debts arising from their purchase contracts. This requires the factor to seek the debtor’s consent to have debts assigned to the factoring facility, to have a record of debts paid and to receive the payments for invoices.
Faced with an obdurate debtor who is looking for legal means to avoid payment, a factor may start insolvency proceedings against the debtor. This is an extreme move to pressure the debtor into paying and for the factor and its client to avoid the cost and delay of court proceedings. However, it is a move that involves substantial risk. The courts view such a move as unreasonable if the debtor has only one creditor seeking payment. To break up a company for a single debt and then allocate all realised funds between numerous creditors according to the relevant statutory scheme of distribution is often viewed by the courts as unacceptable.
As a result, a winding-up petition must be advertised 7 days before it is heard in court to allow other creditors to submit claims. It is an abuse of process to submit a winding-up petition on a solvent debtor in respect of a debt which the creditor knows to be disputed on substantial grounds. The result is that the debtor will be granted an injunction to stay advertising of the winding-up petition. The court may instead dismiss the petition. The creditor will be made liable to pay the court costs for the failed winding-up petition.
When A Debt Can Trigger Legal Proceedings
Currently in the UK and Wales, a company can be taken to court for the inability to pay a debt. This is grounds for a winding-up petition. If a debtor has failed for three weeks after having being served notice to secure, compound or pay a debt exceeding £750 then the debtor is regarded as being unable to pay a debt.
It is generally the case that if a debtor goes insolvent the creditor will end up partially or entirely out of pocket. The insolvency proceedings block the quick payment of a creditors unpaid invoice. Instead, a process must be followed.
It is still possible for older companies in the UK to go into receivership. This is where the company is taken over by an administrative receiver who continues to run the company and sell it as a going concern. If they are appointed all the property of a company becomes available to the receiver to operate the business. Thus, it is very hard for the factor to enforce payment of unpaid invoices against the company property. A liquidator cannot take property and convert it into cash to pay debts outstanding until the receiver has been discharged.
Receivership works against a factor trying to get payment from a debtor company. Indeed, since the debtor company becomes a going concern it is not unlikely that the receiver will approach its suppliers and ask for trade to continue under the factoring facility. The creditor then has to decide whether it will risk more money in order to retrieve the original sum outstanding. The factor will consider the profile of the receiver and if he or she is personally liable for any future unpaid invoices and decide whether to take up the offer.
Companies formed after 2003, due to a legal change, go into administration rather than receivership.
Another alternative to winding up a company is to install a voluntary arrangement whereby the company is allowed to continue its business on the basis of an agreement. All creditors are called to a meeting. They have voting rights and the ensuing agreement is binding on all creditors whether they voted or even attended the meeting. Usually, the factor as the assignee of debt takes the voting right.
Voluntary arrangements like receivership aim to rescue a company from being forced to wind up. The terms of the binding arrangement will stop the factor receiving full payment from the debtor. Rather the factor will be offered a gradual pay down of the debt through instalments or a partial payment of all debts shared proportionally with all creditors. The factor might be given the option of a delayed payment.
When a company goes into administration there is an immediate moratorium to prevent any unsecured creditor from bringing any court proceedings against the company to recover their debt or petition for winding-up without the consent of the administrator or court.
Theoretically, this is only temporary since once the administration has been terminated a factor is entitled to try legal remedy to recover the debt. However, administration normally ends in liquidation for a company and all unsecured debts are nullified.
Administration is not like receivership where the possibility of slowly retrieving a company and putting it on a path to good financial health is a desired outcome. Administration has much more limited goals – to meet legal requirements and then to liquidate or dissolve the company. Administration might also seek a quick sale of the company.
Winding Up and Bankruptcy
Once a winding up petition has been submitted to the court a factor must halt any further proceedings for the recovery of debt. If there is a voluntary winding up then secured debts are paid first using the property of the company. The remaining available money is shared equally between the rest of the creditors (pari passu). The factor can tacitly agree to a voluntary winding up or it can challenge the voluntary winding up arrangement. The courts will listen to not only the opinions of the factor but also to the other parties holding unsecured debts when deciding the matter.
When an SME enters into a factoring arrangement it is usual for the factor to insist on personal guarantees from the directors or owners of the client company. This might sound like the ideal solution for a factoring firm wanting to avoid losing money on unpaid invoices, however, there are numerous legal complexities involved in guarantees and indemnities. A key part of these complexities revolves around the slight difference in legal character between a guarantee and an indemnity. These differences are beyond the scope of this post.
A person who has signed as a guarantor against the payment of an invoice can contest clauses in the guarantee agreement that are ‘unfair’ in the context of relevant legislation. The Consumer Rights Act 2015 sets out the definition of ‘unfair’ as it applies to consumer contracts. It states that a contract is unfair:
“if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer”.The Consumer Rights Act 2015
Therefore, a clause in a consumer contract if deemed unfair is unenforceable. Typically, no-set-off clauses and conclusive evidence clauses are most likely to be challenged in a guarantee agreement under the ‘unfair’ rule. Case law in the UK and the EU continues to grapple with issues of whether a guarantor can be regarded as a consumer.
Another legal avenue for a guarantor to challenge a factor asking for payment on unpaid debt is to claim misrepresentation. This again involves complex legal arguments and counter-arguments that are beyond the remit of this article.
The above review of the legal aspects of taking legal action in order to force payment on an overdue invoice clearly shows that it is not a simple matter of filling in a form and submitting it to a court. A factor that has experience in dealing with these matters is a major benefit for a creditor. The factor can advise its client about the legal options available and chart the best path to recovering a debt. And this should only be considered once all other means of securing a payment on a debt have been exhausted. By far the best way of getting a debtor to pay a debt is through negotiation. The severity of tone of letters demanding payment should be focused on getting the debtor to negotiate payment terms that are acceptable to all parties – the creditor, the debtor and the factor. Legal proceedings are a threat and a last resort for securing payment.