Zombie companies, although generating cash, after covering running and fixed costs, only have enough funds to service interest on their loans and not the debt itself
Everyone is in trying times, and businesses that are looking to reel in what they are owed are struggling. If getting paid in normal times was tricky, firms are now having to up their game just to stand still.
Chris Else, a solicitor and managing partner with Else Solicitors LLP, has been in debt recovery and commercial dispute resolution since 1987 and says that, the current crisis aside, he has never known a period where debt recovery has not been busy. ‘Of course,’ he adds, ‘clients only instruct lawyers when they need to chase substantially overdue debts … and, inevitably, as we provide this service, we are bound to be busy, and so do have a cynical view of the business world’.
The matter respects no boundaries for Else: ‘we act for law firms, banks, pub companies, commercial landlords, schools, construction companies, dentists and even surgeons—there is no specific sector that is immune from bad debt’. As he sees it, there seems to be a general rule that some always wait until they are forced to pay.
Furthermore, a new trend has emerged during the COVID-19 pandemic: a request from customers to effectively wipe 10% or 20% off any outstanding invoices. However, when this happens, the response should be a commercial decision, where the supplier will need to weigh up the benefit of keeping the customer against the potential loss of profit. Of course, if a client unilaterally makes a deduction, the balance can be treated as an outstanding debt.
Avoiding the zombies
There have always been companies unable to pay their way properly, as they live from one day to the next. Known as ‘zombie companies’, they are classically defined as carrying substantial debt that, although generating cash, after covering running and fixed costs, only have enough funds to service interest on their loans and not the debt itself.
These businesses, says Else, ‘generally depend on banks and creditors for their continued existence, which effectively puts them on a never-ending life support system’. That support has recently moved to the public sector; zombie companies are growing increased payment times.
Identifying zombie companies is not easy and, in these circumstances, as Else advises, ‘the only way to be paid on time is to ask for the full amount due in advance of the goods and/or services being supplied’.
So, to lock the stable door before the horse bolts means engaging a business information service or credit reference agency to assess debtors or a (potential) customer's credit worthiness. As Else says, this allows firms to ‘understand exactly who you are dealing with, and the customers correct title’. He adds that it is crucial that a limited company and directors are checked against Companies House records looking for details of past failures.
However, Else says to also look at the Register of Judgments, which is kept by the Registry Trust, to ‘check whether there are any judgments against the individual directors of a company, and also whether there are any judgments or, indeed, winding up petitions issued against a potential customer’.
Business information services are important and are often overlooked, sometimes because of the cost. However, where they are deployed users should remember that the information can be out of date.
Allied to this is a robust system that starts with a credit application form that all new customers must complete. This will capture the information that is needed to understand who the customer is; this should be followed up with a couple of trade references. Beyond that is the setting of a credit limit for customers and sticking to it.
» Aside from the Act, Else recommends that firms have terms of business that cover things such as charges for late payment with a standard administration charge of £100 and interest on late payment (for example, 2% per calendar month or part of a month) as a standard «
One critical part of the business infrastructure that Else says should be in place is ‘an individual member of staff, if you do not have a full-time credit controller, to carry out the credit control function’. Additionally, to be effective, they must use a standard procedure, so that if an invoice is due and payable after 30 days, then, at 45 days, all services and deliveries are stopped if payment is not made. In Else's view, overdue accounts are immediately due, and all work should be stopped to minimise further loss. For him, the benefit of a good credit control process is that problems become apparent much sooner—not after 90 days when invoices become aged.
This process can also be tied to a factoring arrangement to help cash flow. However, it should be remembered that a firm using a factor will suffer a shortfall on each invoice paid, and, furthermore, cash advanced by the factor will usually need to be paid back if customers do not pay. Also, a factoring arrangement may limit the ability of the company to access other forms of borrowing and, additionally, a factor may deal with customers differently and cause damage to the supplier–customer relationship.
Carrot and stick
For over 20 years, the Late Payment of Commercial Debts (Interest) Act 1998 has been in place to level the playing field. Its purpose was to help creditors claim interest on overdue accounts, obtain compensation and, latterly, payment of reasonable legal costs or costs of recovery.
However, as Else points out, a seller does not have to actually use the legislation, but just refer to it: ‘compensation, interest and costs … [offer] leverage to add costs onto the debt to ensure the ‘will not pays’ now pay, rather than face the increased costs of court proceedings’.
In other words, he is saying that, when a debt is over the agreed payment, credit controllers can offer to ‘waive’ the compensation fee (due on each overdue invoice) and possibly the 8% per annum statutory interest due if the debtor pays very quickly. These charges are a powerful tool for credit controllers. However, Else notes that the legislation will not counter those who cannot pay.
Aside from the Act, Else recommends that firms have terms of business that cover things such as charges for late payment with a standard administration charge of £100 and interest on late payment (for example, 2% per calendar month or part of a month) as a standard.
Good credit controllers should, Else says, be calling and writing to confirm payment dates and requesting confirmation of the date upon which payment will be made. Reference can be made to terms of business and/or the late payment legislation. Else thinks that a good ‘credit manager ought to say something such as: “if there are reasons for non-payment or if you are unable to pay, please confirm this in writing and confirm a later payment date … if you keep to the later payment date, we will waive the administration fee and the interest charges. However, if you fail to adhere to the later payment date, then we are likely to instruct solicitors who will claim these charges and in addition legal fees”’.
However, sight of the fact that there is always the risk of losing clients if there is a dispute should not be lost, especially if a heavy-handed approach is taken to debt recovery. Yet, the contrary argument is that there is no point supplying a client that does not pay. Even so, the reasons for non-payment should be understood: is it cannot pay or will not pay? Is there a complaint about delay or quality to deal with? If it is a temporary cash flow problem, firms could consider an instalment arrangement.
It is of interest that Else has ‘sued many debtors on behalf of the same clients and the same debtors often (re)appear; they actually use the debt recovery process as a red letter … they pay on judgment before enforcement proceedings’. He has found that, sometimes, a debtor will receive the judgment, which is sent to the High Court for a Sheriffs High Court Enforcement Officer to visit when payment is then made. It is fascinating that some clients still deal with these customers, and ‘it all seems to be part of a game of cat and mouse … but the important point to remember is that, if action is threatened, it must always be taken’.
If, ultimately, it is not possible to agree a resolution with a customer, then court proceedings may be the only option. However, before embarking on this, a wise litigant will always be mindful that court proceedings and enforcement involve cost. The commercial reality is that not all debts will be collected, even if the plaintiff is granted a judgment in its favour.
Conclusion
Ultimately, it is better to talk than to throw stones, for it is possible to win the battle (and receive payment) but lose the war (lose the client). In the current climate, many firms will be having genuine, but temporary, cash flow problems, and instalment arrangements could reduce a firm's exposure to loss. However, it makes commercial sense to help good customers stay in business, but not if doing so pushes your business towards insolvency.