A guide to the practicalities around chasing overdue invoice payments and loan repayments
Overdue invoice payments
When considering how best to deal with a customer, client or other stakeholder that has failed to pay an amount of money that has fallen due, it is important to try to achieve a compromise between your interests and theirs. This is for both commercial and reputational reasons.
Rather than threatening to take a debtor to court (or worse, to apply to have them wound up or declared bankrupt), you could instead consider whether you might be able to offer more sympathetic terms. For example, extending the payment deadline or spreading the payment over a defined period of time might place the debtor in a position that enables them to better manage the repayment (from a cash flow perspective), whilst also preserving your relationship with them. Pushing too hard for a payment could end up driving a debtor into insolvency, in which case you may well receive back nothing.
However, you will of course need to consider the circumstances on a case-by-case basis, assessing the merits of each particular debtor. If it is clear that a debtor is on the brink of insolvency, or it’s a debtor that regularly defaults on payment terms, then extending the payment deadline might result in you receiving back nothing at all. In contrast, if a debtor has a solid payment history and can evidence that the lack of payment resulted from an operational error or a temporary cash flow issue, you might feel comfortable offering more latitude.
After all, establishing a structured, sympathetic compromise in connection with the payment of invoices is far more likely to generate enhanced loyalty from your stakeholders in the longer-term.
Strictly manage your own cash flow
However, where you are reliant on receiving payments in respect of a number of debts, it is essential that you strictly manage your own cash flow.
In times of crises, including throughout the COVID-19 outbreak, it may be imperative that you adhere to a strict spending regime. Perhaps avoid any unnecessary investments, constantly monitor your expenses (and assess whether these can be reduced), and consider whether there are government fiscal policies that could help to alleviate any financial uncertainty.
If your industry is likely to experience a negative financial impact for a prolonged period of time, try to plan for a higher than usual percentage of debtors defaulting on payments due (or only managing partial payments) and for a greater proportion of payments coming in late. For example, if you offer credit terms, consider whether the credit limits should be made more stringent.
Overdue loan repayments
As with client or customer debtors, lenders should not ignore early warning signs that a borrower is or may shortly be in financial difficulty. Such early warning signs could include breaches of financial or other covenants included within a loan agreement, missed payments (either of principal or interest) due under a loan agreement and/or reductions in the value of any security held by lenders.
All of these circumstances, either immediately on occurrence or with the passing of any applicable grace periods, are likely to amount to an event of default under a loan agreement.
Event of default: first steps
If there is an event of default under a loan agreement, the first step a lender should take in order to preserve its right to take action in relation to that default is to issue a reservation of rights letter to the borrower. Such letters formally notify borrowers of the default and reserve a lender’s right to take action in relation to such default at a future time.
This buys the lender time to properly analyse why the default has occurred and the action it should take in relation to this, whilst also preventing the borrower from trying to assert that the lender’s subsequent inaction constituted an implied waiver of the default.
Under such circumstances, the lender should liaise with the borrower at the earliest opportunity to understand why the default occurred and to determine whether the default is a sign of longer-term financial instability. The lender may need to request additional financial or other reports at this time in order to inform this assessment.
Potential solution to short-term cash flow issues
If a lender has satisfied itself that any cash flow issues the borrower is experiencing are only short-term then it may consider the following to alleviate the immediate financial pressure on the borrower:
- Repayment holidays: lenders could offer temporary “repayment holidays” that allow borrowers to cease making Interest payments and/or capital repayments for a limited period of time. In such circumstances, each lender would need to document the arrangement to make it clear (for example) that the repayment holiday will only last for a predetermined period of time, no payments due under the loan are being waived, and interest will continue to accrue on the balance of the loan during any such repayment holiday.
- Reducing amortisation: if a loan has been provided on an amortising basis, the repayment schedule may be amended to reduce the amount of the actual loan that is being repaid by the borrower on each payment date (e.g. monthly/quarterly). Any amendments to the repayment schedule should be clearly documented and it should be made clear that as the loan will be repaid over a longer period of time, the overall amount of interest charged in respect of the loan will increase.
- Further lending: another option would be to lend additional funds to the borrower to help it through its short term financial issue(s). This should only be considered where a lender is comfortable that the borrower’s financial position will improve to the extent that it will be able to repay both the original and additional debt.
- In such circumstances, a lender should consider whether it can take additional security from a borrower or third party to secure the increased amount of the loan.
- If additional security is going to be taken, the lender should take advice as to whether the granting of such security would be considered a “reviewable transaction” under insolvency law, which could result in the security later being deemed invalid.
- If taking security from a third party, a lender should also carry out a full credit check/analysis of the financial position of that third party and ensure that third party obtains independent legal advice before granting the security.
- Amending loan agreement: lenders could also amend the financial covenants set out in a loan agreement to reflect the short-term cash flow issue and ensure that the borrower doesn’t repeatedly breach such covenants in the short-term.
Longer-term financial issues
While it is often better for a lender to support a borrower through a period of short-term financial difficulty, lenders needs to put in place contingency planning in case the borrower’s financial position deteriorates.
Where a borrower is in distress, a lender may wish to review any security it holds in connection with the funds lent to that borrower. It may be prudent to obtain updated valuations of any property or other assets secured, or updated statements of net worth from individual guarantors.
A lender may also wish to carry out a security review to make sure the security taken has been properly documented and registered and that any defects in the security are (if possible) remedied before enforcement action needs to be taken.
If the lender has taken a fixed charge over any of the borrower’s assets, it may want to seek advice to ensure that it is demonstrating a sufficient degree of control over such assets (otherwise the fixed charge may not be upheld in an insolvency process). If the lender cannot demonstrate sufficient control, the charge may be reclassified as a floating charge, which will likely impact the amount the lender will be able to recover following the borrower’s insolvency.
Where it looks like a borrower’s financial position is deteriorating, lenders should consider their enforcement options and perhaps commence early discussions with insolvency practitioners. This can help lenders to understand how they should proceed should enforcement be necessary.
if enforcement action is unavoidable and you require more information in relation to formal insolvency processes/options, we have created a broader guide to insolvency that we would be happy to send you on request.
This short guide has been prepared for directors and owners of private limited companies for information purposes only, in particular to provide a summary of key practicalities that should be considered in the context of chasing overdue debts. This guide does not constitute legal advice and should not be relied upon. For specific queries and any further information, please contact Ignition Law for advice relating to your particular circumstances.