Using insolvency as a debt recovery tool

Recovering debts is a concern for almost any business. Unfortunately, recovering debts through the court is often a frustrating experience.

This is partly because it involves a two-stage process. First, the creditor must obtain a judgment against the debtor, recording their liability to pay the debt. If that does not result in payment, the creditor can then try to enforce the judgment by various means, targeting either the income or assets of the debtor. Even if effective, this can take a long time. Often it is not effective at all, whether or not the debtor actually has the means to pay.

Worse still, the first stage of this process has just become much more expensive, particularly for larger debts. The enormous increase in court fees over the last few years has meant that simply issuing proceedings to recover a debt of £5,000 requires a court fee of £455, while issuing for a debt of £200,000 requires an eye-watering £10,000. This cost is incurred well before enforcement can even begin, so there is no prospect of reducing it if things turn out badly.

The law does set out an alternative route for creditors to take. Rather than go through the two stage approach set out above, they can start winding up proceedings against corporate debtors or bankruptcy proceedings against individual debtors. While insolvency can be used to enforce a judgment, obtaining a judgment first is unnecessary for undisputed debts, as long as they meet the other qualifying criteria.

Insolvency procedures can be commenced without any court involvement at all, usually by serving some form of demand on the debtor. If the demand is not paid or challenged by the debtor, the creditor then starts the court process by filing a petition.

Theoretically, as judges reiterate from time to time, insolvency proceedings are not a debt recovery tool at all. Properly speaking, they are a collective remedy on behalf of all creditors. A third party liquidator or trustee is appointed over the debtor’s assets, which are then distributed among the creditors after the costs of the process are paid. This prevents the creditors wasting their resources trying to get to the front of the queue, each hoping to get paid before the others.

On the face of it, this makes starting insolvency proceedings an unattractive option for an individual creditor. While the petitioning creditor will have their costs paid as a priority, they otherwise obtain no advantage compared to the other creditors.

It is certainly true that there are cases where starting court proceedings and enforcing against individual assets is a better and more targeted approach. However, even with traditional enforcement methods, the object is as much the threat as the reality. The creditor is not interested in seeing enforcement as an end in itself – they simply want their money paid.

Most debtors are not completely incapable of paying. They simply have other priorities at present – whether they want to spend the money on something else or prioritise the payment of other creditors that are pressing them harder. In short, they won’t pay rather than can’t pay.

This is why insolvency procedures can be a useful debt recovery tool – they apply pressure like nothing else. Given insolvency has an effect on all the assets of the debtor, there is no simple way for them to escape serious consequences, and there is no need for the creditor to know what assets to target. If they are made bankrupt or wound up, anything the debtor owns will be vested in a third party, and even their previous dealings will be investigated.

As a result, insolvency procedures soon sort out the debtors who won’t pay from the debtors who can’t pay. While they cannot help with debtors that have nothing to lose, no enforcement method can. Those debtors with something to lose will have to react when threatened with insolvency. Even debtors that are in serious financial difficulty may end up paying, simply because it makes them revise their priorities. Ironically, although the purpose of insolvency proceedings is a collective remedy for creditors, most insolvency proceedings are actually brought by creditors looking out for number one.

Insolvency procedures not only apply particularly strong pressure, but that pressure is applied at an early stage. Even if court proceedings are begun swiftly, it is normally weeks before judgment can be obtained. Only then can enforcement begin. Insolvency proceedings follow a more brutal timetable, and cannot be ignored for long. This is particularly so for companies where merely advertising a petition will normally be enough to stop them trading, long before they are officially wound up.

Traditionally, this came at price. Insolvency was always a more expensive option than traditional court proceedings, at least as far as the initial outlay was concerned. There is still a widespread perception that insolvency is an effective but expensive method to recover debts.

In reality, rapidly rising court fees have meant that the position has changed completely. The different nature of the proceedings makes it impossible to carry out a direct comparison, but for larger debts, the entire cost of the insolvency process can now be less than the issue fee alone.

This does not mean that going down the insolvency route is appropriate in all cases. For smaller debts, court proceedings may still be a cheaper option. There may be specific tactical reasons to pursue a particular form of enforcement. Nonetheless, using insolvency as a debt recovery tool is more useful than ever before.

Nathanael Young is a senior associate at SA Law and leads the firm’s insolvency practice area.

 

 

 


 

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