Guide

Unpaid invoices – what to do if a customer cannot or will not pay

Gateley Legal

Article by

Poorly paying customers can have a disproportionate effect on cashflow. How can you get paid earlier, separate the “can’t pay” from the “won’t pay” and manage new customers to minimise future late payment?

In this article Jenna King looks at how managing customer relationships can improve cashflow, protect directors from customer insolvency and focus on customers with stronger covenants.

Long term vs short term solutions to debt collections

Many businesses face issues with cash flow liquidity and as a short term solution to this problem may seek to delay payment of existing invoices, seek to agree longer payment terms with their creditors or in some cases, stop paying their creditors altogether.

Whilst this may serve as a short term solution for the business in question, if your business has several customers who all are facing cash flow issues and are not paying your invoices on time or at all, this can have a negative effect on your own cash flow and ability to continue to trade.

We set out below some practical tips on what you can do if a customer is not paying your invoices and key steps you can take to mitigate your loses and avoid trading with customers who may not pay your invoices in the future.

Practical tips to improve debtor collection

Negotiate early and try to seek an agreement with your customer

Businesses often fail to engage early with customers who are late in paying their invoices largely for fear that this may damage the commercial relationship with their customer whose trade may be crucial to the business in question. Although this may be a commercially sensitive topic, failing to engage with a customer who is late in paying your invoices consistently could be the first sign that your customer is in distress and as a result may not be able to continue to trade with you at all moving forward. It is therefore crucial at the front end to engage in active dialogue with any customers that are late in paying your invoices so that you understand the reason for this late payment and can assess if and when this payment will be forthcoming and if this is something that is likely to be a one off or will continue to be something that affects the customer in question in the long term. Early dialogue affords you the ability to decide ahead of time if you wish to continue to trade with the customer in question which may save you money in the long term if the customer cannot pay any of your invoices and you continue to supply them with goods and services.

Determine whether you will be paid or not

If you have determined that a customer is not willing or able to pay your invoices, you should seek legal advice as early as possible to determine the likelihood of recovering the monies owed to you from the customer. This will vary depending on (i) what the customer is withholding payment of (goods or services) and (ii) the reason why payment is being withheld.

(i) what the customer is withholding payment of

If the customer is withholding payment of goods supplied, it is likely that a business can rely on the terms and conditions agreed between the parties as set out in a contract and/or terms and conditions attached to any invoice to determine that goods have been provided, they have not been paid for in accordance with payment terms (e.g. within 30 days of delivery) and therefore enforcement action may now be commenced to seek recovery of any monies owed. If the customer is withholding payment for specific services such as commercial rent, for example, this may be more difficult to recover in the short term due to various restrictions that have been placed upon the recovery of commercial rent arrears since the start of the pandemic which may be subject to the terms of the Commercial Rent (Coronavirus) Act 2022. You will therefore need to seek specific advice accordingly dependent upon exactly what it is that the customer is withholding payment of.

(ii) the reason why payment is being withheld

The enforcement options available to a business will depend on the reason why payment is being withheld. For example, businesses will need to take different types of enforcement action against customers who fail to pay due to a dispute over the quality of the goods or services provided and customers who cannot pay as a result of their own distress.

Practical alternatives to legal action

Do you have any rights to recover goods under a Retention of Title clause in the contract agreed between the parties?

If a customer has failed to pay for goods provided, you should check the Retention of Title (ROT) provisions in the contract or agreement that you have with your customer to see if these provisions allow you to claim that you own title to the goods and that these goods should be returned to you as they have not yet been paid for by the customer. This may negate the need for any additional enforcement action against a customer directly who cannot pay for the goods.

Click here to read more about Retention of Title clauses.

Do you have any third party guarantees which you could seek to enforce?

You may have sought additional security as part of any initial contract or agreement with your customer in the form of personal or group company guarantees that you can enforce against a third party guarantor should the customer not pay your invoices. Enforcement of a guarantee may prove more advantageous that enforcing your debt directly against a customer who is in financial distress where it is uncertain how much of your debt you would recover from the customer in any subsequent Liquidation.

Can you exercise a lien over goods pending payment from the customer?

If you have agreed to provide goods to a customer which are still in your possession but have not yet been paid for by a customer in accordance with the contract or agreement you have with your customer; it may be possible for you to exercise a lien over these goods which would entitle you to retain possession of the goods pending payment from the customer.

Do you have any rights and remedies available to you under the terms of your contract and/or agreement that you have with a customer?

For customers who consistently fail to pay your invoices on time but who do eventually make payment, you should take legal advice as to any contractual rights or remedies you may have to amend your payment terms with problem customers, withhold supplies of goods or services, charge interest for late payment and/or seek to terminate any contract that you have in place. This may not be an appropriate remedy for customers who cannot pay your outstanding invoices but would be relevant for those that may be suffering short term cash flow issues and do eventually make payment.

Taking legal action for unpaid invoices

If your customer has failed to make payment of an invoice in accordance with the terms and conditions under which you have agreed to trade, the goods or services supplied are not disputed or subject to any legislation specifically codifying a procedure to be followed in order for you to enforce a debt owed (i.e. for certain commercial rent arrears mentioned above), and you would not benefit from any of the options to be considered prior to enforcement (detailed above) then the next step would be to commence enforcement action against your customer on the basis that they cannot pay your invoices.

For commercial customers, it may be appropriate before issuing a Winding up Petition to send a Statutory Demand which sets out a period of days within which the customer must make repayment of any debt owed. You are not required to issue a Statutory Demand before issuing a Winding Up Petition but a failure by the customer to pay the Statutory Demand does provide good evidence to the Court at any subsequent hearing of the Winding up Petition that the customer is unable to pay its debts as they fall due. If the Petition is successful, a Liquidator would be appointed over the business of the customer and you, as a creditor of the customer, would submit a proof of debt in the Liquidation setting out the amount that you are owed from the customer. There is no guarantee that you will receive repayment in full or even a small proportion of the debt that you are owed as this will depend on if there are sufficient recoveries/assets in the Liquidation which may be realised to allow a return to creditors.

For customers who are individuals, a Statutory Demand may be issued against an individual for a debt owed which is in excess of £5,000. If the debt remains unpaid after 21 days from the date of service of the Statutory Demand and an application has not been made to set the Statutory Demand aside, you may then issue a Bankruptcy Petition against the individual. If the Bankruptcy Petition is successful, the individual will be declared Bankrupt, and a Trustee in Bankruptcy appointed over the Bankrupt’s assets. You, as creditor of the Bankrupt, would submit a proof of debt in the Bankruptcy setting out the amount you are owed. Again, there is no guarantee that you will receive payment in full or even a small proportion of the debt that you are owed as this will depend on if there are sufficient recoveries/assets in the Bankruptcy estate which may be realised to allow a return to creditors. 

Managing your customer base effectively

  • Run credit checks on new customers (corporate entitles and individuals) ahead of finalising any agreement to trade so that you can determine if they are in any sort of distress (e.g are they subject to any County Court Judgments), repeat these checks every 6 months and/or set up monitoring functions to alert you to any changes to a customer’s credit report so that you may spot troublesome customers ahead of time. You can also carry out informal checks of new customers by making discreet enquiries of their other known suppliers to determine if they are appropriate customers for your business.
  • Explore opportunities to secure trade credit insurance in relation to a particular customer and take this insurance if it is available at an appropriate cost. If insurance is not available for a particular customer, this is a good early warning sign that a potential customer may not have a good credit rating.
  • Depending on the size of the customer and your own business’ exposure to cash flow issues should this customer not pay your invoices, you may wish to seek adequate security as part of any agreement with your customer in the form of personal or group companies guarantees that you can then enforce against a third party should the customer not pay in the future.
  • Regularly review your pro-forma contractual terms and conditions with your legal advisors to ensure that your contractual clauses are up to date, afford you appropriate rights and remedies and are appropriately drafted dependent upon the relationship that you have with each customer.
  • Invest in a robust accounting system which tracks customers who have overdue invoices and ensure that you have a strong credit control team that monitors customers who fall late with their payments and engages in active dialogue with any late paying customers as soon as possible.
  • Seek to agree shorter payment terms with troublesome customers for future orders if they are late in making payment of your invoices for example, by changing payment terms from 60 days to 30 days or insisting on payment upfront for some customers.

Our Restructuring Advisory team have the required expertise and experience to assist you with restructuring challenges you may face. Please contact us if you would like to discuss any aspect of this article or series.

Gateley Plc is authorised and regulated by the SRA (Solicitors' Regulation Authority). Please visit the SRA website for details of the professional conduct rules which Gateley Legal must comply with.