What is a debt and does it matter?
A debt is any money that is owed or due under an agreement to pay. It is an agreed, definite sum of money that is fixed by the parties to a transaction, and which becomes due following a trigger for payment.
Most of the time, you won’t have to concern yourself with what counts as a debt, and it will usually be obvious when businesses owe money to one another. The debt will normally be recorded in an invoice. But the absence of an invoice or a written agreement to pay does not prevent a debt arising; verbal terms and agreements will suffice.
There is an important distinction between a debt and damages. A debt is a definite sum due following an agreed trigger, whereas damages are set by reference to the loss suffered following the failure to fulfil an obligation. Damages are subject to rules that govern the extent of recovery, such as causation, remoteness and mitigation. In a debt claim, it only matters that a debtor has failed to pay the agreed sum. Further, if you are looking to recover a debt you can do so through insolvency proceedings.
What are my options?
If you’ve tried negotiating repayment and have exhausted your options short of taking formal action to recover the debt, you can either look to pursue insolvency proceedings or civil proceedings.
What do insolvency proceedings involve?
The end point of insolvency proceedings is bankruptcy for individuals or a winding-up for companies. Proceedings can be started where there is no reasonable prospect of the debtor being able to pay, and the debt is above the statutory threshold: £5,000 for an individual and £750 for companies.
The first step is usually the service of a Statutory Demand, which is prepared using a prescribed form.
A Statutory Demand is useful because if the debtor fails to pay the amount sought within 21 days, the demand will stand as evidence that the debtor is unable to pay its debts, allowing the creditor to continue with insolvency proceedings.
Insolvency proceedings must not be commenced where (a) the debt is disputed on substantial grounds and/or (b) the debtor has a counterclaim that would bring the debt below the statutory threshold.
It is important to take a broad view when considering (a). Debtors sometimes give reasons to assert the existence of a dispute that seem spurious. However, the court often takes a generous view on what constitutes substantial grounds, and can penalise creditors who proceed with insolvency proceedings despite the debt being disputed.
If there are no impediments to proceeding and the debt remains unpaid 21 days after the Statutory Demand, the creditor can present a bankruptcy or winding-up petition. Although these are not overly complex processes, there are deadlines and tasks that must be completed by the petitioning creditor at each stage. It is vital that these are observed, as failure to do so can result in a petition being rejected.
What do civil proceedings involve?
If the debt is below the threshold, or if it is disputed, you will need to issue civil proceedings at court. Depending on the value, the claim may be issued at the High Court, County Court or one of the online money courts.
Before issuing a claim, you should send a letter before action that is compliant with the Civil Procedure Rules. That letter will set out the legal basis of the claim and how much you are claiming. You should allow the defendant at least 14 days to respond.
If you are unable to resolve the dispute in correspondence you will need to prepare, issue and serve your claim. From that point your dispute will be governed by the relevant court process. Our guide to the litigation process in England and Wales gives an overview of the stages that each claim goes through (for cases involving disclosure in the Business and Property Courts please see this guide, and for all other cases please see this guide).
Which route is appropriate for me?
The route available will often be pre-determined because a debtor may say that it disputes the debt or that it has a sufficient counterclaim, in which case insolvency proceedings will not be an option. Where both routes are available to you, the factors below will impact on which one is likely to be most appropriate.
What are the relative costs of the two routes?
A key driver in your decision as to which route to take will be the cost benefit analysis of pursuing a debtor. It is possible that you will have little knowledge of the debtor’s current financial position. This increases the risk of throwing good money after bad.
It is generally cheaper to complete the insolvency process than to run civil proceedings to trial.
A Statutory Demand is a relatively low-cost step. The form is prescribed and requires limited detail. There is also no fee involved in serving one, other than legal costs, whereas a court fee – which can reach £10,000 – is payable for any new civil claim. There is also no obligation to pursue insolvency proceedings if a debtor does not pay a Statutory Demand. But once a claim is served on a defendant, and in particular a defence is served, the court timeline and obligations are engaged, meaning if you withdraw you may be liable for the defendant’s legal costs as well as your own, and you will not be able to recover the court fee paid.
A Statutory Demand is therefore more attractive if you have limited insight into the debtor’s finances. It can be a low-cost way of flushing out the debtor’s position. Once that is done, you can make a more informed decision on how to proceed.
What are the typical outcomes for each route?
Insolvency proceedings and civil proceedings have significantly different outcomes. In short, if successful in civil proceedings you will obtain a judgment for the debt, and potentially some of your legal costs, which you can look to enforce if the debtor fails to pay.
In insolvency proceedings, if the debt is proven, the debtor will either be declared bankrupt (if an individual) or (in the case of a company) be put into liquidation. Read more in our article about “Dealing with a counterparty who is facing insolvency”. The debtor’s assets will be distributed to all of the creditors. As it will have been established that the debtor cannot pay its debts, it is very unlikely you will recover all of what you are owed. That issue is not exclusive to insolvency proceedings: you cannot enforce a court judgment obtained in civil proceedings if the debtor has no assets.
From a commercial perspective, insolvency proceedings work best as a pressure tactic. Debtors are likely have multiple debts overdue and often it is the creditor which shouts loudest that moves to the top of the pile for payment. Threatening insolvency proceedings can be the most effective way to achieve that.
How long will each route take?
Although insolvency proceedings will generally be concluded quicker than a civil case running to trial, that is only part of the process. There will then be a process whereby creditors’ interests are ascertained, and the debtor’s assets are distributed.
The Civil Procedure Rules provide mechanisms to allow court proceedings to be resolved earlier than going through to trial, such as default judgment, summary judgment or the strike out of a defence. Often there are costs risks associated with seeking these, but if applicable they may lead to a quicker resolution than insolvency proceedings and, importantly, may do so before other creditors are able to make good their claims. Many claims also settle before reaching trial.
How can I maximise my chances of recovery?
A key issue in any debt matter, however pursued, is whether the debtor is good for the money.
So, at the outset, do as much as possible to ascertain the debtor’s financial position. Providers exist who can undertake financial investigative work at a reasonable cost.
Also, use the prospect of further proceedings to engage with the debtor and, ideally, secure payment or agree a settlement with a revised payment plan. It is better to get a realistic payment timeframe than none, although always be sure to include accelerator provisions so that if the debtor defaults on the plan, you can immediately recover the entire debt, not just the missed instalment.
You can mitigate costs spent on recovery by seeking to recover interest and / or legal costs. Often terms and conditions will include provisions for this. But if not, the Late Payment of Commercial Debts (Interest) Act 1998 implies a highly favourable interest rate on late commercial debts of 8% above the Bank of England base rate.
Whatever your position, the best approach is typically to set a strategy at the outset and look to build pressure on a debtor, whilst offering them a realistic route out, on terms that are as favourable as you can make them.
To view our debit recovery dispute resolution process flowchart click here or use the download file button.
LS Unlock
We have created an initiative called “LS Unlock” to help businesses access legal advice during the uncertain times ahead. LS Unlock comprises a free initial assessment of significant commercial claims together with a menu of alternative fee arrangements which can reduce and, in certain cases, eliminate the upfront cost of pursuing a claim. This initiative has been designed specifically to assist clients in this uncertain economic climate and is part of our commitment to working with clients to help them survive its effects.