Debt recovery for small businesses: The legal options and avoiding bad debt

Most businesses will experience a customer not paying by the due date.

This bad debt can be a significant challenge for small businesses, impacting cash flow and profitability.

It is a major contributor to business failure. How can you avoid bad debt and what are the legal options for recovering in England and Wales?

Avoiding bad debts

The best approach to bad debt is prevention. Taking proactive steps can reduce the likelihood of non-payment:

• Request Advance Payments: Where feasible, secure funds (all or a deposit) upfront before entering into contracts. This is particularly important with overseas customers where debt recovery is even more challenging.
• Perform Credit Checks: Conduct discreet credit checks on prospective clients to assess their financial reliability. Don’t ignore the findings. Adjust your payment terms if the prospective customer is a higher risk.
• Draft Strong Contracts: Ensure your terms and conditions are clear and comprehensive and get them checked by a specialist lawyer. Well-drafted contracts can minimise disputes and provide a solid foundation for enforcement if issues arise, so will save you far more than they cost. Review your contracts regularly and each time you have a payment issue as you will learn from experience.

Despite these measures, small businesses often face situations where taking on some level of risk is necessary to secure valuable contracts. If a client defaults, understanding your legal options is critical.

Legal options for debt recovery

When a debtor fails to pay, you have several potential courses of action:

1. Court Proceedings
2. Insolvency Proceedings
3. Settlement
4. Doing Nothing

Court proceedings

Taking the matter to court is a common route for debt recovery. Depending on the claim’s value, it will fall into one of several tracks:

• Small Claims Track: For claims up to £10,000.
• Fast Track: For claims between £10,000 and £100,000.
• Intermediate Track: For claims up to £100,000 with specific procedural rules.
• Multi-Track: For higher-value or more complex claims.

If the debtor disputes the claim, consider applying for early judgment if there is no credible defence. However, be prepared for delays due to court backlogs and procedural stages.

• Costs: Recovery of legal costs is limited, especially for small claims where costs are generally not recoverable (see below).
• Court Fees: Fixed fees apply at key stages in both the County Court and High Court.
• Enforcement: If judgment is obtained and the debtor still fails to pay, enforcement options include bailiffs, transferring the case to the High Court for enforcement by sheriffs, charging orders, or attachment of earnings orders.

Small claims track

This is the route to take if the claim is under £10k.  The cost of using lawyers cannot usually be recovered to limit costs for both parties.

There are a number of ways to access the courts for small claims. The simplest is to use Government’s Money Claim Online (MCOL) service. This is the route to take if your claim is straightforward and you know the exact amount you’re claiming. This is far cheaper than going through the county courts. Fees for the MCOL service are based on the amount claimed but start at just £35.  You can even use a credit card to pay the fee. If you win, the court is likely to order that the other side refunds the fee to you. You can also claim statutory interest on the debt.

To access the service, go to: https://www.moneyclaim.gov.uk/web/mcol/welcome.  The site takes you through the process and is designed to be accessible for all.

Once you’ve submitted the form, a claim is sent to the debtor through the court. This official claim is often enough to make the debtor pay up and you don’t then need to take your claim any further.  If the claim does continue, and you win a judgement, you then have the same rights to enforce (see above).  If the debtor still doesn’t pay, they risk a CCJ (County Court Judgement) going onto their record.

Insolvency proceedings

Insolvency proceedings, while not primarily designed for debt recovery, can pressure debtors to settle. This includes:

• Bankruptcy Proceedings (Individuals):

• Start with a statutory demand.
• Issue a bankruptcy petition if the debt exceeds £5,000 and remains unpaid.
• Be cautious: issuing a petition for a disputed debt may be considered an abuse of process.

• Winding Up Proceedings (Companies):

• This involves issuing a winding-up petition under the Insolvency Act 1986 if the company owes at least £750 and cannot pay.
• If successful, the company’s assets are liquidated, but unsecured creditors may receive little to nothing after the distribution of proceeds.

Before initiating insolvency proceedings, consider the following:

• Are you prepared to follow through, or is it a bluff?
• Is the debt genuinely disputed?
• What is the likelihood of recovering a meaningful portion of the debt?

Settlement

Settlement is often the most practical option, especially when legal costs and delays are factored in. Negotiating a repayment plan or accepting a reduced sum can be more cost-effective than pursuing court action or insolvency proceedings. Each case should be assessed on its merits, considering the debtor’s willingness and ability to pay.

Doing nothing

In some cases, walking away may be the best decision. Writing off the debt can save time, money, and management resources that might otherwise be tied up in recovery efforts. Consider the following factors when deciding whether to pursue recovery:

• The size of the debt.
• The likelihood and cost of successful recovery. A key part of this will be the robustness of your contract and the evidence you have that the money is owed.
• The impact on internal resources, including management time and staff morale.

Conclusion

While bad debts are an inevitable risk for small businesses, careful planning and robust contracts can help minimise their occurrence. When debts arise, it’s essential to weigh the available legal options against the potential costs and benefits. In some cases, settlement or even writing off the debt may be more advantageous than pursuing the often lengthy and expensive legal proceedings. However, in England and Wales the Money Online Claim Service, where you don’t need lawyers, is a simple and cheap option for smaller debts.

If you’re unsure about the best approach to debt recovery or contract drafting, seek legal advice tailored to your business’s specific needs. A proactive and informed approach can safeguard your business’s financial health and long-term success.