SMEs Urged to Tighten Up Customer Contracts

Changes to the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (LASPO) came into force in April and look set to have a shutterstock_289448927damaging impact on creditors. UK companies are now being urged to tighten up their customer contracts in a bid to protect themselves against a potential insolvency. This is due to warnings from lawyers that given the recent LAPSO changes, creditors with claims of less than £100,000 against companies entering administration are unlikely to go ahead.

The new rules are supposed to increase the amount of money creditors receive when insolvent companies are taken to court. However, the removal of no win/no fee deals from insolvency litigation has left a funding black hole. The result is that many creditors can now not afford to bring claims against their debtors to court. In reality, the only winners will be the rogue directors who refuse to repay money owed to creditors after insolvency.

How can SMEs protect themselves?

The biggest risk area for SMEs centres on their contracts with customers and clients. In many cases, businesses will simply lack the resources to make a claim as the LAPSO changes have removed any protection from the cost of litigation.

When asked about the changes, 94 percent of the legal and insolvency professionals surveyed said businesses should be much more careful when entering into contracts. Employing a lawyer or other professional before entering into new contracts is advisable. Not only is it essential to make sure the contract is watertight, but it’s also important to thoroughly check the counterparty and establish whether any director has a history of involvement with repeatedly failing companies.

Credit checking new and existing customers is the first line of defence when it comes to controlling bad debt. The following steps should form part of your credit checking process before entering into new contracts:

• Get a status report from credit agencies – An agency will provide you with details of financial results, payment experience of other suppliers, county court judgements, registered lending and a recommended credit rating.

• Bank references – For larger contracts you should ask for a bank reference, known as a ‘status enquiry’, to see whether the bank thinks its customer will be able to meet a specific financial agreement. There is a fee for providing a reference which is typically met by the business making the enquiry.

• Trade references – Only use referees selected by you and not by the customer. You want to know how long the referee has been working with the company, their payment terms, the history of payments and any other useful information.

• Company accounts – The Companies Act requires public limited companies to state the average time taken to pay their suppliers and publish this figure in their directors’ report.

• Companies House – Companies House holds details of all the companies registered in the UK, including accounts, mortgages and information about directors and disqualified directors.

• Visits to customers – Although time consuming, it can be beneficial to visit the customer to assess their premises, staff morale, payment systems and company progress.

Small businesses and micro-businesses will be worst affected

The majority of the insolvency professionals surveyed believed one-in-three cases where companies enter insolvency while holding undeclared assets will not proceed to legal action. One-in-three said they believed over 40 percent of claims would now not proceed due to the lack of funding.

60 percent of those surveyed said they felt it would be small businesses and micro-businesses employing less than 20 people that would suffer the most. This is simply because such small companies are unlikely to have the financial resources to pursue an insolvent company in court.

The changes could lead to an increase in illegal behaviour

78 percent of the professionals surveyed thought the removal of an effective deterrent would lead to an increase in illegal behaviour by unscrupulous directors. With the risk of reprisals reduced, rogue directors will take advantage of the situation and prevent money getting back to honest creditors.

The concerns are such that the litigation reforms have been described by some as ‘a payday for rogue directors’, and unfortunately it’ll be ordinary businesses and the taxpayer that loses out. The president of insolvency trade body R3 supported these claims: “With no exemption, rogue directors and others actually have an incentive to withhold creditors’ money from insolvent estates: it makes it almost impossible to fund legal action against them.”

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