The following are the options available to creditors to recover from a defaulting debtor:
(a) Exercising remedies of a secured creditor
Where the defaulting debtor has provided security against the debt owed, a secured creditor has several options available to it under the law. Most types of security include the inherent power to take possession of the secured property; to sell the secured property; or to appoint a receiver to manage and/or sell the secured property.
Where the creditor is in possession of a debtor’s property, the creditor can, in certain circumstances, exercise its lien by selling the property to recover the owed sums. Further, suppliers can ensure their contracts have a retention of title clause to reserve title to the goods until payment for them is received. If the customer becomes insolvent, the creditor/supplier can repossess the ‘unpaid-for’ goods since they belong to it. This mechanism is, however, only useful where title is yet to pass to the buyer.
(b) Attachment and execution by an unsecured creditor
Upon proving that a debt is owed before a court of law, an unsecured creditor can obtain a court order to take possession of the debtor’s property with the aim of on-selling such property to repay itself. However, to be lawfully entitled to the said debtor’s properties, execution of the order needs to be complete before the start of any liquidation proceedings against the debtor. If any liquidation proceedings have begun, the creditor will require permission from the court to proceed.
(c) Contractual creditors’ protection mechanisms
Creditors can also rely on the contracts they have with a potential debtor to protect themselves. The contract should provide for the payment terms and consequences of default by the debtor. In addition, the contract may provide for the control of the debtor’s conduct to protect the interest of the creditor. For instance, charging adequate interest rates; restricting the freedoms of the defaulting business such as restricting its ability to borrow further; restricting distributions to shareholders; allowing for acceleration of loans granted to the debtor upon the occurrence of any of a number of specified “events of default”; and asking for additional securities from the debtor. The above mechanisms place secured creditors at a better position than unsecured creditors. However, the restrictions must be reasonably qualified to ensure that the contract is practicable.
(d) Inter-creditor arrangements
In instances where there is more than one creditor to a common debtor, the risk of some creditors acting against the interest of the others is real. An inter-creditor agreement can be entered into between the creditors to regulate their individual conduct by ensuring that there is a consultative approach taken when dealing with and taking action against the debtor.
(e) Entering into debt settlement plans with debtors
Creditors can also enter into debt payment plans to reduce the principal sums owed to them over time. A creditor may take such action, where it realizes that a demand for full payment will not yield any results.
(f) Factoring and invoice discounting
A creditor can sell off the debts owed to it by a debtor to a third party (called a factor) at a discount, thereby immediately unlocking cash payments and relieving the creditor from the burden of having to constantly collect and/or wait for payment.
(g) Insolvency proceedings/ Debt Restructuring
Finally, if all other debt collection methods fail, a creditor may decide to initiate insolvency proceedings against the defaulting debtor company, where a liquidator is appointed to gather all the defaulting debtor’s assets and pay off its debts.
The liquidator will pay the creditors from the assets of the company in the prescribed order under the Insolvency Act, 2015. The Act gives priority to the secured creditors then, preferential creditors and finally unsecured creditors respectively.
During the course of the insolvency proceedings or during any debt restructuring negotiations that may result, various payment options may be presented to creditors to finalise the process, including: (i) periodic payment plans, (ii) waiver of a certain portion of the debt (often referred to as taking a ‘haircut’) and full payment of the balance in full and final settlement, or (iii) the issue of equity or quasi-equity securities in the company to creditors.
Businesses should, depending on (i) a customer’s payment track record, (iii) their ability to pay and/or (iii) the value of the goods or services in question, insist on requiring customers pay them either on delivery, or provide them with letters of credit or other similar instruments, whereby payments are more or less guaranteed. Should such measures not be available to a creditor, then immediate steps should be taken towards realizing unsecured debts at the earliest opportunity.