Bad Debt Recovery

shutterstock_158522279While every business has bad debts, taking the right steps at the right time can mean the difference between full recovery and a loss to the business. This article looks at those steps and your options when attempting to recover bad debts.

What is a bad debt?

A bad debt is an account receivable or amount owed that has not been paid and unless the steps taken to recover it are successful, it will likely be written off as an expense on your income statement. A business will generally factor in a certain percentage of bad debts when estimating earnings.

Recovering bad debts

There are several steps involved in the recovery of bad debts and they escalate in degree of severity, depending on the response from the debtor.

  • Negotiation – This should be your initial action when a debt is overdue. If a debtor does not respond with payment after receiving written reminders and overdue statements, you should contact them by telephone and ask them why the debt has not been paid. Often it can be an oversight, but if not, making direct contact will often spur them into action. If they are having financial difficulties which are preventing them from paying the debt, you can then work out a payment plan with them. But the only way you will know if this is the case is by contacting them directly.
  • Letter of demand – If, after contacting them directly, the debtor still fails to pay the debt, your next step should be to send them a letter of demand. This should state the amount that is owed, when it must be paid by and what the repercussions will be if it is not paid by that date. You can either write a letter of demand yourself, or have a debt collection agency do it for you.
  • Debt collection agency – This is the next step available to you, although in many instances, it may be wiser to involve a debt collection agency earlier rather than later. An early debt collection service, such as that offered by Consolidated Collections Australia, can take care of this process for you, as they specialise in everything from phone, letter and email reminders through to full collection services. If you have a lot of bad debts, hiring such an agency to deal with them at an early stage provides a cost-effective solution, which often results in higher recovery rates.
  • Legal action – this is the last resort in the debt recovery process. If the debt is substantial and you have a strong case, you can serve a Statement of Claim or Complaint on a debtor, who then has a period of time to respond with a Defence document. If they do not respond within that period of time (which varies depending on jurisdiction), you can obtain a default ruling and take enforcement action, which includes having property seized and sold to pay the debt. If they file a Defence, then the matter will proceed through the court process which may involve a pre-hearing conference or mediation to attempt to resolve the matter, failing which the matter will proceed to a contested hearing.

Considerations

When attempting to recover bad debts, a business must take several factors into consideration before proceeding with each step. These include:

  • The importance of the debtor as a client. If the debtor spends a lot of money with you and the debt is relatively small, you may prefer to take a softly-softly approach in order to avoid losing them as a client. If bad debts are a common problem with them however, it may be more worthwhile for you to pursue the debts, even if it means losing the client.
  • The costs associated with recovering the debt. If the debt is only for a small amount and the client is not a regular customer, then it may cost more in time and expense chasing the debt than it is actually worth. This is where a debt collection agency may be able to help as they often work on a no-collect/ no fee basis, minimising the time and cost risk to your business.
  • The financial position of the debtor. If the debt cannot be recovered and requires court action, you need to be sure the debtor has sufficient assets to pay the debt when you obtain judgment. If the debtor is a company and you attempt to enforce any judgment by winding the debtor up there is the possibility that the debtor will not have sufficient assets to pay all creditors, in part or in full, which means you may only ultimately recover a fraction of the debt, if anything at all. Similarly, if the debtor is a business or individual, it is important to consider the financial position of the debtor to ensure that the costs involved in litigating will result in actual recovery when enforcement action is taken.

Conclusion

In an ideal world, no one would incur bad debts, but they are unfortunately a fact of business life. One way to reduce the likelihood of them occurring is to spell out your trading terms and conditions very clearly at the outset.

If all documentation and contracts that you provide or enter into clearly indicate what goods or services are being supplied, the time limit for payment and the repercussions of non-payment, then the number of bad debts you incur will be reduced. Further, having clearly defined terms that both parties have agreed to greatly increases your chances of recovering the debt in the event that legal action becomes necessary.

Jarrod Kagan
Having practised at a major law firm before moving across to Probe Group (one of Australia’s most prominent credit management organisations), Jarrod has over 8 years’ experience in credit management and debt recovery. He now holds the position of Head of Business and Compliance and as a qualified Lawyer, his skill level and experience covers the technical aspects of credit management and debt recovery, including: best practice, compliance, legislation, strategic analysis and industry specific detail.