A recent judgement proposes that further businesses could be at risk from cash-flow difficulties, if without them knowing, an important customer becomes insolvent. What action can they take to avoid this?
The idea of ‘good faith’
A reminder of ‘good faith’ alone is not being enough to protect suppliers against potentially having to repay payments, that they have received from their customers. This can be seen from the recent case of Dingley and others vs Nisa Retail Ltd.
Any disposition of property made by the business after the date a company is issued with a winding-up petition, is void. This comprises cash paid to a business’s suppliers, which will have received payments without knowledge of the petition and in good faith. Putting the correct credit controls in place and having regular interaction with customers could aid suppliers in protecting themselves from this situation, whilst also protecting their cash position.
Normally a period of time is established between a winding-up petition being issued and it’s eventual advertisement, an online journal and print which publishes notices of insolvencies, in The London Gazette. This does allow time though for the company to protect its reputation and pay the petition debt. However, suppliers still trade with them in ‘good faith’, oblivious of the fact that they are facing financial difficulties.
The struggles might arise as a result of Section 127 of the Insolvency Act 1986, which states that a disposition of a company’s property made by itself after a winding-up petition has been issued is in fact void. Where the petition is heard and the company is wound up by the Court, these payments may be recovered by a liquidator so to benefit the creditors of the liquidated company. There could be serious implications for the supplier’s cash-flow and even triggering its own collapse.
Before, suppliers have relied on the argument of ‘good faith’ to encourage the court to give validation orders to check any void transactions, protecting their cash situation. But, this approach is not always successful, as we have witnessed from the recent judgement in Dingley and others vs Nisa Retail Ltd. Business should be aware and take the necessary steps to minimize the risk of a key customer becoming insolvent.
In 2010, the retailer MKG Convenience was incorporated and started trading under the Nisa franchise. They held £31,104 worth of shares in Nisa and paid a £25,000 cash deposit for the supply of stock, whilst Nisa received direct debit payments for the goods they supplied.
MKG Convenience was presented with a winding-up petition on 16 March 2015 (advertised on 7 April 2015) and liquidators were appointed on 14 May 2015 subsequent to a compulsory winding-up order. Nisa continued to receive weekly direct debit payments from the company until 20 May 2015 despite of this. To bring back value for its creditors, the liquidators of MKG Convenience sought after the repayment of payments totaling over £162,000.
Trying to make use of a ‘good faith’ argument, Nisa applied for a validation order on the idea that it was unknowingly in possession of void payments. Therefore, they continued to supply goods to MKG Convenience Ltd. The Court found that the defense was unsuccessful as the payments to Nisa did not benefit the general body of creditors.
Suppliers need to be prepared
Suppliers should make sure they are prepared to respond to any financial red flags, which could indicate that a customer is at risk of insolvency, so to avoid having to repay funds are have believed to have been rightly earned. For instance, increased number of CCJs, previous winding-up petitions which were later dismissed or breakdowns in communication might be signs that a business is facing cash-flow challenges.
Implementing policies and procedures as part of tight credit controls can also help suppliers limit their exposure to bad debt. Introducing stricter credit limits and more thorough credit checks for potential new customers is a possible way. If, however suppliers lack the resources to chase customer payments internally, they may also want to consider outsourcing their credit management processes. This would help to provide businesses with more cash certainty by making sure that customers make their payments on time.
It is important that businesses are attentive to signs of financial stress from customers and take proactive measures to improve their credit controls where suitable. By seeking specialist insolvency advice and improving their credit management processes at the earliest opportunity when a customer faces insolvency or stops paying, suppliers can secure their financial position and manage some of the risks and uncertainties faced in the current climate.