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How to prevent bad debt

Author: Erex Chen


Reason for bad debt

In business operation, receivables which cannot be collected timely occur frequently. With time lapses, the chance of collection on some receivables becomes very little which finally leads to bad debt.

Various reasons which may cause failure in collecting receivables include but not limited to:

1. the buyer encounters fund shortage or gets involved in financial crisis;

2. the buyer rejects to pay due to quality issue in relation to the product or service;

3. the term of payment cannot be met due to reasons caused by the buyer or a third party;

4. the buyer’s project is suspended or cancelled which makes the product/service useless;

5. the buyer goes into abnormal operation which leads to financial suspension or paralysis (e.g. criminal case is involved);

6. the buyer refuses to pay in bad faith.

How to prevent the change of receivables into bad debt – enterprise internal control system improvement

1. The sales department shall timely trace and monitor the status of receivables

The sales department and sales guys are usually at the front line and directly deal with the buyer. Usually the sales guys know well of the term of payment and they are aware of any delay in payment. Furthermore, in most cases, the work performance and income of the sales guys are related to the collection of the sales amount directly. Therefore, they have good reason to resolve the collection of receivables.

However, according to our observation, the following reasons may probably lower the chance to resolve the receivables collection at the level of sales guys:

(a) due to the need to maintain the client relationship, sales guys may delay to take effective measure to collect receivables which may miss the best timing to collect;

(b) the sales guys fails to timely report to the financial department or management resulting that the management cannot take necessary action (such as litigation) which may miss the good timing to collect;

(c) the change of sales guys (such as leaving) which results in the less efficiency in tracing and monitoring the receivables.

2. Regular monitoring and reporting by the financial department

The financial department is responsible for monitoring the receivables. Therefore, it is necessary to set receivables monitoring system at the financial level.

The sales department shall supply sales amount payment schedule to the financial department in advance, according to the sales contract. The financial department shall regularly monitor and report to the management.

To timely collect the receivables through legal channel, we suggest any receivables with 6 months delay shall be alerted and go into legal proceedings.

3. To collect receivables through legal channel

To collect receivables through legal channel is usually the ultimate way, which shall involve in-house legal expert or outside lawyers to handle.

Several issues in collecting receivables through legal channel

Although litigation/arbitration is the ultimate way to collect receivables, this does not mean all receivables can be collected successfully through litigation/arbitration.

In particular, if the legal professionals are not able to get involved in handling the dispute timely, which results in the failure to obtain important evidences, or lack of element for litigation/arbitration, then the chance of success may become very little.

From the legal perspective, the following aspects shall be noted:

1. Statutory period for litigation/arbitration. All receivables collection shall run the risk of lapse of statutory period for litigation/arbitration. Usually the statutory period for litigation/arbitration is two years, starting from the due date the receivable should have been paid. Since October 1, 2017, the statutory period has extended to 3 years. The enterprise shall note this statutory period otherwise there is no chance to resolve through legal channel;

2. Dunning letter. Dunning letter can be used to interrupt and restart the statutory period for litigation/arbitration. However, dunning letter shall be prepared and sent in written form and receipt of the letter shall be kept properly. Usually the receipt of such letter by signing/chopping company stamp by the other party can be good practice. However, if it is estimated the other party will not cooperate, then the letter shall be sent through first-class courier (such as EMS or Shunfeng). The logistic record showing the receipt of the letter shall be kept;

3. Preservation of evidence. In all cases the legal professionals are encouraged to get involved as early as possible. For instance, any receivables which have been late in payment for 6 months shall go into the legal proceedings immediately. This is because at this time point, there is still much room to make evidence preservation and make remedy if necessary, and enable to have a good position in the coming litigation/arbitration for a good result;

4. To find a good timing for litigation/arbitration. In case of delay in receivables payment, the operation and financial status of the buyer shall be closely monitored. As long as there is any proof the buyer has ability to pay (such as arrival of cash into the buyer’s bank account), or on the other side, the financial status of the buyer may become worse, litigation/arbitration proceedings shall start immediately. Property preservation (such as freezing of the buyer’s bank accounts) shall be done to enable a successful enforcement after the case wins.

This article is published solely for the interest of friends and clients and should not be relied upon as the legal advice of any kind from us. Should you have any questions about this article, please contact the partner of Mylink Law Office.

Contact Person:

Erex Chen, Managing Partner