NZ Credit & Finance Institute
Governance New Zealand
Associate Member
New Zealand General Member

The Perils of Being an Unsecured Creditor

Most businesses trade with their customers as an unsecured trade creditor. And on a day to day basis there is nothing wrong with that – until your customer enters insolvency…and then it can matter a great deal.

Before we get on to the options about strengthening your unsecured status, let’s take a look at why being an unsecured creditor can be so detrimental to your cash health. The answer lies in the Companies Act 1993 and schedule 7 in particular. This section sets out the priority in which any liquidator must pay out in a company liquidation. Now this is a fairly complex area in practice, and the specifics can change in each case, but generally the priority order is:

  1. Fees, expenses and remuneration of the liquidator;
  2. Costs of the applicant creditor including reasonable legal fees;
  3. Any “out of pocket” expenses incurred by a liquidation committee;
  4. Costs incurred by a creditor assisting the liquidator in protecting or recovering assets;
  5. Wages owed to employees for the four month period prior to the liquidation and any holiday pay and redundancy payments up to a specified maximum amount;
  6. Inland Revenue preferential taxes including GST, PAYE & child support deductions;
  7. Secured non-preferential creditors;
  8. Unsecured non-preferential creditors.

If you fall into category 8, and most trade creditors do, then that puts you a long way down the payment list. If you add in the fact that your customer, being in liquidation, obviously had a cash shortfall to begin with, then your chances of recovering anything significant look vanishingly small.

Whereas it is difficult to get accurate statistics on the outcome of New Zealand liquidations as a whole, it is my experience that unsecured creditors are lucky if they see more than 20c in the dollar – and often it is less than 5c.

So, what can you do about it?

Well firstly there is not much you can do about positions 1-6. These are preferential status creditors each with its own specific criteria. No matter how hard you try it is unlikely you are going to get yourself recognised as an employee for instance! But, there is usually a fair amount of cash left for secured non-preferential creditors and this is where you can take some action.

Firstly you have the option of becoming a secured creditor. This requires that you agree a General Security Agreement (what used to be called a debenture), or GSA, with your customer and register this on the Personal Property Securities Register. But a word of warning – as a trade creditor it is highly unlikely you will get your customer to agree to this. GSA’s are generally reserved for cash-flow funding providers, generally banks, so it is unlikely your customer is going to let you disturb financing avenues.

If you supply goods to a customer on credit then you may have a retention of title clause in your contract. This states that title to property does not pass until paid for. On liquidation you may use this to claw back unpaid for goods from the liquidator. But care needs to be taken here as there are a couple of crucial steps that need to happen in order to make this enforceable. Firstly, the clause must be part of a contract, and not just referred to on the back of an invoice (or even the front of an invoice for that matter). And secondly this needs to be registered on the Personal Property Securities Register. I have it on good authority (i.e. liquidators) that  trade creditors still do not complete these two steps satisfactorily and therefore miss out.

Another way of securing your interests is by way of a personal guarantee (PG). Used when dealing with incorporated entities, a PG is usually (but not legally necessarily) sought from a director. This method is useful as it creates a separate binding contract to your trade contract and is therefore enforceable against the third party even in a liquidation. Of course to be of any value the guarantor must be solvent so due diligence must be conducted in advance of any agreement.

The key take-outs are thus:

  • DON’T be caught as an unsecured trade creditor
  • DO consider all security options when agreeing to supply goods on credit
  • DO conduct due diligence on all new credit customers (and for that matter existing ones if this has not been done) – it’s never too late
  • DO get expert help in this complex area