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Bad debts represent a significant challenge in personal finance and business management. They often occur when a debtor is unable to meet the repayment terms of a loan or credit agreement, leading to financial losses.
For a business owner, dealing with bad debts could be the most frustrating thing to do, which may take a toll on his finances.
It is utterly stressful and disheartening to continually chase clients to make them pay back the money they owe you. Irrespective of how much restructuring is done within the business operations to gain back the dues, bad debts remain a constant problem for many businesses.
Collecting bad debts also has a negative impact on cash flow and productivity!!
Every year millions of dollars are lost in bad debts. Statistics by the US Central Bureau indicated that 26% of invoices, which have been due for over three months are uncollectible. Once it is 12 months old, the figure increases to 90% !
What is a bad debt?
Bad debt is simply a receivable that a customer is not willing to pay.
It reflects the total amount of accounts which a company was unable to collect back despite repeated attempts of contacting the customer.
They have a toll on the company’s income statement, as it reduces the number of accounts receivable.
Most bad debts mainly occur due to the following two reasons:
- When a company gives out too much credit to a debtor who is incapable of paying back. This will result in either delayed or missed payment.
- When a customer fraudulently misrepresents himself in obtaining a sale on credit, and has no intention of paying back. This is caused due to faulty internal operation, or unexpected loss of the ability of the customer to pay back the debt.
Different types of debts
Following are the different types of debts used in the business world:
1. Secured Debt
Secured debts are those debts for which a debtor puts some assets as security for the loan. It merely means that in the event of default, the creditor can use the assets to get back the money that has been paid to the borrower.
The most common types of secured debts include car loans and mortgages. Under these scenarios, the item being financed becomes the collateral or security for the loan.
If the borrower fails to repay back, the item being financed will be acquired and/or sold by the financier.
Let us take the example of a housing loan. If the debtor fails to pay back the money on an instalment basis, the financier can sell the house to recoup the funds.
2. Unsecured Debt
Unsecured debts are debts that are not backed up by security or collateral. Here, since the debtor is not required to pledge any assets as security, the creditor won’t be able to recover their investment.
Unsecured debts are very risky when compared to secured debts. They usually carry higher interest rates than the secured ones.
If the debtor is unwilling to pay back the amount, the creditor can sue to recover the debts.
However, there is no guarantee to get back the money, since in most cases, it has been noted that the borrower evades the repayment by winding-up the company or declaring bankruptcy.
Student loans, medical bills, credit card charges, telephone bills, trade debts, etc. are examples of unsecured debts.
3. Revolving debt
Revolving debts are an easy way to get credit. Under these conditions, an agreement is made between the borrower and the financier.
This enables the debtor to borrow an amount up to a particular limit on a recurring basis.
Credit cards and lines of credit are some of the examples of revolving debt. A credit card will usually have a maximum limit up to which the user can take money. The consumer can use the card until the maximum limit is reached.
Once the user repays the debt, the amount which was initially paid becomes available to borrow again.
For example, if the user uses the card to make a purchase of RM 1000 and pays back RM 600 in the first month. He is allowed to utilise RM 600 again immediately.
In Malaysia, the mortgage is the most common type of debt that many debtors carry. These are usually the loans to purchase homes.
In Dec 2019, the Malaysian household debt accounted for 82.7 % of the country’s Nominal GDP.
Mortgage loans are often taken to purchase homes and properties. This typically has the lowest interest rate when compared to other consumer loans. To keep mortgage loans affordable, these are issued for a term of 15-30 years.
Bad debt recovery in Malaysia
In Malaysia, recent updates to the law require debt collectors to follow fair and legal practices set by Bank Negara Malaysia.
Debt collection should be respectful and follow local laws. Agencies must respect borrower privacy and treat them fairly during the debt recovery process – including negotiation, issuing a Letter of Demand (LOD), and legal action.
However, when it is clear that the debtor refuses (or is unable) to pay the debt, and negotiations and the LOD are unsuccessful, then the creditor must consider to recover the bad debt. Bad debt recovery is the attempt to get some payment, whether in full or in part, for the bad debt.
This may involve initiating a small claims action, applying for a Garnishee Order, or pursuing bankruptcy proceedings if the debtor owes a significant amount.
When a debt is written off, it is considered a significant loss. Recovery of bad debts will add to additional income for the creditor. This will usually be recorded on the credit section of the income statement.
Let us consider this example: A creditor loans a particular amount of RM 100,000 to Z without any security for starting a business. However, later he finds out that Z is being liquidated, and there is only a rare chance of recovering the debt. Thus they write off the debt.
However, the liquidator of Z, after selling all assets, is able to pay back RM30,000 to the creditor. Here, the 30% money recovered will reflect in the income side for the creditor.
a. Give an alternate payment plan to the customer
Sometimes businesses or individuals cannot repay back the amount due to sudden unexpected reasons.
In such scenarios, it is better to offer a payment plan on the invoice. Chances are high that such act of kindness will encourage the debtor to pay back the debt.
Additionally, you could hire a mediator who will work with you and the debtor to determine a payment plan and amicably settle the problem.
b. Get a friendly personal connection with the customer
As a formality, creditors used to send a letter of demand asking for payment to the debtors. Sometimes this might not give a proper response from the delinquent debtor.
In situations like these, meeting a debtor in person is a good approach to consider in order to to trigger a favourable response. Informal meetings may be a good approach to seek an amicable resolution with the debtor.
c. Offer a settlement plan
Something is always better than nothing!!!
There are times when a debtor won’t pay you back, no matter how much you try.
In such a case, it is better to offer the debtor a settlement plan to close the payment once and for all. For example, if the customer owes you RM 100,000, you could negotiate and ask him to pay RM 70,000.
Tried all the above and nothing is happening?
It is time to push things a little further.
d. Send a final letter of demand.
It is not necessary to hire a lawyer to send a letter of demand.
However, hiring a lawyer is definitely recommended as he is professionally trained and experienced when it comes to dealing with all the intricacies involved in dealing with a bad debt.
A letter of demand will be a final warning to the borrower, as the next step would be legal action. This will contain specific details regarding the amount due, the period of non-payment, details of the contractual agreement, etc.
e. Hire a debt collection company
When it comes to dealing with bad debts, the creditor might not be equipped with all the tactics to recover the money. In such a scenario, hiring a debt collection company is an effective tool in getting back your money.
The trained professionals at the debt collection companies have all the necessary tools to encourage the debtor to pay back the debt as soon as possible.
Since they work on behalf of the creditor, a rude approach could earn your firm a bad reputation, so make sure you use a company that will comply strictly with all legal requirements.
Research thoroughly and choose a company with a good reputation. Make sure that they work according to the Fair Debt Collection Practices Guidelines, which gives rigorous guidelines as to how a collection agent should interact with the debtor.
f. Initiate court action
If all the above methods have already failed and the debtor still hasn’t paid you back, you can decide to initiate a legal action by suing the debtor. If you have employed a debt collection company to collect back the amount on your behalf, they could also initiate a case on your behalf.
Provisions in Malaysian law for bad debt recovery
The legal framework governing the recovery of bad debts offers creditors a range of avenues to pursue debt collection, all while ensuring the maintenance of fair and lawful practices.
In Malaysia, there is a Debtors Act 1957 which applies. The Act has various provisions such as arrest, imprisonment, attachment of property, etc(Sec 4 to 12 )
- Attachment of property (Sec 19 )
- Arrest and examination of debtors if they haven’t appeared in court(Sec 6)
- Expenses to be added to the judgment debt
- Order for sale of perishable goods(Sec 21)
- Arrest before judgment
Summary judgement-This is a short cut remedy. As per the Malaysian law, if you have all the valid material proofs to prove your financial relationship with the debtor, you could successfully earn a court order in favor of you within six months of filing.
Winding Up Proceedings- Here, a court order is filed to force an insolvent company into compulsory liquidation. As per the order, all the company assets can be sold to pay off the debts.
Garnishee proceeding-The court can garnish the accounts of the debtor to satisfy the debt.
Bankruptcy-This is one of the most popular means of debt recovery. As per the Bankruptcy Act 1967, a petition for bankruptcy can be filed if the debtor owes you RM 100,000 and above. Once a court adjudicates the debtor to be bankrupt, the Insolvency Department will liquidate all the assets of the debtor to pay off the debts.
No business wants to lose their beloved customers, but a queue of long and outstanding dues affects the goodwill and messes up their business environment.
For financiers, it is imperative to maintain business relationships. Extra-legal methods are generally used to recover bad debts at an initial stage and legal methods are deployed as the last option.
These days, corporates are pushing beyond their previous limits to recover bad debts by proactively hiring a debt collection company. Considering the economic and financial development of the country, this is definitely a good move!
Malaysia is facing an alarming rise in the number of cases related to bankruptcy!!
The Insolvency Department of Malaysia has reported that since 2007, the bankruptcy cases are on a steady rise.
Shockingly the number of reported cases in the last five years was 80,000.
Creditors often find themselves in a messy situation when they are unable to recover the debt from a debtor who declares to be insolvent. The situation is not better when considering insolvency amongst companies.
What is insolvency?
Insolvency means a particular state in which a company cannot pay back the money owed to its creditors. Financially it means that the company’s liabilities outweigh all its assets.
In Malaysia, pursuant to the Companies Act 2016, a company will be deemed insolvent if the following conditions are fulfilled:
- If a creditor serves a written notice of demand for the payment of money which the company owes him.
- The amount should be more than RM10,000.
- The company did not pay or compound its debt to the satisfaction of its creditors for a period of three weeks.
How about individuals?
An individual can also be insolvent if he has no means to pay off the debts owed to his creditors.
In a scenario where no alternate option is available to him for repayment, he can declare bankruptcy. His creditors can also petition to make him a bankrupt after obtaining a judgement in Court.
The Insolvency Act 1967 deals with both individual bankruptcy and corporate insolvency.
According to this Act, an individual can be made a bankrupt if the following conditions hold true:
- There is a period of six-month default for the debt.
- Unable to pay back the debts to his creditors, even for a minimum amount of RM 50,000.
- The applicant should be domiciled in Malaysia for a minimum of one year.
How do I know if I am insolvent?
On an individual level, to be insolvent means either one or both of the conditions should be fulfilled.
- The total amount of your debts overweighs the value of all your assets.
- You are unable to pay back the debt you owe to your creditors due to inadequate income or cash flow.
Insolvency vs Bankruptcy
People often get confused between the terms “Insolvency” and “Bankruptcy” and tend to mix them up. However, there is a difference between these two.
Insolvency is a financial state in which all the liabilities of a company or an individual exceeds its assets and the said company or person is unable to pay its/his debts as and when they fall due.
Bankruptcy is a legal declaration that the person is unable to pay back the debt which he owes to his creditors, and following such declaration the Insolvency Department assumes control of the bankrupt’s assets. A company that is insolvent will be wound-up.
Some interesting points to note here:
- An insolvent person or company does not automatically become bankrupt or wound-up.
- An insolvent person or company can pay off his debt after discussing it with his creditors through any alternate payment plan.
- A bankrupt person’s (and a wound-up company’s) assets will be liquidated by the Insolvency Department, and debts will be paid back based on the amount obtained after selling.
Let’s get down to the billion dollar question.
Best practices for avoiding bad debts
Maintaining financial health is crucial and one of the ways to do this is by preventing bad debts. Here are five effective strategies to consider:
- Conduct thorough credit assessments: Before extending credit, it’s important to thoroughly assess the creditworthiness of potential borrowers. This includes reviewing their credit history, financial stability, and payment track record.
Read: How to improve your credit score?
- Clear credit terms and agreements: Establish and communicate specific payment deadlines, interest rates, and consequences of late payments to ensure there is no ambiguity.
- Regular monitoring and follow-up: Keep a close eye on outstanding debts and be proactive in following up with debtors. Regular monitoring helps in identifying potential issues early and addressing them before they escalate into bad debts.
- Effective dispute resolution mechanisms: Have a system in place for quickly and efficiently resolving disputes related to payments or invoices. This can prevent minor disagreements from turning into reasons for non-payment.
Leverage legal resources when necessary: Understand and be prepared to use legal channels for debt recovery in Malaysia. While legal action should be a last resort, being aware of and ready to use these options can sometimes be necessary to recover outstanding debts.
How to recover money from an insolvent debtor?
Litigation becomes a reality when debt collection efforts fail. Following are some of the valid legal remedies for money recovery in the event of an insolvency:
1. Judgement Debtor Summons
Judgment Debtor Summons (“JDS”) is an excellent remedy once a judgement is obtained from Court, very well known to ‘drag’ the debtor to the court and force him to disclose all his financial status.
Once a Judgment Debtor Summons has been sent, the debtor will have to appear in court and produce all the material evidence as a proof of his expenses and income.
The evidence includes details of assets, properties, business revenue, source of income, bank accounts, etc. This process will take about three to four months once filed.
If the court is satisfied that the individual will be able to pay back the debt, an order will be issued, which will require him or her to settle the debt in full or an installment basis.
Some important questions that can be asked in this context include:
- What if the judgment debtor does not appear in court?
An order of arrest against the debtor can be issued from the court.
- What if the judgment debtor fails to make payment as per the order of court?
A show-cause notice can be issued against the debtor to appear in the court to explain. He/she will be required to answer questions like:
- Why did the debtor fail to perform as per the direction of the court?
- Show cause why the debtor should not be sent to prison for his failure to repay.
2. Winding Up Proceedings
To submit a petition for winding up proceedings, the debtor has to be a company and not an individual entity.
This can be initiated if the debtor owes RM 10,000.00 and above to the creditor. A winding-up petition will be submitted to the court, and the court will generally take four or five months to review and approve.
If the petition is approved by the court, a winding-up order will be issued to force the insolvent company into compulsory liquidation.
- How will creditors benefit?
The entire assets will be gathered and sold off. The money will be equally distributed to all the creditors.
3. Garnishee Proceedings
This is an excellent and fast means of realizing a judgment debt. First, an application should be made to court for the order. Once approved, the court will direct the account of the debtor to be frozen and to be handed over to the creditor instead.
- Wage garnishment-where a suit is filed to garnish the salary so that the employer will pay a particular portion of the monthly salary.
- Garnish debtor’s bank account-If the creditor knows the bank details of the borrower, he can file an application in the court to get money from the account until the debt is paid back.
4. Writ of Seizure and Sale
A Writ of Seizure and Sale is an enforcement proceeding whereby the creditor files an application in Court to request for an order for seizure and sale of judgment debtor’s property.
The seizure and sale is made through an auction. All the movable and immovable properties are included in the auction.
For this, an application has to be made to court for an order to seize the property. If the application is successful, the court will appoint a sheriff to seize all the properties of the judgment debtor.
- Can the judgment debtor deal with his properties after an order has been passed?
No, once the properties are seized, the judgment debtor is prohibited by law to deal with the assets in any manner which will affect the validity of the seizure.
What is a bad debt in collections?
A bad debt in collections is money owed that is unlikely to be paid back, often written off as a loss by creditors.
What is the process for collecting bad debts?
It involves contacting the debtor, issuing formal demands, possibly using a collection agency, and potentially taking legal action.
Can a creditor sue for bad debts?
Yes, creditors can sue for bad debts, but they must follow legal guidelines and statutes of limitations.
What are the consequences of bad debt for a business?
Bad debt can lead to reduced cash flow, increased collection costs, lost revenue, and a negative impact on financial statements.
What strategies can help prevent bad debts?
You can conduct credit checks, set clear payment terms, offer early payment incentives, and regularly review customer creditworthiness.
The business environment is continuously subjected to market glitches. Debt collection efforts should be a part of the sales cycle and it’s important to understand how they are collected and the legal aspects, including your rights and duties.
For a debtor, it is quite easy to evade payment, stating that the debt is beyond repayment. But the creditor, on the other hand, takes a toll on his finances. Fortunately, Malaysian debt collection laws are sufficiently developed to facilitate recovery of delinquent debts by aggrieved creditors.
Take a deeper dive into your rights about debt collection by visiting Recover Debt to learn more about bad debts.