Protecting Chinese Businesses' Financial Position in the UK: Managing Credit Risk (Part 3): Dealing with Payment Defaults

In Part 3 of this series, we look at how Chinese suppliers, retailers, service providers and trade creditors can mitigate the risks associated with payment defaults. 

We have summarised a number of key areas that we most frequently discuss with Chinese businesses. 

Customer Due diligence  

We are often asked by Chinese clients to assist with unpaid debts once they arise. However, preventative measures should ideally be taken from the outset. Chinese businesses often focus on speed and contract negotiations and may pay less attention to conducting due diligence or obtaining professional advice. 

Due diligence on potential counterparties is relatively straightforward in the UK. All UK limited companies and Limited Liability Partnerships (LLPs) are required to make statutory filings at Companies House. Publicly available information that can be obtained free of charge includes: 

In addition, it is possible at no cost to check the various bankruptcy and insolvency registers and at very low cost obtain details of real estate interests and restrictions/ covenants.  

Where other jurisdictions are involved, especially those that may be more opaque in terms of available information, it is sometimes advisable to engage specialist commercial intelligence firms who, for a relatively low cost, can check a little deeper into the potential counterparty, connections with other parties in the deal and their respective ability to pay and financial history.   

Contractual terms 

Businesses normally have a set of precedent contracts to use. However, it is important to review each contract and update terms based on each circumstance. 

Retention of Title  

One effective credit protection strategy is the use of Retention of Title (ROT) clauses, which allow a seller to retain ownership of goods until payment is received, even when goods are delivered, stored in the buyer’s warehouse, or resold.  

Usually, if the buyer enters insolvency, ROT goods do not form part of the insolvency estate, allowing the seller to recover them instead of ranking with unsecured creditors. To be effective, ROT clauses must require the buyer to segregate and clearly mark the seller’s goods, as where the ROT assets become irrevocably mingled with other goods, the purpose is likely defeated (e.g. supplies of grain from multiple suppliers being mixed together in a single silo). 

Where an ROT claim can be successfully made out, release may still require, for example, settling warehouse charges as a matter of practicality, whether or not these are contractually enforceable.  

A valid ROT clause leaves the seller in a significantly stronger position than trading without one. 

It is also possible to design the ROT clause in a way that may be classified as a type of security and be registered on the Companies House (see below). 

It is worth noting a ROT clause is not usually enforceable against a reseller's customer who buys the equipment in good faith, and without notice of the seller's title claim.  

Security 

Where the ROT clause contains an "all monies" provision, title to the goods remains with the seller, not only until those goods have been paid for, but also until all amounts due to the seller from the buyer have been paid. In this context the ROT acts effectively as security for a wider arrangement between buyer and seller and is likely therefore registrable as a charge, which would need to be registered at Companies House to be valid. 

There are limitations in insolvency law around activating the priority right of seller over creditors of the buyer without the permission of the Insolvency Practitioner or the Court if the buyer is in administration/insolvency.  

Therefore, it is important to look into each circumstance and prepare the security document accordingly rather than simply taking a template security document.  

Other types of security are available in respect of commercial arrangements including a pledge over assets, fixed security over physical or defined assets and floating charges over assets that are variable on a day-to-day basis (e.g. book debts). All of these also need to be registered to be valid. Where a buyer is in default, the seller can enforce against the relevant asset by appointing a receiver to sell that asset to satisfy the debt.  

Landlords   

Landlords of commercial real estate have a particular status as a creditor in respect of tenants of their property. In addition to having a statutory power to appoint a receiver in the event of tenant non-payment, landlords may also have rights of forfeiture (early compulsory termination of the lease), peaceable re-entry (changing the locks and re-occupying the property) in certain circumstances, and recourse to rent deposits and guarantors. 

Trust Assets  

If assets can be shown to belong beneficially to a third party, they will not form part of the insolvency estate. Trust asset claims rely on the third party being able to provide evidence of its proprietary right to the asset in question.  

A trust claim can still be pursued through tracing where the asset has been sold away, and the claim can also attach to the proceeds of any sale. 

Key takeaways  

In addition, structuring arrangements so that assets are held on trust or otherwise remain outside the borrower’s estate can provide further protection. 

The key message is that credit risk management is not just financial, it is contractual and operational. Suppliers should use a mixture of contractual, practical, and financial measures to minimise potential risk exposure.  

Our multidisciplinary approach brings together corporate, insolvency and commercial disputes lawyers to support Chinese suppliers, retailers, service providers and trade creditors throughout the credit lifecycle. We can assist with due diligence, contract drafting and negotiation, taking security, debt recovery and asset recovery. 

Please get in touch if you would like assistance with commercial contracts, credit risk management or recovering unpaid debts.