It is, unfortunately, an all too common result of a company failure – customers who have paid a deposit for an item or service only to have the provider placed into liquidation before the goods or service are delivered, are left as unsecured creditors in the liquidation or receivership, with little likelihood of any recovery.
Why are Prepayments Made?
Prepayments by customers help give certainty to a business that the customer is genuine in their intention to complete the transaction proposed and will not leave the business holding unwanted stock or with preparation costs incurred that will not be met.
Paying a deposit to a property developer when buying off the plans secures one of the planned properties in the development for the customer and gives the developer certainty of sale to ensure on-going support from financiers.
What happens in an insolvency?
If the company to which you made the prepayment goes into receivership or liquidation, before the goods or services have been delivered, you will most likely lose the amount you have paid and rank as an unsecured creditor in the insolvency. The same would apply to amounts paid for gift cards issued by the company as generally they will not be honoured by the insolvent company.
In most insolvencies, there are little or no funds available for unsecured creditors.
If the receivers or liquidators decide that it is economically viable to trade the business on to try and complete some contracts, it is possible that your transaction may be able to be completed with the goods or services being provided on payment of the full price.
How can you protect prepayments?
Do as much due diligence as you can on the business you are dealing with. Have there been any adverse reports in the media or are there on-line comments or reviews that suggest the business has financial issues?
If you are purchasing from a retailer and enter into a layby agreement, you will be a preferential creditor in the insolvency, ranking behind other preferential creditors such as employees and the Inland Revenue Department but ahead of the unsecured creditors. This does not guarantee you will receive payment, but it does improve your chances.
The Fair Trading Act 1986 describes a layby sale agreement as any agreement, whether or not described as a layby sale agreement, that provides that –
• The consumer will not take possession of the goods until all, or a specified amount, has been paid and either -
o the price of the goods will be paid by 3 or more instalments: or
o if the agreement specifies that it is a layby agreement, 2 or more instalments
A layby sales agreement does not apply if the purchase price of the goods is more than $15,000.
If prepayment is included in a contract, such as for building or renovating a property, get independent legal advice on the contract. Can you require the deposit be paid into a solicitor’s trust account or an escrow account? Can you register a security interest in the assets of the company for the funds you have paid?
What are your remedies?
In normal circumstances, if a contractor fails to complete the project in accordance with the terms of the contract, consideration could be given to taking legal proceedings to have it completed or to recover any deposit paid or extra costs incurred.
However, if the party that breaches the contract is a company in liquidation, there is limited ability to do this as the liquidator can, and usually does, refuse to agree to legal proceedings commencing or continuing against a company in liquidation.
Application to the High Court can be made to allow the proceedings but any financial orders made against the company would rank as an unsecured claim in the liquidation.
Liquidators will investigate the affairs of the company and, if breaches of director’s duties are identified, may initiate legal proceedings against the directors personally, seeking orders from the Court that the directors make a contribution towards settling the losses incurred by creditors.
If there are grounds to show that the company’s directors were dishonest in their dealings with clients and by doing so obtained funds when they knew that they were not going to be able to complete their end of the agreement, consideration could be given to reporting the matter to the Police.
If sufficient evidence is available, the Police could prosecute and seek reimbursement of losses caused to the complainant. The standard of proof in criminal trial is “beyond reasonable doubt” much higher than is required in civil matters. The mere fact that the person didn’t do what they said they would is not generally evidence of fraud. There is also no guarantee that a Judge will order an offender to make payment to the victim.
Other than if the funds are paid into a trust account, it is difficult to safeguard prepayments totally in the case of a company going into liquidation or receivership. Doing some background enquiries or gaining professional advice before committing yourself may help avoid the issue but, if you have to make the payment, pay as little as possible before gaining access to the goods to limit the damage if things go wrong.