Innovation in receivables litigation

By Fu Xiye, Hylands Law Firm
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Creditors generally start legal action or arbitration proceedings based on the underlying contractual relationship, seek to preserve the bank accounts, land and real property, machinery and equipment, equity, intellectual property and other assets of the debtor, and then apply for enforcement to recover the money once they have won the legal action.

However, in many instances, the effect of the recovery is less than ideal. This is especially so where the debtor is involved in multiple cases, its property is subject to several rounds of preservation, making a repayment in full close to impossible.

Under such circumstances, accounts receivable (AR) that have fallen due may become some of the debtor’s few quality assets. However, creditors can recover debts using such new means and strategies as assisted enforcement, subrogation legal actions, claim transfer and debt set-offs.

Assisted enforcement

付希业__Fu_Xiye__Hylands-S
Fu Xiye
Partner
Hylands Law Firm

Where a debtor cannot discharge a debt, it may be owed an AR by a third party. These are known as a “third party” in the field of assisted enforcement of accounts receivable, the “counterparty” in the subrogation system or the “debtor” in claim transfers and debt set-offs – for the sake of convenience, here all will be called the third party. Where such an AR has fallen due, the court may issue a notice to the third party to perform the debt obligation that has fallen due and pay the debt directly to the creditor.

This solution applies when the creditor has certain information on the debtor’s AR and the third party co-operates. According to the law, if the third party promptly raises an objection, arguing that such an AR does not exist or has not fallen due (unless confirmed in an effective legal document), the assisted enforcement procedure cannot take place and creditors will need to turn to new means, such as a subrogation legal action.

Subrogation legal action

Generally speaking, a contract is relative in nature, i.e. the creditor can only request payment from the debtor and cannot request that someone other than the debtor do so. A subrogation legal action breaks through the relativity principle. When a debtor is negligent in exercising a claim that has fallen due against a third party, affecting payment to the creditor, the creditor has the right to directly assert the right against the third party. In such cases, the third party has to pay the amount directly to the creditor.

The subrogation system offers several advantages: the legal action has a preservation attribute – once a subrogation legal action is instituted, the debtor loses the right to directly dispose of the AR and the third party may not pay the amount to the debtor; such a procedure can easily be exercised, as the creditor can resolve all of the claims against the debtor in one fell swoop based on multiple sales and purchase contracts, loan contracts or even another legal relationship (such as rights in bills, etc.); and it expands the scope of the creditor’s rights without causing the creditor to forfeit the right to demand payment by the debtor should asserting the right against the third party prove unsuccessful.

This solution applies when the creditor has more detailed information on the debtor’s AR. The principle of subrogation litigation is not complicated but, due to such reasons as the difficulty facing the creditor in ascertaining and adducing evidence of the debtor’s AR, the relative complexity in determining whether the debtor is negligent in exercising its rights, potential conflict between the right of subrogation and other rights, such as a pledge of the AR, etc., this system has yet to fully demonstrate its anticipated value in judicial practice.

Nevertheless, this solution remains an innovative method that is worth trying and through past experience a number of subrogation legal actions have achieved good recovery results.

Transfer and set-off

Transfer and set-off of AR is a means of discharging a “chain of debts” by a negotiated arrangement among the creditor, debtor and third party. These methods can be used when the debtor finds it impossible to pay the creditor and is owed AR by a third party but is unwilling to directly assert the rights.

Claim transfer means that the creditor and the debtor and/or the third party reach an agreement where the debtor transfers its claim against the third party to the creditor to offset the outstanding amount and the creditor, as the transferee of the claim, directly asserts repayment against the third party.

Debt set-off means that the creditor transfers its payment claim against the debtor to the third party. The third party then pays the creditor and subsequently extinguishes the claim/debt relationship by way of the set-off.

Claim transfer and debt set-off can resolve a “chain of debts” in a supply chain, avert a series of vexatious legal actions among the parties, and is additionally conducive to promoting co-operation among parties and maintenance of their relationship. In other words, it permits the achievement of multiple objectives in one go. This solution applies when there is a good rapport between the creditor and the debtor, the creditor and the third party or among all of them.

Considering that the debtor and the third party may have placed certain restrictions on whether the claim may be transferred or the conditions for such a transfer, or other legal restrictions, it is incumbent upon a creditor to conduct a review focusing on these issues and come up with a reasonable design when using such a solution in order to avoid the attendant risks.

It is worth drawing attention to AR litigation and enforcement. Regardless of which of the collection methods is opted for, creditors should focus on the following key points: seizing the first available opportunity to collect an outstanding amount, as once the debtor is involved in too many legal actions and enforcement procedures the difficulty in collecting increases exponentially; paying attention to investigating and staying apprised of the state of the debtor’s property and promptly carrying out preservation to facilitate recovery and enforcement; and professional lawyers should be promptly retained to provide assistance.

Fu Xiye is a partner at Hylands Law Firm. He can be contacted on +86 133 9173 5150 or by e-mail at fuxiye@hylandslaw.com