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Abu Dhabi, UAEThursday 18 October 2018

How SMEs can prevent cash flow challenges

In the first of a two-part series, lawyer Andrew Morris offers his tips on mitigating exposure to bad debts

Securing timely payments from clients is critical for SMEs to avoid cash flow issues. Silvia Razgova / The National
Securing timely payments from clients is critical for SMEs to avoid cash flow issues. Silvia Razgova / The National

According to a 2017 study by US Bank, cash flow is the main reason behind the downfall of 82 per cent of small businesses worldwide.

Debt collection continues to be a challenge for companies operating in the UAE, which ranks as one of the most difficult countries for collecting debt, just behind Saudi Arabia, in a recent poll conducted by international credit insurance company Euler Hermes.

Small to medium sized enterprises (SMEs) make up 95 per cent of the total enterprise population in the UAE. While securing timely payment from clients and customers is critical for businesses of all sizes, non-payment or late payment can be especially challenging for SMEs that may lack the free cash flow or finance facilities larger companies can draw on to manage short-term issues.

Formal pursuit of debts in local court and arbitration forums can also be time consuming and costly with the prospects of successful enforcement not guaranteed. The consequences of non-payment or late payment for an SME can, and often does, affect its ability to continue as a growing concern.

The old proverb ‘prevention is better than the cure’ is particularly applicable to managing debt recovery matters in the UAE. There are three distinct stages in which a business can take effective steps to mitigate its exposure to bad debts:

a. Pre-contract/contract formation

b, Contract management

c. Dispute resolution

This week, we will focus on pre-contract and contract formation. Assessing the credit worthiness of a client, pre-contract, can be invaluable in anticipating potential payment issues, even before a contract is signed. Similarly, understanding whether the customer has a track record of late payment can be helpful in mitigating this issue, whether in terms of controlling the credit extended, or in terms of the protections that need to be built into your contract. Key pre-contract/contract formation considerations include:

1. Assessing credit worthiness through credit checks, background searches and industry feedback. The entity you contract with is also important. Overseas companies may be harder to recover from than those domiciled in the UAE. You also need to consider whether the entity you are contracting with has assets. If not, your ability to recover judgment monies may be limited.

2. Factoring anticipated late payment into credit terms offered, if any.

3. Ensuring the elements of a binding contract and due execution are present. The legal names of the parties must also be correctly stated in the contract.

4. Ensuring the description of the parties’ obligations in the contract is an accurate statement of what will in fact be performed. If the scope of work is not an accurate record of the work performed or the goods supplied, clients/customers could use this to challenge the payment obligation or its quantum.

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5. Provisions should be included that clearly address variations or extensions to the scope of work, such as penalty and interest provisions applicable in the event of late payment. Be explicit on whether non-payment permits the business to suspend services or terminate the contract.

6. Ensuring the dispute resolution clause gives recourse to a suitable forum that will make it commercially viable to pursue claims formally. It is often not commercially viable to pursue small debts in the local courts; recourse to small claims forums can assist here. It is also important that any judgement or order obtained can be effectively enforced against a company or individual in the jurisdiction in which the judgement or order is issued.

7. Where possible, terms and conditions should be future-proofed for changes in the law. An example of this might be a DIFC Small Claims Tribunal clause, which specifies a claim threshold of Dh1,000,000 “or such higher threshold as the law may permit from time to time”. This clause may be effective for the purpose of taking advantage of such a change without having to amend the terms of the contract.

8. Standard terms and conditions should be periodically reviewed by a lawyer to ensure they reflect changes in law. Also, they should address specific issues encountered by SMEs in the course of their business and be ‘fit for purpose’. This minor cost could save large amounts of money if it enables debt issues to be more efficiently and cost-effectively dealt with.

9. Being aware of the relative strength of the contract and the profile of counterparties can enable SMEs to identify and avoid ‘bad contracts’ where the commercial upside in these contracts is disproportionally offset by the risks associated with non-payment and the cost of having to pursue a debt.

10. In some cases, SMEs will have little control over the terms of the contract they enter into, i.e. the terms may be presented on a ‘take it or leave it’ basis. It may also be possible to mitigate risk through extended insurance cover in these cases. Otherwise, it is a case of being aware of and managing risk as efficiently as possible.

11. SMEs should, where possible, seek advanced payments under their payment terms and/or security for payment, such as post-dated cheques (PDCs). PDCs have been a popular method of security due to the criminal consequences of bouncing a cheque. More recently, however, there has been some relaxation of how bounced cheques are dealt with. There have been positive steps in Dubai towards implementing a system whereby bouncing cheques under Dh200,000 will not automatically be considered a criminal offence, which may limit the effectiveness of that security in those cases. With bounced cheques below Dh200,000, a fine may be paid to avoid criminal sanction (and jail time) and to refer the cheques back to the civil courts. For cheques under Dh50,000, the fine is Dh2,000; for cheques between Dh50,001 to Dh100,000, the fine is Dh5,000; for cheques between Dh100,001-200,000, the fine is Dh10,000. However, the new laws are still relatively untested, and if the money cannot be paid back through the civil courts, the cheques may be referred back to the criminal prosecutor.

Andrew Morris is a Partner at Banks Legal, a UAE legal consulting firm

In part two of this series, Mr Morris will offer practical advice to SMEs for mitigating exposure at the contract management and dispute resolution stages