Dealing with accounts receivable
Many companies increasingly face the prospect that their partners cannot fulfill their obligations because of the difficult economic situation brought about by the COVID-19 pandemic. Issues related to accounts receivable became relevant to many of our clients after the pandemic restrictions were lifted in 2021.
Accounts receivable confer the right to claim against a counterparty that has not fulfilled its obligations to pay for goods or has not performed work or has not provided services. If a counterparty fails to fulfill its obligation within the period specified in the contract, then the amount owed becomes overdue, and the other party (creditor) will be entitled to take actions to collect the debt.
The following preventive measures may be taken:
- Check counterparties’ practices and solvency;
- Work with advance payments;
- Insure debt.
When problems arise with counterparties, it is best to first try to agree on debt repayment or restructuring on terms acceptable to both parties. If, for some reason, it is not possible to reach an amicable agreement, then the only options to try to collect the debt is in court or by selling the debt to collectors (usually at a discount).
Constant monitoring of payment terms in contracts is essential to the debt collection procedure as this allows identifying in a timely manner where actions are required whether it is debt review or debt collection. Overdue accounts receivable for which creditors take no collection actions may become uncollectible in two cases:
- After expiration of statute of limitations;
- When an act for non-collection is issued by a state body, or in case of the debtor’s liquidation or bankruptcy.
In such case, the creditor will have to write off such bad debt as a loss, and this will adversely affect the creditor’s balance sheet. Article 266 of the Russian Tax Code gives a definition of doubtful and bad/uncollectible debt and provides for a procedure to make reserves for bad debt.
Counterparties should be chosen carefully. For example, Federal Tax Service Letter БВ-4-7/3060@ dated March 10, 2021 provides detailed clarifications of how to apply Article 54.1 of the Russian Tax Code, in particular, how the Federal Tax Service (FTS) will check whether counterparties have been duly chosen with proper due diligence.
When counterparties turn out to be unreliable, creditors may not only end up with uncollectible accounts receivable but also have difficulties in recovering VAT. Russian Ministry of Finance Letter No. 03-07-11/70423 dated October 26, 2017:
"Following a letter requesting the refund of the amount of VAT paid to the budget for the provision of services for which the obligation to pay has not been fulfilled by the buyer and has been recognized as bad debt, the Department of Tax and Customs Policy informs that such VAT refund is not provided for this case under the rules of the Russian Tax Code.”
“If a bank writes off the accounts receivable for services rendered subject to VAT, the tax to be paid to the budget should be calculated in the tax period in which the debt is written off. Such VAT amounts are to be paid as set out in Article 174 of the Russian Tax Code.”
Russian tax authorities uphold that companies must do their due diligence when concluding any transaction. In other words, they must exercise the utmost vigilance and review the counterparties with which they conclude contracts. Otherwise, creditors may be brought to tax liability, and their directors may be prosecuted and be brought to criminal liability (for example, under Article 159 of the Russian Criminal Code on grounds of fraud or Article 199 of the Russian Criminal Code for evading to pay taxes and/or social insurance contributions). Federal Tax Service Letter БВ-4-7/3060@ dated March 10, 2021 also states that if tax authorities prove that a company was aware of the counterparty’s bad practice (including when the counterparty selected suppliers, co-contractors, and sub-contractors), then VAT deduction could be denied to the company:
"Adverse consequences could arise for the taxpayer if the taxpayer’s counterparty fails to fulfill its obligation to pay the appropriate amount of VAT as the taxpayer could, in such case, be denied its right to deduct such tax if tax authorities prove that the taxpayer was aware of the tax offenses committed by the counterparty (including as a result of the counterparty’s non-compliance with the requirements of Article 54.1(2(2)) of the Code on the suppliers (sub-contractors, co-contractors) that it has engaged) and has benefited from the counterparty’s unlawful conduct causing damage to the budget of the Russian Federation. This approach is based on the legal position held and expressed in Russian Supreme Court Ruling No. 309-ЭС20-17277 dated January 25, 2021.”
System to deal with accounts receivable
To minimize risks, it is necessary for companies to provide for each stage of dealing with accounts receivable in their business processes and ensure their implementation. Companies must specify in their credit policy the amount of acceptable risk and ways to reduce it. Pricing and contractual terms must be individually selected for each counterparty considering the counterparty’s risk profile and in compliance with the company’s credit policy. When negotiating contracts, it is necessary to insist on the inclusion of additional conditions for counterparties whose reliability and solvency can be reasonably doubted (or, if possible, choose more reliable counterparties). When negotiating, it is recommended to use publicly available information on the counterparty’s practice as well as financial models that make it clear that it is justified to include additional guarantees in the contract under negotiations.
Once contracts are concluded, the company’s financial managers are advised to monitor the deadlines for payment of receivables as well as the financial conditions of counterparties and their solvency. It is recommended to send reminders when the due dates approach (for example, automated sending of notices could be set up in the company’s accounting system). It is also recommended to monitor and at least roughly forecast the financial position of large buyers based on the demand for their goods and services, as well as changes in the company’s plans.
Depending on how often counterparties are changed/selected and on the specifics of your business, the following options may be used to deal with accounts receivable:
- Allocating functions among employees from different departments based on their specialization. For example:
- Lawyers could check the good business practice of each counterparty in compliance with a certain procedure;
- Financial experts could review the financial position of the counterparties selected by the lawyers;
- Accountants and IT could automate the monitoring and reminder of due dates;
- Lawyers and financial experts could negotiate if risks may arise or have arisen. They could also consider alternative options for debt recovery;
- Lawyers could initiate debt recovery proceedings in court and ensure the enforcement of court decisions by bailiffs.
The above model is optimal for small and medium organizations that work with a small number of relatively reliable partners. We provide services to introduce in the business processes of your organization a system to deal with accounts receivable (we review requirements, develop regulations, assess competencies, and train all participants in the process).
- Setting up a separate structural unit whose main task is to deal with accounts receivable. The advantage of this option is that accounts receivable are not handled by different departments, and performance may be assessed by individual KPIs. This option is usually optimal for large companies with a large number of counterparties that change frequently.
- Outsourcing. This option presents several advantages. First, negotiations will not be conducted directly with debtors but through professional lawyers and financial consultants focused on optimizing client risks. The monitoring, control, and recovery of debt do not give rise to any additional workload for the company’s staff, and difficult accounts receivable may be recovered (by agreement) for a percentage of the debt if successfully returned.
Collection of receivables
Negotiations are the easiest way to settle disputes with counterparties over accounts receivables. As a result of negotiations, the parties may come to various agreements such as concluding additional agreements to contracts changing the payment terms or the deadlines for performance of work/provision of services, changing contractual relationships by replacing the original obligation with another obligation (novation). If negotiations are unsuccessful, then it will be necessary to go to court. Article 4(5) of the Russian Commercial Procedure Code provides that it is possible to go to court only upon expiration of 30 days after having attempted to settle the dispute out-of-court, namely “from the date on which the pre-action letter is sent.” From the filing of court action to the final decision, the debtor could end up with not enough liquid property to pay off its debt. This method is costly as the creditor will have to bear legal costs that may subsequently be recovered from the debtor.
If the actions or inactions of the heads of counterparty companies constitute criminal offenses under Russian law, the heads of such companies could be prosecuted, for example, for fraud or willful evasion from paying accounts payable (Article 177 Russian Criminal Code). More information about the investigation of crimes under Article 177 of the Russian Criminal Code can be found in guidelines N 04-12 approved by the Federal Bailiff Service of Russia dated August 21, 2013.
Another way to deal with accounts receivable is to assign such debt to specialized collection agencies under an assignment agreement as set out in Article 382 of the Russian Civil Code on the terms in place at the time of assignment (Article 384 Russian Civil Code). This way of resolving the issue of receivable does not always apply as the debt is assigned on market conditions at a price for which debt collectors agree to buy it.
The law also allows debtors to assign their debt (Article 391 Russian Civil Code). To do so, it is necessary to obtain the consent of the new debtor and the creditor.
We can help in dealing with the risks of non-repayment of receivables at all stages:
- We review the situation as well as tax, administrative, and criminal risks for company officers and the company as a whole:
- We set up a system to assess the solvency of counterparties and develop an optimal credit policy ensuring, in particular, compliance with due diligence from a Russian tax law standpoint;
- We automate reconciliation with counterparties in 1С or assign an accountant for one-time or periodic reconciliations. Although reconciliation reports are not mandatory documents, they allow identifying and recognizing debt and can subsequently be used as evidence in possible proceedings with counterparties. When a counterparty signs a reconciliation report, the counterparty actually recognizes its debt, and Article 203 of the Russian Civil Code also provides that signing such document suspends the statute of limitations:
“The statute of limitations is suspended when the debtor performs actions that provide evidence of debt recognition. After such suspension, the course of the statute of limitations begins anew, and the time elapsed before the suspension does not count towards the new time limit.”
- We set up a system to monitor and forecast liquidity. Companies may use this system to fulfill all obligations and take liquidity risk measures in a timely manner. Our clients may therefore be sure that they will have no problems with their obligations to employees, the budget, and counterparties, and they will not have to deal with problematic debt.
- If some accounts receivable become problematic, our lawyers and financial consultants can negotiate with counterparties and offer the best options for debt repayment or restructure obligations. If negotiations fail for some reason, our lawyers can provide debt collection services, and will:
- Review contracts for compliance with Russian law;
- Collect and review information about the counterparty;
- Determine whether debt collection is possible under the contract;
- Investigate the subject of dispute and review available evidence;
- Prepare a legal position and determine the jurisdiction for the dispute;
- Conduct pre-action check;
- Prepare and send mandatory pre-action claims/letters;
- Prepare and file a claim for debt collection;
- Represent client interests during the examination of the claim in the commercial court;
- Ensure the enforcement of the court decision;
- Assist with technical issues related to the collection of receivables for foreign companies and with the opening of current accounts in banks.