Steve Harms

Tuesday, June 25, 2013

Advantages of being a SECURED CREDITOR when it comes to bill collecting

There are significant advantages to being a secured creditor versus being unsecured. This is particularly true if there are several creditors competing against the same pool of assets when a debtor defaults in payments. This is extremely significant should the debtor file for bankruptcy.

Let’s take an example. A debtor is struggling and seeks money from several sources. Bank A provides a loan on an unsecured basis. Bank B provides a loan containing a lien on assets which is not perfected. Bank C loans money, taking a perfected security interest in collateral through either possession or properly filed financing statement and security agreement.

The debtor runs into financial problems and starts defaulting on loans. Trade creditors are typically unsecured. Trade creditors file suits quickly because they know they must move swiftly. This typically has a domino effect. In other words, once trade creditors start filing their collection lawsuits, secured creditors move in in order to protect their collateral.

In the circumstance described above, bank A provided a loan on an unsecured basis so it is basically in the same situation as the trade creditors. Should the debtor’s business fail completely, trade creditors usually receive less than $.10 on the dollar and bank A will find itself in that position, typically. Therefore, being an unsecured creditor is very dangerous. The only reason trade creditors are unsecured is because of competition. If a trade creditor were to try and seek a security interest in its collateral, the debtor would simply go down the street and purchase goods from another vender, particularly if those goods were commodities, which are easy to find.

Bank B loaned money and a security agreement was attached but was not perfected. Therefore, a security agreement is valid as between the bank and the debtor, but not valid as protection against third parties. Bank three did perfect. Therefore, if bank A, bank B and bank C start to move in on the collateral at the same time, bank C wins. A perfected creditor is going to have superior collateral rights to a creditor who has only attached a security interest, which is the situation with bank B. Bank A, as indicated above, is just another unsecured creditor with no rights against assets of the debtor absent a legal judgment.

In a worst case scenario, the debtor files for bankruptcy. Bank A and Bank B are both out of luck. They are being treated as unsecured creditors and unsecured creditors typically get less than $.10 on the dollar in bankruptcy liquidations.Bank C, by way of contrast, gets to foreclose on its collateral in most circumstances and at least will recover some money, depending on the value of the collateral it secured. If the collateral is worth the full amount of the loan, bank three will be made whole. Banks A and B will, as stated, be walking away with less than $.10 on the dollar.

In order to appreciate the difference between the secured positions of Bank B and Bank C, the following discussion is offered. Bank B attached, but did not perfect its interest as a secured creditor, whereas Bank C attached and perfected. Attaching and perfecting are separate concepts, and both are necessary to attain the highest status of becoming a truly secured creditor.

To attach, the parties simply prepare and sign a security agreement, which is a document describing the collateral and pledging the collateral as security to the debt. It should be noted while we normally consider the security agreement to be written, and electronic version is perfectly acceptable in most jurisdictions.

Perfection, under the Uniform Commercial Code occurs in commercial transactions where the lien is filed with the appropriate authorities; typically the Secretary of State in the state where the debtor transacts business and sometimes a copy is filed within the local county (a political sub-division of the state) where the property is located. Simply put, the filing is the action which creates perfection of the lien.

The filing process is very inexpensive and there are forms readily available. These forms are typically referred to as “UCC 1” forms or “Financing Statements”. Lenders who choose to do business with a particular debtor will search the public records to find evidence of other secured creditors. A search through the records of the Secretary of State will turn up all filed financing statements. A creditor can then be aware of persons or businesses which have taken a lien on collateral. These same public record searches also show any tax liens filed against a debtor. A creditor can then be guided accordingly in making a decision as to whether to lend money or not. For example, if you are loaning money, you need to know whether your debtor has other secured creditors or tax liens having liens on the same property you are about to take as collateral!

It is extremely valuable to be a perfected secured creditor! This is particularly true if you are a lender. Lenders deal exclusively in money. They don’t provide a product; they simply are in business to loan money and recover it back plus interest in order to make a profit. Therefore, it is extremely important for lenders to loan money on a secured basis.

Manufacturers, to the contrary, take more risk in terms of providing goods to their customers on open account terms, which means on an unsecured basis. Presumably, the manufacturer has a sufficient profit that it can absorb certain losses each year for maybe 2% or 3% of its customers failing to pay/filing for bankruptcy. In a situation where a manufacturer is operating on a very tight profit margin or, where a manufacturer provides “big ticket items”, very expensive milling machines or robots, a manufacturer in this category would be foolish to continue to do business with debtors who were “marginal” without taking a security interest in the products that it sells.

Whether a lender or a manufacturer, or any other position in the “chain” of commerce, it pays to be a perfected secured creditor!


Steven A. Harms

Muller, Muller, Richmond, Harms & Myers

33233 Woodward Avenue

Birmingham, MI 48009


Fax: 248-645-5478

Tuesday, June 11, 2013

Collections: Getting Slow Payers Back on Track!

Stopping Slow Payers in Their Tracks

Short of going over to your customer and handing them their check book so they can write you a check for payment on outstanding invoices, the most effective action you can take to keep customer payments coming in smoothly is to closely monitor progress and communicate with the customer as often as necessary to keep the check or checks coming in promptly. You might even look at this as a training process. You are literally training your customers to respect your selling terms.

At the first sign of slowness, which will show up on your aging sheet, communicate promptly in writing. At this stage, the letter is just a gentle reminder. It is important to keep good customer relations. After all, the customer may have just simply forgotten to make the payment.

The next communication may be just as polite but should be done by phone. It seems there are quite a few ways to communicate with customers these days but the two most effective ways to communicate are still two of the oldest: face to face contact and the telephone. Face to face contact is probably not practical or even possible with most of your customers (years ago in house bill collectors were common place. A lot of shoe leather was spent knocking on doors and collecting accounts). The telephone is a close second, however. 

Avoiding Bad Habits and Broken Promises

Using a letter plus a very polite telephone call acts to keep an otherwise good paying customer in line. It also acts as a quick signal to you if a customer does not keep a commitment. For example, if you contact a customer on Tuesday and that customer indicates a check is in the mail to you that day, you may expect to have that check in your possession a few days later. If it doesn’t arrive, a follow up communication is necessary to see if some chance the check is lost in the mail but the odds are greater that the customer has simply broken his promise to you.

Watching for Fires and Putting Them Out Quickly

When it comes to collecting on invoices from customers, it is much better to be pro active than reactive. Simply put, you need to stay ahead of the game by spotting problem areas very promptly and following up with quick action. The following is a discussion of typical areas in customer relations in connection with the prompt payment of invoices.

Changes In Ownership of A client Business

A change in ownership of the customer can change bill paying habits dramatically. You may have had a great relationship with a customer for years which may have resulted in being lax on updating credit information such as information contained on the credit application, financial statements and  other documentation. Upon making a call, you may discover that there are different voices on the phone and it can be revealed that new ownership took over. The name of the company remained the same so as to show some continuity of business. People like to deal with businesses that have been around for a while with little change.

Perhaps the most dramatic event which can occur on a change of ownership was refusal of the new owners to pay debts incurred by the prior owners. For example, if the change of ownership occurred in June last year, even though the name of the company remained the same, no changes were reported to you, an investigation may have to be initiated as to which invoices were actually sold to the prior owners, which invoices were sold to the current owners, and are the current owners liable for the debts of the prior owners. 

Changes in ownership can significantly affect bill paying habits. Therefore, this is a key reason to periodically have your client submit a new credit application as the application itself defines the name of the business entity and who the owners are. Don’t count on your customer to be forth right in providing that information.

Changes of Address or Phone Number

Observing a change of address or phone number is significant. It may reflect new ownership. It may be a result of a conflict with the landlord (an eviction perhaps).

Two trends have become increasingly popular in terms of address and phone number. With regard to addresses, it is increasingly common for small and medium sized businesses to show a post office box as the address or, more disturbing, the address of a mail drop service (such as a UPS store) as the physical address of the company. It is much easier for a customer to become elusive if a physical address is not disclosed to you. If a customer uses a post office box or a mail drop address, your credit application or some other form should insist that a physical address also be disclosed. 

A customer having the same phone number for a long period of time use to signify stability because phone numbers were tied in with addresses. Now, a phone number can receive a call and through modern technology that call can be forwarded anywhere in the world. Thus, a customer having the same phone number for a long period of time no longer signifies stability. You must keep tabs on the customer as to the physical address where the customer is located per the discussion above.

Enforcing Good Pay to Improve Your Cash Flow

Both a seller and a buyer are more comfortable with their relationship when goods and services are flowing smoothly and payments for those goods and services are being made promptly. You will find your customers do not object to close monitoring and eager follow up for prompt payment of invoices. Indeed, those customers who do find your close monitoring to be offensive, are customers you probably are going to have some trouble with down the road any way.