Steve Harms

Wednesday, October 23, 2013

Credit Risk: how much can you stand?

Savvy credit managers know that new customers almost always pay for their first few orders in order to build up their reputation as good pay. But then the third or fourth credit extensions show signs of slipping. Payments slow to 30 days or so beyond your selling terms. Without careful monitoring and close follow up, your new customer can quickly become your new headache.
Appearances may deceiving. The trappings of wealth, including luxury cars, fancy offices, the latest and greatest of all gadgets and gizmos, sometimes signal that the customer is a poor risk, not a good one. Some folks just have to look successful, even when there’s no money in the till to pay bills. Your goal is to discern which customers are worthy of credit without being deceived by appearances.

Your biggest risks come from

                           *  New Accounts: Whether newly in business, or established business and simply new to you; and

                           *  Marginal accounts: Customers in some degree of financial instability, or start-ups with unknown finances.
Monitor risky accounts often –  really often – for any change in payment patterns and any red flag events, including their general attitude toward your business relationship, drops in orders, new management, or changes of address or phone numbers.

Be on guard for the customer who is always in a rush, the “We need it today” or “Please help us get this done over the weekend” customer. All too often, you will pour your body, soul and direct disproportionate company resources into that customer to make them look good, only to find they had no idea what they were doing. Next, you hear that you won’t get paid until they’re paid by their own customer, and their customer is upset. You’ve incurred bills of your own to pay for materials and owe overtime pay to your own employees, and now you may get nothing back.

When a customer introduces pandemonium to your business, avoid being set up by slowing down the process, and don’t make no exceptions to your credit policies (including a credit application, financials, and a full credit evaluation).

When you extend credit, the type of legal entity you are extending credit to is a key factor in the decision of how much credit to grant. There are huge differences between lending to an individual versus a corporation. Many business entities, including corporations, provide a significant shield against collections, allowing their owners or shareholders to avoid any personal responsibility for their unpaid debts.
For example, you’re about to start doing business with a famous, wealthy, well-respected person. Or should I say, that person’s newly formed corporation. Their wealth and fame leads you to extend considerable credit. The next thing you know, you find yourself down in the dumps when the corporation goes out of business leaving its debts unpaid, and the “respected” person behind the company has neither the responsibility nor the inclination to pay your bill. Famous people can fail in business, just like anybody else. Remember that over 90% of all new businesses fail in the first five years, and some of those are… er… were owned by successful and highly respected folks.

Wednesday, October 16, 2013

Contracts: read 'em to avoid disapointments

When you enter into a contract that obligates you to do something in the future, even if it’s as simple as paying for goods or services you’ve received, you may find a contract provision that allows your customer to escape payment. Imagine that you’re manufacturing an expensive piece of machinery.  What if a contract clause allows the customer to not pay until they have been paid in full by their own customer. That’s a debtor escape clause…sometimes referred to as a “pay-when-paid” clause.

From the standpoint of a debtor, it’s easy to see the advantage of an escape clause. If their customer cancels the order or never pays for the machinery, they don’t have to pay you. You end up taking on a huge risk that you can’t control. You’ve shipped a valuable product to your customer, your customer used it (sold it to their customer), and you still can’t get paid because your customer hasn't been paid.

When you’re negotiating contract terms with a buyer, particularly if the buyer has presented you with its own form contract, watch carefully for any debtor escape clauses like the one just mentioned.

Remember to read contracts before entering into them. Some contracts contain provisions that you may not like. Before you sign you can renegotiate their terms or, if not possible, you can refuse to enter into the contract. Sure, you can just go along with the contract and hope for the best, but that approach has a way of sometimes blowing up in your face.

Another example is an arbitration clause in a contract.  While it may be a good idea in many circumstances, arbitration clauses are not particularly helpful in many ordinary collection cases as they result in more costs than a routine collection case and the creditor still has to file the matter in court to have the arbitration award accepted as a final order of judgment, required to enforce collection via garnishment or other forms of court-ordered collection.  For example, a $30,000 collection case could easily cost $3000 to arbitrate, whereas an ordinary collection law suit may only cost a few hundred dollars to file and serve.  Of course, this decision should be made on a case by case basis after consulting with an attorney as there are distinct advantages and disadvantages to each.

Tuesday, October 8, 2013

Credit Reports: be cautious when you access them

We've said this before, and it bears repeating, that theUnited States District Court in the Ninth Circuit held that the Fair Credit Reporting Act severely limits when a creditor can access a consumer credit report. Specifically, the court held a consumer credit report (Experian, Equifax, and Trans Union are the key players in this arena) could only be drawn when the underlying debt involves a “credit transaction.”

So, what is a CREDIT TRANSACTION? Well, it is where the consumer voluntarily seeks credit, such as a credit card, promissory note, or other voluntary credit transaction. Examples of an involuntary credit transaction, where the creditor can’t pull a credit report, would be where the consumer didn’t voluntarily enter into a credit relationship with a creditor, such as where the debt arose from a traffic ticket or towing charges for failure to pay a ticket.

Many industry groups have opposed this ruling as it has become common practice to draw a credit report during the collection process of any debt, no matter how the debt was incurred. How-ever, the United States Supreme Court ( in a January 2011 refusal to grant Certiorari), has refused to review the Ninth Circuit’s decision, thus, the ruling stands.

So, bottom line, a consumer credit report can be drawn only where:

1. There is a judgment against the consumer for a debt, regardless of source. Or,

2. The underlying debt before a judgment is entered is based upon a “credit transaction” which means, according to the court, a voluntary transaction such as a credit card, a note, a debt voluntarily entered into...basically, situations where a consumer requested and re-ceived credit.

The case was Pintos v Pacific Creditors Association. It was heard in May 2010. The U.S. Supreme Court refusal to review the Ninth Circuit holding was done in January 2011.

Where do we go from here? Well, stay tuned as there may be more case decisions on point as we go forward, perhaps from other circuits. However, for now, we must look at the underlying debt on each file to determine whether (unless we have a judgment) we have a permissible purpose to pull a consumer credit re-port—the key being whether the consumer voluntarily requested the credit transaction.

Thursday, October 3, 2013

Sometimes it pays to read the manual...

When you’re in business, you may feel that a competitor always lurks on the horizon, plotting and scheming to take away your customers, cut into your market share, and take your profits. And you’re right. Competition is a fact of life, and with it comes the pressure to extend credit to all the customers who come your way, whether they deserve it or not. After all, if you don’t give customers credit, they can probably find a competing business that will.

If you’re relatively new to the credit and collections process, you may be asking yourself several questions:

                           *  Should I always be willing to open a line of credit for a customer?

                           *  How do I balance the risks of extending credit against the risk of losing the business of customers I turn down?

                           *  What happens if a client doesn’t pay an invoice?

                           *  How can I deal with issues such as any bad checks or disputed claims with a customer I’ve done business with?

                           *  What do I do if a customer suddenly moves, leaving no address or phone number to make contact?

                           *  Can I file a lawsuit, and how do I sue?

                           *  When do I need a collections professional to help me, and how do I find one?

The book Credit and Collections Kit for Dummies addresses those questions, both in short form in Chapter 1 and in detailed form in the remaining chapters of this book.   As for Dummies book readers know, each chapter of a Dummies book provides a stand-alone guide to a particular topic, so you can peruse the topics that most interest you and come back for all the rest at your leisure.

As an example of the types of practical tips offered in the book:

You can avoid a lot of difficulties with defaults in payments from customers if you monitor your clients for changes in their business and financial health. For example, if you find out that a customer’s business has new ownership, or that the owners have formed a new but similar company (John’s Bike Shop is now John and Mary’s Bike Shop), it may be time to thoroughly recheck that customer. Sometimes your clients really don’t want you to find out about changes, and that’s a reason in and of itself to recheck them.


If a customer won’t take the time to fill out a credit application, and you choose (or need) to extend credit to the customer anyway, you can protect yourself. Make sure you interview that customer to obtain the information you need to determine creditworthiness and to use as a resource if the customer’s paying habits deteriorate. If you interview the customer by phone, keep a recording of the call (but be sure you can legally record the call under the laws of your state), or write the answers down on your standard credit application and add the completed document to the client’s credit file.