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It is frustrating, or worse, when a business customer does not pay their first open invoice on time. Perhaps something just happened at the customer's business after the credit decision was made that has resulted in cash flow problems. But, there is also the concern that this is just a 'bad apple' that was not observable during the credit evaluation process. When trying to collect, whether in house or when assigned to a collection agency, quickly determining which is the real situation can have a big impact on deciding how to proceed and ultimately collecting the money.
In recent articles we've talked about methods to determine if a debtor is telling the truth. But, in a situation where a business has never paid a specific vendor, regardless of the documented circumstances, the overriding question is: "Will this company ever pay anything?" The only way to know is if they make a payment.
In collections, we are all concerned about establishing a bad precedent by accepting a small payment. We don't want customers or debtors to get the impression that small payments over a long term is acceptable. Nor do we want them to think that a small payment from time to time will prevent a vendor from taking more aggressive action. But, at some point with a first time customer who has never paid, finding out if they have integrity is more important than the concern about setting a precedent.
When these accounts come to our collection agency, we quickly pivot to this integrity question if our standard collection efforts don't result in immediate payment. We use 'transparency' as a way to determine if we are working with a professional debtor or a potentially viable payer. We explain to the business owner or executive that we need a small payment just to establish their integrity, and if they can't afford as little as $100 (on smaller claims), we have to assume they will never pay anything unless forced by the courts. We of course explain that this does not set any precedent regarding size and timing of future payments, but is simply to determine their integrity.
We have found that this technique frequently is successful in getting payments from some companies, and this does impact the collection process going forward. Even more importantly, if a company refuses to make even one small payment, it tells us and our clients a lot about how we should handle the claim. This same technique can be used by in house collection departments to give insight on how a specific account should be handled.
Excuse or Explanation? How to get your money!
How to Separate Fact From Fiction
Fact vs. fiction media
“We can’t pay due to cash flow problems” media
This Article by Dean Kaplanwas originally published on our Blog at The Kaplan Group. At our commercial collection agency, we aren't afraid to talk to attorneys. When we call a debtor and they tell us to talk to their attorney, our biggest fear is that the attorney will not actually talk to us.
Once we are instructed to talk to a company's attorney, we are no longer allowed to contact people at the company directly. All communication must go through the attorney once the company has identified who represents them and the law firm confirms they have been retained. Unfortunately, all too often the attorney will not communicate with us after this initial confirmation.
There could be a number of reasons for their lack of communication. The attorney may not have the information from their client to have an informed discussion. Or, the attorney may also be owed money by the client and does not want to invest more time until they have been paid. The attorney may be so involved in other cases that we aren't even on page 1 of their priority list and there will be a long delay before they can devote attention to the issue. In all of these situations, there is some chance that eventually we can talk to the attorney, have meaningful conversations, and ultimately resolve the matter.
Alternatively, the attorney may be refusing to engage as a defined strategy agreed to with their client. They realize that if they don't talk, our only option is to file a lawsuit. This can be a very effective debtor strategy if they believe the circumstances make the chance of litigation very small. For example,if the cost to litigate is high relative to the amount owed, it may not make economic sense to file a lawsuit. Or, if the debtor's financial situation is unclear, or worse, known to be poor, they know it will be difficult for the creditor to justify investment in collection litigation when the chance of eventually getting paid is highly uncertain. When a debtor is using this 'hiding' strategy, it means they have decided that in no circumstances will they consider paying anything unless a lawsuit is filed.
We find this situation very frustrating, as we know that if we can't get engagement, we don't have any chance of collecting without litigation. Somehow this is worse than being stonewalled by the debtor, as we have many different strategies to pursue in that situation. For our clients, this is an insult added to the injury of providing goods or services and not getting paid. Their customer, who they trusted to keep their payment commitment, has now spurned them in a defiant manner. Thankfully most businesses do not utilize this effective yet ethically questionable strategy.
The chances of collecting on an invoice due from a company that has ceased operating are very slim. If the business was organized as a corporation or LLC (limited liability company) then only the business entity itself is liable for outstanding invoices. If there are no assets remaining in the entity then the entity has no way to generate cash to pay creditors. We call these entities “defunct.”
It frequently requires significant effort to prove a company is defunct. Websites can be active for a year or more after a company ceases businesses, as the website hosting company may not be aggressive in shutting down delinquent customers. The company’s phone may be working with voice mail for many months after operations cease. Owners keep the phone service so they can get messages they want but ignore ones that don’t benefit them, such as collection calls and customer service requests. So just because the phone and website are still working does not mean the company is still operating.
At our collection agency, we’ll do extensive research and field work to try to prove a company is defunct before we give up on a claim. We look for alternative phone numbers, addresses, and web addresses for the business and its owners. We call neighboring businesses and ask if they know if the target business is still open. Usually they confirm our worst fears that it is closed, but occasionally we learn the business is still open. Then it is clear the phone is not answered and messages are not returned when the topic is a past due amount. At that point we know we need to take an alternative approach in the debt collection process.
If the company's phone is no longer in service, that usually is a very bad sign. It is almost impossible to keep a business going if customers cannot reach a company. If we confirm a company is closed it is usually cost prohibitive to confirm that there are no assets remaining. Business owners are not obligated to provide financial information and rarely even respond to creditors after closing their company – they are focused on finding a new source of income. The only way to force the owner to provide the information is to file a lawsuit, get a judgment, and conduct a debtor exam. Given the cost of the legal process and the low likelihood of recovery, the return on investment potential is not high and our clients rarely can justify this investment.
A company that goes out of business is not obligated to file bankruptcy. It typically costs about $3,000 to hire an attorney to file bankruptcy. Most small business owners rightfully choose to not spend money just to officially bankrupt a company as they don’t get any value for this expenditure. In most cases we see, bankruptcy is only filed if the owner is also filing for personal bankruptcy protection or to deal with personal liability related to tax penalties and interest.
For our collection agency, well over half the claims we close without collecting are invoices due from defunct companies. In 95% of these cases, the invoices were very old before they were turned over to us. Had third-party debt collection started sooner there would been a much better chance of getting some recovery.
As explained in prior articles onand, there is a chance of collecting when the company is defunct if an individual is legally liable. However, in most cases where the business was the owner’s primary source of income, their personal financial condition is probably very poor. We often find it can take a couple years before they bounce back financially and we can then collect on their personal obligation. Thus, getting a can have value. But, the best way to avoid not getting paid by a defunct company is to escalate the collection process sooner and get to them before they go out of business.
We frequently get asked by new clients about piercing the corporate veil on owner-operated companies that go out of business owing money. Everyone's heard about someone else piercing the veil to create personal liability for business debts and getting paid. These 'stories' make it sound simple and a highly effective method for debt collection.
Unfortunately, this is more myth than reality. The truth is that it is so expensive and uncertain to pierce the corporate veil that our clients rarely try.
One of the main reasons small business owners incorporate or form an LLC (limited liability company) is to protect their personal assets from the liabilities that their companies create. This legal structure creates an entity separate from the individual. However, if the owner co-mingles their personal financial transactions with their company transactions, then you can argue that the company is not truly separate from the individual. If you prevail in court with this argument, you have pierced the corporate veil and the owner is now personally liable for the money the business owes creditors.
Many (or most?) small business owners will pay some personal expenses from the corporate account since they are using pre-tax dollars and the expense reduces their tax burden. Meals, memberships, family cell phones and gasoline purchases, and subscriptions are common deductions. Others get more aggressive, paying home utilities, credit card bills, and other home improvement expenses from the business banking accounts. This may be by design to lower tax liabilities, or simply sloppiness where the owner treats the business checking account as if it was their personal money.
The problem in piercing the corporate veil is we don't know to what extent this co-mingling has occurred without getting to review all of the company's financial transactions. As described in this article by attorney Paul Porvaznik, we usually cannot know if there are grounds to pierce the corporate veil until after we have a judgment and it may even require a separate lawsuit. After getting a judgment, a debtor examination can be scheduled where we look for evidence of co-mingling. This can be easy if the debtor’s check register is available and the payees on checks are indicative of personal expenses.
But, it is rarely this simple. Individuals have to be personally served to appear at debtor exams. This can be difficult, requiring multiple postponements and sometime expensive stakeouts. They frequently miss the exams so they have to be rescheduled multiple times, each one requiring personal service to notify of the examination time. They do not always bring all the documentation, requiring more rescheduling and appearances. (See our 5 minute video on the judgment collection process for more information).
If the check register does not clearly show co-mingling transactions, further investigation is required. All the company’s financial records need to be obtained. A professional needs to be hired to review the information and identify violating transactions. This could cost as little as $2,000 or more than $25,000 for larger owner-operated businesses. All too often this process is stymied by the debtor claiming the records no longer exist.
If we are successful in getting evidence of co-mingling, we need to get back in front of the judge. The case needs to be made that the co-mingling is sufficient to pierce the veil and create personal liability. This means more court fees, hearings, and attorney time. And even if we are successful, we still do not know if the business owner has personal assets available to pay off the judgment. If the business was their primary source of income, they may be under severe financial distress for many years and therefore your judgment will not get collected.
Many debt collection litigation attorneys will not want to take cases like this on a pure contingency basis unless there is strong evidence of eventual success. They know a lot of time and effort will be required and only a very small percentage of cases will result in piercing the veil AND finding personal assets that can be seized to pay the judgment.
At our commercial collection agency, we advise clients that if they want to try to pierce the corporate veil on marginal or difficult cases, they should be ready to spend a minimum of $10,000 and it could easily run $25,000 to $75,000 in complex cases where the debtor clearly has other personal and business interests that they are trying to protect. And there is no guaranty of success in piercing the veil and/or ultimately collecting any money. Thus, this investment can only be justified when very large amounts are owed, the individual has personal assets available to pay the debt, and we have strong anecdotal suspicion of significant co-mingling. Since all of these conditions are rarely met when we are asked about piercing the veil, our clients rarely attempt it.
Recently I wrote about a simple personal guaranty that has frequently saved our client from significant losses. Despite all you may have heard about piercing the corporate veil, if you don't get a personal guaranty in advance, you probably won’t attempt to pierce the veil due to the cost and uncertainty. If you want the business owner’s personal assets as a secondary source of repayment, get a personal guaranty.
There just might be a new Deputy in town! This past November, the House Financial Services Committee approved 6 bills that could possibly add sorely needed oversight and accountability to the Consumer Financial Protection Bureau (CFPB).
To date, it has been pretty much like the Wild West of regulation. The CFPB and its posse of 100s have been running roughshod from California to Florida to Maine, resembling a lynch mob looking for any culprit just happening to be in the financial services industry.
I’d say that they’ve found a culprit or 2 that needed to be lynched, but at what expense? How many people have been unnecessarily shot and wounded? And, before the lynching, wouldn’t justice have been better served with a judge and/or a jury of some kind?
Well that may be a little facetious of a description, but maybe not. Honestly, I feel certain that 98% of the people in the CFPB likely do a good job and try to do the right thing. That’s quite a coincidence, because 98% of the financial industry is also made up of good people that do a good job and try to do the right thing.
So thank goodness for consumers, there is now a serious move to lasso some of the power from the CFPB and make sure it has appropriate oversight and accountability.
Out of the six bills passed, these three might be the most workable:
My hope is that the CFPB will handcuff the financial industry culprits, dispense the posse to go back to herding cattle, and set up a structure where the financial services industry can wake up all of the sleepy towns in the Wild West, and all of America.
Martin Sher, Co-CEO of AmSher Collection Agency and a past president of ACA International, is the author of the Collector’s Pledge. Hundreds of thousands of collectors all over the world have signed this unique document committing to treat people with dignity and respect. AmSher is known as the collection agency that collects with compassion.
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