Preventing Debt Collection Problems Up Front

There are many steps a business can take up front to avoid having collection
problems. Equally as important, business must realize that by the time a collection case has
been referred to an attorney for suit, the client-creditor, through its actions, has either
provided the attorney with a case that is a winner or one that is a loser. The following list
of “Recommendations to Creditors” has been created based on 20+ years of performing debt
collections for large and small businesses throughout much of the United States and
elsewhere. These recommendations will assist businesses both to 1) minimize delinquent
accounts and 2) increase the likelihood of collecting when it is necessary to employ a
collection attorney.
1. PRIORITIZE – Make collections important from CEO down. Do not treat
sales and marketing as more important than collecting the very monies that comes from sales
and marketing. Make collections a vital part of the marketing, sales, and contracting
planning. Take responsibility for the fact that collection problems do not just happen and
that they are largely avoidable.
and emphasize to salespersons and other employees that each “net-30″ sale means the
company is in the lending business. Ask yourself: Would you lend money to this customer,
and, if so, on what terms and with what security or personal guarantees?
To put this in perspective, imagine a bank that hired a number of young sales people
with no experience in lending and offered them a ten percent (10%) commission each time
they made a loan. Would it surprise you at all that the bank would soon have very serious
debt collection problems?
3. TRAINED, MOTIVATED STAFF — Have well-trained collection staff, good
collections procedures, incentives for performance, and support from CEO down. Do not
treat collections as unimportant or as something that is not worthy of your time or that of
your better employees.
4. ACCOUNTABILITY FOR SALES FORCE — Force accountability on sales
personnel; do not pay commissions on a credit sale when the particular account receivable
proves to be uncollectible. Sales people are the eyes and ears of the company; have them “on
your team” in the battle against bad debt.

5. SALESPERSON VS. CREDIT DEPARTMENT – Strive to achieve a proper
balance between salespersons (who almost always want to make the credit sale) and the
credit organization (that often wants only risk-free credit sales.)
6. BANKRUPTCY LAW – Develop considerable knowledge of bankruptcy
law. Expect a significant number of customers to file bankruptcy–Chapter 7, Chapter 11 and
Chapter 13, and plan to deal with that in terms of price, security, guarantees, and otherwise.
7. KNOW YOUR CUSTOMER – Experienced bankers say “banks lend to
people, not to collateral.” It is the person, not the collateral, who is expected to repay the
loan. Smart bankers know their customers. The Internet, Beacon scores, and many good
information services and software programs make it much easier today to know more about
the customer than ever before.
8. MONITOR EXISTING CUSTOMERS, TOO – Many, many companies
suffer serious financial losses because they fail to have any mechanism in place to do follow
up checks on customers who were in the past approved for credit and who may in fact have
been credit risks for many years. The warning signs are often there; the customer has been
slower and slower in paying, going from net 30, to net 45, to net 60, to net 75. The customer
has been returning merchandise, making warranty claims, and not ordering as much. In some
cases, a valued customer has switched suppliers and no longer needs you—and no longer
feels the need to pay your bills. Sometimes, on the very eve of filing bankruptcy, the
customer will pay one of his or her 3 or 4 outstanding invoices, place a large order, and then
file bankruptcy shortly after you delivery the final order “net 30.” Had you had in place a
mechanism to pick up on the red flags or routinely rechecked even your good customers, this
large financial loss and months of dealing with a bankruptcy court might well have been
9. AVOID “PROFESSIONAL DEADBEATS” – Question: How much money
does a deadbeat make when he buys goods net 30 for $10,000 and sells them for $12,000
cash? Answer: $12,000 (when he never pays the $10,000 and not just $2,000). There are
many people who simply do not feel any obligation to pay for goods or services—especially
services—purchased on credit. These people are often easily identifiable because they have
low Beacon score, prior repossessions, prior bankruptcies, prior evictions, and large credit
card balances with very few payments. They may also have prior “NSF” checks, excessive
warranty claims and returns, and other evidence of nonpayment of bills. Take care, too, that
they may use aliases or set up shell corporations, limited liability companies, or simply
operate under an assumed business name—“D/B/A” (“Doing Business As”).

– Special care is required when dealing with small businesses that have incorporated or
formed an LLC. Just an the IBM salesman who sell you a computer is not personally
obligated to make it or stand behind it, the President of ABC Company, Inc. is not
responsible for the goods or services ABC Company, Inc. agreed to purchase from you for
$1,000 on credit (net 30 sale). Unless you require the President to sign personally—not just
on behalf of the corporation—or personally guarantee the debt of ABC Company, Inc., you
will have a claim against only the corporation for the $1,000. You should be guided
accordingly in extending credit, having contracts signed, and in having credit applications
11. CREDIT CHECKS, ETC. – Do up-front credit checks, become a member of
the local Credit Bureau, subscribe to Dunn & Bradstreet, or a similar service, check Beacon
scores, use Internet resources, and so forth. Place the burden on the would-be borrower;
decline to make credit sales (net 30 sales) until and unless the potential buyer satisfies you
that he or she is creditworthy or can provide security or the guarantee of a creditworthy
applications that are well-drafted, up-to-date, thorough, require references, and are signed
under penalty of perjury. CHECK THE REFERENCES! Preferably, a customer’s
signature should be witnessed by your employee or by a Notary Public. Credit Applications
should provide for a) interest at one and one-half per cent (1½ %) per month for late
payments, b) attorney fees upon default; and c) personal guarantees for small corporations
and LLCs. In North Carolina, the proper use of the word “Seal” will give you ten (10) years
rather than three (3) years to collect on a debt, and that can be a substantial sum when interest
is accruing at 1½ % per month. Some well-drafted credit applications recite that sales are
made on the seller’s terms and conditions, including limited warranties and limited remedies.
For reasons that should be apparent, you should have an experienced collection attorney
review or assist in developing your form, especially if you deal with consumers.
13. PERSONAL GUARANTEES – As discussed in connection with small
corporations and LLC buyers on credit, you should require well-drafted personal guaranties.
In some states you need to restate the right to attorney fees, even though it is contained in the
contract being guaranteed. It is often best to insist that the spouse also sign because a) the
home is often the most valuable asset a family may own and it is usually owned “by the
entireties” and cannot be reached by a creditor of only one spouse, and b) assets have a way
of “belonging to the other spouse” when a collection case is commenced or bankruptcy is

14. SALES AGREEMENT; FORMS – Use well-drafted sales contract forms,
updated periodically with input from an experienced collection attorney. See above
comments under CREDIT APPLICATIONS about provisions for a) interest at one and onehalf
percent (1½ %) per month for late payments, b) attorney fees upon default; c) personal
guarantees for small corporations and LLCs; and d) in North Carolina, the proper use of the
word “Seal” to give you ten (10) years rather than three (3) years to collect. Needless to say,
the sales forms should address far more than collection matters. However, nothing is more
important to the seller who sells product or services on credit than the critical issue of getting
paid. Accordingly, expert advice and assistance should be obtained at the outset; do not wait
until your company has at risk millions of dollars in contracts and Accounts Receivable
before doing all that is reasonable to insure your company will get paid and paid in timely
15. AVOIDING FRIVOLOUS COUNTERCLAIMS — On a very related matter,
because collections actions can often be thwarted by frivolous counterclaims, it is important
to anticipate counterclaims in contracting. It helps to provide limited warranties and limited
remedies and require prompt written notice of warranty claims to avoid belated, frivolous
“warranty” claims and counterclaims that occasionally show up only when suing to collect
on old debts. See Uniform Commercial Code Section 2-607. That statute contains a
provision designed to invalidate “late” defenses and counterclaims that surface for the first
time when a creditor attempts to collect on a delinquent account. The applicable language,
dealing with the effect of acceptance of a tender of goods, is as follows: “Where a tender has
been accepted, the buyer must within a reasonable time after he discovers or should have
discovered any breach notify the seller of breach or be barred from any remedy.” Where the
contract involves the sale of goods, this statute should be utilized to full advantage. Where
the contract involves services or the UCC does not otherwise apply for some other reason,
the Court should be asked to apply the statute “by analogy.” In any event, a well-drafted
contract should create or preserve this right for the seller.
Consider also that the seller of goods is permitted by the Uniform Commercial Code,
Section 2-725(1), to reduce the statute of limitations to one year and thereby avoid stale
counterclaims in that fashion. The question then is: Has the seller also limited the seller’s
right to bring a collection action to one year?
16. CONTRACTING PROCEDURES – All too often a company has very good
forms but very little in the way of procedures for getting forms signed or retaining signed
forms to deal with collection problems that arise years later. Use good contracting
procedures, updated periodically, detailed, in writing, with adequate training of key
personnel, and index and store contracts and guarantees properly.

17. SECURITY IN GOODS SOLD – When selling goods having substantial
value and worth retrieving should the customer fail to pay, add a provision in your sales form
retaining a purchase money security interest whenever practical. Perfect by filing when
practical and/or should the buyer default.

  • Monitor accounts for changes—slow pay, reduced orders, excessive returns, personnel changes, and so forth.
  • Develop and rely on a “tickler” system to keep track of delinquent accounts.
  • Promptly follow up on delinquent accounts and keep steady pressure until paid.
  • Go to the customer’s physical site. Perhaps the single most effective collection techniques is simple to show up unannounced and wait for your check. You may also learn a lot from the visit.
  • Use the telephone. Telephoning is much more effective than letters, which are easily ignored. Telephoning also provides feedback and information.
  • Listen to any claims or defenses raised by the debtor, without any way encouraging the debtor to raise any such claims.
  • Seek oral admissions that the debtor owes the sum sought.
  • Obtain oral admissions regarding the “non-quality” reasons why the debtor has not paid (business downturn, health problems, etc.)
  • Record excuses in a detailed log stating dates, responses and reasons.
  • Send confirming letters reiterating non-quality reasons for not paying.
  • Determine the disputed portion of a debt if such a claim is made. Where a debtor acknowledges that the debtor does not dispute 90% of the debt, ask the debtor to pay the other 90% while you investigate the disputed portion.
  • Promptly sue and aggressively pursue collection activities; use a good law firm experienced in debt collection.

COLLECTIBLE OR NOT—YOUR CHOICE – The contracts businesses make every day
more or less dictate the outcome of future litigations. In that sense, the collection aspects
of contracts are no different.
Scenario 1: A business brings the collection attorney a contract that is signed,
guaranteed, and has the right to reasonable attorney fees and interest at 1½ % per
month. The attorney collects the entire debt plus the attorney fee and a substantial
amount of interest. Furthermore, the attorney is able to prevail at a summary
proceeding without trial or indeed able to convince the debtor to pay the full amount
owed without a long, costly trial. Why? Because the debtor does not want to have
to pay the creditor’s attorney fees and the 1½ % per month interest.
But, change the facts slightly:
Scenario 2: The same sale of goods is involved, but no written contract was used.
There is no personal guarantee, no right to attorney fees, and no right to high interest.
Indeed, there is no particular reason for the corporate buyer to settle as suit will take
a year of more, interest is accruing only at the legal rate of 8% non-compounded, and
the seller cannot recover attorney fees. Indeed, the owner of the corporate buyer can
collapse his company and set up a new one in a week for only $125. Result: after a
six month legal battle and threats of bankruptcy, the seller-client settles for 20% of
the debt, receives no interest, has to pay his own attorneys fee, and is lucky to get
anything at all.
The choice is yours.