Credit and Due Diligence

Think like a credit professional and make every effort to improve a creditor's position by getting additional information or security.

By Harold Stotland, JD

This is a story about two clients who have totally different perspectives regarding the establishment of their customers' credit worthiness.

The first client operates a small radio station and will routinely send me invoices, a statement and a telephone number with the claim placement. Because this client primarily is concerned with disposing of unsold airtime – an item that is worthless at the end of each business day – this client does not perform any due diligence in establishing the advertiser's credit worthiness, and as a result, the station does not have any other pertinent information to send to me to assist in the recovery of the claim.

Another client is a finance company that leases business equipment. When the company sends me a claim, it always includes a personal guaranty, as well as a complete personal and business credit application. It should come as no surprise that the recovery rate for the finance company is greater than the rate of the radio station.

Everyone who is a part of the credit process (credit managers, collection agencies and attorneys) needs to understand the credit process and the reasons for the lack of due diligence. It is important to understand that credit decisions are a valid economic judgment on the part of our clients.

I respect each of these clients, and I have learned over the years that my clients usually are more astute at making credit decisions than I would be in the same circumstances. If we examine commercial collection matters, we see the whole spectrum of credit diligence. Usually, the creditor makes a well-informed decision about when to grant or deny credit, but it is often the case that the owner of the company cannot or does not articulate to the credit manager the basis for credit decisions.

While representing creditors, I have seen that credit-granting decisions are inextricably associated with the sale price for goods and services. For example, if my client is in the business of selling ice cubes, the odds are that his credit decisions will not be any different from his competitors' credit decisions. If my client decides to demand cash on delivery for all customers, he will lose many of them to other vendors. However, if he manufactures an item not available elsewhere, such as replacement parts for a product, and there are no competitors, then he can and should demand cash before delivery on all sales of replacement parts.

Attorneys need to apply credit concepts of due diligence when we represent creditors and enforce judgments. As attorneys, we need to understand that when we advise our client to grant an extension or payment plan, we also would apply valid credit concepts, such as demanding credit information from the debtors at all stages of our legal process. Over the past 10 years, I have seen fewer companies that are willing to invest in training for credit professionals. In fact, it is now the exceptional company that has a fully trained staff of credit approval and collection personnel. This change in the corporate landscape requires agencies and attorneys to be more astute regarding credit issues because there is often no one with an understanding of these issues to provide guidance.

We recently had a judgment against a small camera shop. We proceeded to levy on the debtor's inventory and the sheriff set a date for sale of the business assets. We knew from public records that there was a security interest by a local bank that had a first lien on all of the debtor's assets. The debtor requested a payout plan that extended over six months. It would have been useless for our client to sell the debtor's assets because the ultimate owner of those assets would have been the secured creditor.

However, when the debtor requested an extension or stay of execution, it gave us an opportunity to request the debtor fill out a personal financial statement and execute a personal guaranty. This ensured that the judgment would be satisfied under the terms worked out in the stay of execution. This is a case in which the debtor wanted time to pay and, as consideration for that extension, executed a personal guaranty with full disclosure.

Due diligence is a concept that runs throughout the entire credit process, from the opening of an account by the client to the enforcement of a judgment by the attorney. At every stage, it is imperative that all of the parties dealing with the credit process think like credit professionals and make every effort to improve a creditor's position by getting additional information or security.

ABOUT THE AUTHOR

Harold Stotland is a principal with Teller, Levit & Silvertrust, P.C. in Chicago, Ill., where he directs and supervises the firm's Commercial Collection Division. Contact him at hstotland@tellerlevit.com.