Questions & Answers

How many collection calls should one make before referring a file to a collection agency?
What is the best course of action to follow when dealing with accounts payable staff does not result in payment of an overdue account?
What can creditors do to protect themselves when a customer remits a cheque, for less than the full amount owing, and marks it "Paid in Full" or words to that effect? Also, what can a creditor do to protect themselves in this situation when their company uses a "lock box" or "shared service" center and the A/R personnel may not even see the cheque prior to it being negotiated? Is the law that governs these scenarios Federal or Provincial?
We see more and more public companies partially or completely reorganizing as Income Trusts. What are the advantages and disadvantages to the company and what could the ramifications be to trade creditors? Is there anything we should be questioning or looking for in this type of transaction?
Is there a timing difference from the time a security agreement is registered and perfected?
Is it a recession?
What triggers a recession?
What is a Credit Crunch?
What is Stagflation?
How does a slowdown affect companies?
What action can be taken to address recessions?
How does theoretical economics affect credit decisions?
Is credit insurance the answer to a credit manager’s prayer?


Question

How many collection calls should one make before referring a file to a collection agency?

Answer

The best way to determine this is by establishing a process whereby a collector goes through a series of steps in which h/she establishes the ability and willingness of a debtor to pay the overdue bills.  It’s quite possible to make a decision to escalate a file to a collection agency right after the very first call.  On the other hand, if there are reasons to believe that a cooperative debtor is experiencing temporary cash flow difficulties, then it may take repeated calls to work out a solution over time.


Source: Derek Cherewick, Commercial Credit Adjusters
Gerry McFaddin, CCP (Emeritus)
Murray t. Box, Pallett Valo, LLP


Question

What is the best course of action to follow when dealing with accounts payable staff does not result in payment of an overdue account?

Answer

Dealing with A/P staff is part of the initial stage of collecting on a delinquent account.  Rightly, they deserve every due respect.  However, if a solution is not forthcoming, then one should resort to the principle of escalation.  This entails finding out who the A/P personnel answers to and whether that person (general manager, controller, director of finance, accountant, etc…) has the genuine decision making power or the authority to provide information as to the company’s ability to pay.



Question

What can creditors do to protect themselves when a customer remits a cheque, for less than the full amount owing, and marks it "Paid in Full" or words to that effect? Also, what can a creditor do to protect themselves in this situation when their company uses a "lock box" or "shared service" center and the A/R personnel may not even see the cheque prior to it being negotiated? Is the law that governs these scenarios Federal or Provincial?

Answer

Courts are very familiar with this tactic and will generally not give effect to it. A cheque marked “paid in full” may very well be evidence of an agreement to reduce the debt owing, but it is easily rebuttable by clear evidence that the creditor accepted the payment only as partial payment. This is based at least partially on the concept of consideration. Put simply, this concept involves the idea that you do not get something for nothing. What the debtor is attempting to do in this situation is to receive a discount on its debt without providing any real benefit to the creditor in return. The courts will not allow a debtor to unilaterally alter its agreement with its creditor - which is what it is attempting to do with the notation on the cheque.

One possible method of dealing with such attempts would be regularly forwarding statements thanking the debtors for any payments received and indicating the account balance to date. If the debtor then challenges the statement arguing that payment had been made in full by way of the cheque in question, all the creditor would have to do would be to respond by saying it was received in partial payment. Unless the debtor is able to produce some sort of an agreement with the creditor showing the creditor’s agreement to accept the reduced amount in full satisfaction for the amount owing, it is extremely unlikely that the courts find in favour of the debtor.

Of course, if the creditor notices the notation before it deposits the cheque, it can also send a specific letter to the debtor thanking it for the payment and saying that the payment has been applied against the amount owing, that the creditor did not agree to accept the payment in full satisfaction of the amount owing and that the balance remains owing by the debtor.

The law governing these scenarios is the common law of contract, which is a matter within the jurisdiction of the provinces. As such, the law as interpreted in one province may not necessarily be applied in another. However, frequently the courts in one province will consider and often follow the decisions of courts in other provinces.



Question

We see more and more public companies partially or completely reorganizing as Income Trusts. What are the advantages and disadvantages to the company and what could the ramifications be to trade creditors? Is there anything we should be questioning or looking for in this type of transaction?

Answer

An income trust (the "Trust") is essentially an investment vehicle which a corporation (the "Corporation") can establish in order to divert and distribute its revenues in a generally more tax efficient manner to the investors of the Trust.

While the pros and cons of establishing an income trust are largely tax driven, extremely complex and beyond the scope of this forum, income trusts basically operate by taking the monies raised by the Trust from its investors and loaning them to the Corporation. Such loan can either be on a secured or an unsecured basis. Revenues from the Corporation's operations are then paid to the Trust in order to service the loan with those monies then being available for distribution to the Trust's investors.

The typical structure sees virtually all of the Corporation's distributable income paid out without corporate tax because the income is being used to service the Corporation's debt (e.g., the loan from the Trust). If the investors of the Trust are tax-exempt entities such as RRSPs or pension funds, payments to them from the Trust will be received on a more favourable tax basis than if the monies were distributed as dividends.

While the establishment of the Trust will not alter the manner in which the Corporation carries on its business (note that the Trust does not carry on business - it is simply an investment vehicle), the difference is that with the establishment of the Trust, the Corporation has a new and typically large creditor (being the Trust) whose debt must be serviced by the Corporation.

From the perspective of companies doing business with the Corporation and extending credit to the Corporation, while the creation of the Trust in and of itself will not negatively impact upon the Corporation's ability to carry on its business, companies doing business with the Corporation may be at a greater risk should the Corporation subsequently run into financial difficulties. Aside from the Corporation having less flexibility to refinance since cash flow will be committed to debt service on the monies owing to the Trust (and other lenders), the Trust represents a new creditor which did not previously exist. If the Trust's loan to the Corporation is made on a secured basis, the Trust will be entitled to recover its monies prior to all of the Corporation's unsecured creditors, thereby diminishing the pool of funds available to the unsecured creditors. Similarly, secured creditors are at risk to the extent that the Trust's security has priority over their security. If the Trust's loan to the Corporation is made on an unsecured basis, the Trust will be another unsecured creditor sharing in the monies available to the unsecured creditors, meaning less monies will be available for the unsecured creditors had the Trust not been created.


Source:


Question

Is there a timing difference from the time a security agreement is registered and perfected?

Answer

They can happen at the same time or at different times depending on the situation. If there are no competing securities registered, a security document can be registered and perfected at the same time. If there are competing securities, a security agreement can be registered one day, but perfection may not take place until the other secured parties are notified.



Question

Is it a recession?

Answer

A recession is defined as 2 consecutive quarters of negative growth in an economy. The problem with the definition is it is only possible to determine if a recession has occurred after the fact. A number of well regarded economists believe that the U.S. is in a recession. This opinion was reinforced when the latest numbers showed a decline in service jobs



Question

What triggers a recession?

Answer

The last 2 recessions, in 1991 and 2001, were preceded by financial catastrophes, the Savings and Loan Fiasco and the Bursting of the Hi-Tech Bubble.  When events like these occur, they not only take equity out of the economy, but more importantly, they reduce the consumer’s confidence; that is, the consumer becomes concerned and reluctant to spend.
  
The intrepid consumer drives the U.S. economy, and for the last decade, it has been overspending.  The U.S. has a negative saving rate.  The ballooning equity in homes or the paper profits in the Hi-Tech Stock Bubble allowed them to overspend based on credit secured by these assets.  When the value of the assets decline, the consumer is often left technically bankrupt.
  
The recovery from the Sub Prime problems may be protracted, as the full extent of the write-offs will not be known until 2010 and the poorest people, who are most affected by the loss of their homes, will definitely not be driving a consumer recovery.



Question

What is a Credit Crunch?

Answer

A number of the largest banks in the World have had to write off billions of dollars of investments in the Sub Prime mortgage market.  When a bank lends money, it must always set aside a certain amount of capital to support the loan.  The term is Capital Adequacy.  To support the loans they are making, banks must have a certain Tier I Capital.  If the bank has to write off large amounts of capital, it may no longer have adequate capital to meet the reserve requirements and it must either reduce its loan portfolio or obtain new capital.  The basic impact is that credit becomes tighter and more expensive.



Question

What is Stagflation?

Answer

Stagflation as experienced in the 1970’s was a combination of a slowdown in the economy at the same time as prices were rising.  Today, the U.S. economy is definitely slowing, if it is not already in recession, and at the same time, we are seeing inflationary pressures on energy and food.  When energy and food prices increase together, it often signals a recession as the consumer’s discretionary spending is heavily constrained.  A larger part of a decreasing pie is eaten up by these 2 items.



Question

How does a slowdown affect companies?

Answer

As demand is affected by a decline in consumer confidence, it becomes more and more difficult to maintain sales levels.  The inflationary pressure felt on inputs becomes harder to pass on and margins become squeezed.  As margins become squeezed, the companies must reduce costs by purchasing less and laying off workers.  The recessionary spiral steepens.



Question

What action can be taken to address recessions?

Answer

Because recessions are often caused by decreasing demand, the financial engineers want to increase the demand by offering financial stimulants in the form of tax reductions, subsidies in the form of transfer payments or interest rate reductions to make credit easier to obtain.  This slowdown is largely caused by a collapse of the debt structure resulting in many people declaring bankruptcy or being laid off.  It is unlikely that easier credit is the answer.  As the Sub Prime collapse really affected poor and middle-class families, a tax break is not about to put much money in their pockets.  The solution may take us back to the 1930’s when the focus of Government had to be on creating real jobs.  Fortunately, real jobs in Western Canada are insulating Canada from the full impact of the situation in the U.S., but there may only be a 3 to 6 month delay.



Question

How does theoretical economics affect credit decisions?

Answer

  1. As we have seen in the recessions of 1991 and 2001, marginal companies in many sectors will be forced to file for protection because of liquidity problems caused by them failing to meet their financing covenants, or the bank not renewing their line of credit, or credit becoming more expensive.  A failure of a major buyer can cause a company to break its covenants and be outside of its margining limit.
  2. With publicly traded companies, the problems may occur, but at least there is disclosure required if public companies are not meeting forecasts or they are outside of their banking covenants or they are having difficulty renewing their lines of credit.  Furthermore, often the debt of these companies is rated and the company’s fortunes are followed by industry analysts.

By the time a credit manager gets the information, the company may already have a large exposure to the buyer.  As the situation deteriorates it may be difficult to bring the exposure down.  It is a question of timing, the poor results may not be reported for several months and during that period the exposure has been continuing to run.  The time between the disclosure of the problem and the reorganization may be very short as the buyer and secured creditors want to protect the assets.

  1. With private companies the problem is exacerbated, as it is difficult to even obtain financial information, let alone be advised in advance of developing problems.  Suppliers don’t know if sales are down, margins are being squeezed or there are problems with the bank.  If a credit manager can obtain Financial Statements, they provide a historical picture at best.  The effect of the recession is happening in real time, out of sight.

In summary, credit managers work with very imperfect information.  Time works against them in obtaining information and they have to often make credit decisions projecting 3 to 6 months ahead.  A recession in the U.S. affects many buyers, but in most cases, the credit manager can only guess at how much the buyer is impacted.



Question

Is credit insurance the answer to a credit manager’s prayer?

Answer

Not in every case!  By the time a credit limit is requested on a buyer, the writing may already be on the wall and the underwriters can’t increase their exposure.  This information in itself is useful.

In some cases, the underwriters may only be able to cover some of the exposure due to the credit evaluation or their current level of exposure.  Again, this is useful information.  In most cases, at least one of the underwriters will be able to approve the buyers.  When this happens, credit managers can sleep like babies knowing that they are protected from the unforeseen.  Once the credit limit is in place the underwriters monitor the buyer and they will advise you if problems are arising.

Underwriters can, and definitely will, cancel or reduce credit limits, but the cancellation or reduction only applies to future shipments.  They have no retroactive effect.  Your insured exposures remain insured.




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