Commercial Factor Q&A: Brad Magill Explains the Art and Science of Collections
To help explain how factors can improve their own collection efforts and, should those efforts fall short, navigate collections with a third party, Brad Magill, Esq., of The Collection Law Group, spoke with Commercial Factor in an exclusive Q&A.
In a perfect world, every factor’s clients would pay what they owe when they owe it. The unfortunate reality is that not every factoring relationship works like that. To help explain how factors can improve their own collection efforts and, should those efforts fall short, navigate collections with a third party, Brad Magill, Esq., of The Collection Law Group, spoke with Commercial Factor in an exclusive Q&A.
Magill, whose firm is a preferred vendor of the IFA, also conducted a webinar recently exploring numerous collection case studies. The full recording is available for purchase here.
What is the difference between the art of getting paid and the science of getting paid?
Brad Magill: The art part of getting paid is the intangible part of collections, meaning:
What is your general sense of the debtor?
Do you think the debtor is telling you the truth?
What is your general sense of debtor’s industry? Is their industry generally having problems?
There's no hard, concrete data to the art side of collections. It simply requires taking a common-sense approach.
On the other hand, the science part of collections is more concrete. It involves making sure all documentation for collecting is in place, including executed enforceable contracts, proof notices of assignment were sent and received, verifications are in place that are executed by authorized personnel at the account debtor, contracts have been read and have been adhered to, invoices are created in accordance with all contractual obligations, etc.
An example of art vs. science can be seen in a case study that involved a business that did street marketing that was affected by the COVID-19 pandemic. Obviously, there wasn’t anybody walking the streets, so their marketing got crushed. As a lender, you can understand that makes sense, but you still have to listen and verify to make sure the debtor is not telling you one thing and doing something else.
The science part of the above case study is figuring out if we have good underlying documents that are enforceable. Do we have good notices of assignment that are drafted by IFA attorneys, so we know they're enforceable? Do we have good written verifications that we know are enforceable? That's really the science part because if you have the hardcore documents in place, it is going to make collections much easier. The art part of the above case study is figuring out if it makes sense that the debtor would have payment issues based on the nature of their business and the surrounding circumstances and the science part is do we have concrete enforceable documentation.
One of the case studies that I didn't get to during the IFA webinar in January was one in which we had a great, properly-drafted notice of assignment that was sent to the account debtor. In this particular case study, it was sent to a wrong email address, so the account debtor never got it and the creditor never followed up to make sure the account debtor received it. In addition, in future communications with the account debtor, the creditor never sent another notice of assignment. So that's where the science falls out. The science part is more cut and dry. If you're going to enforce a notice of assignment, make darn sure that the account debtor receives it. How do you do that? There are email registration certification companies that you can engage inexpensively to make sure that your emails get to their intended destination. If you're going to send it via regular mail, use registered certified receipt. If you drop the ball on the science side, you're in trouble from the get-go when it comes to collections.
How does the constant fluctuations of the business world impact the difficulty of commercial collections?
Magill: For factors, there are two levels of collections: there's collecting as it relates to the client of the factor and then there are collections relating to the client of the factor’s client, otherwise known as account debtors. In factoring in general, capital is not provided based on the creditworthiness of the factor's client; instead, funds are advanced based on the creditworthiness of the account debtor. As long as the client has a reasonable financial past, they're going to get funded as long as there are no serious judgments or liens and they have quality, creditworthy customers.
What is a collection policy and why is it important for factors to have one?
Magill: The reason it's important is because collection policies work. They outline the skill sets needed for a collection team member, who they talk to, how they communicate with debtors, etc. It gives every single collection task a protocol so you know that if you do those things, you are doing everything possible to collect quickly and efficiently. Having a quality internal collection policy is important because it will help creditors maximize collections without the need to send every collection file to a third-party collector. Every reputable third-party collection firm only wants its clients to send collection matters to a third party after the creditor has exhausted every internal remedy. And the only way to do that is to have a collection policy checklist of what should be done for every collection account.
When should a factor look to a third-party collection firm for help when its own collection policy runs its course?
Magill: Most collection professionals adhere to a days past due approach to making a determination if a past due account should be escalated to a third-party for collections. At TCLG, we do not adhere to a strict past due approach to collection account escalation. Rather, we believe a better approach is to make a decision as to whether the debtor is communicating with the creditor in a meaningful way. If they are, then keep the matter in-house. If they're not, then get the file out to a third party.
What is meaningful communication? It is when debtors respond to your inquiries in a timely manner with real information being shared. It doesn't mean you reach out to them today and two minutes later you get a call back. But it does mean you except a return call within 24 to 48 hours with valuable information about when and how the past due amount will be taken care of. For instance, if the debtor says, "I know I owe this money, but I can't pay it and I don't know when I can pay it," that's not meaningful. A meaningful communication would be: "I know I owe this money. I can't pay it now, but I'm expecting to get X amount of cash in the next 30 days, and I will be able to enter a payment plan to pay back what is due then.” The next level of meaningful communication is then asking what would a payment plan look like, because if the payment plan is paying the money out over 20 years, well that's not meaningful. However, if the payment plan is paying the money out over 30, 60, 90 days, that might be meaningful. This is more of the art part of the process as opposed to the science part.
What is your company’s approach to collections?
Magill: What’s unique about our approach is all of our collectors are lawyers. We have a collection manager and sometimes our collection manager makes calls, but by and large, every collection matter is managed by a lawyer. Normally there are three types of places that a factor can send their collection matters to: a law firm, a collection agency, or a combination. TCLG is the combination.
There are a lot of law firms out there that don't like getting their hands dirty, so when a matter comes to them, the first thing they do is send out a demand letter: "You owe us this money." That's not what we do. The first thing I do is call the debtor directly, explain to them who we are and give them a sense of why they need to address the matter if they want to avoid further consequences, which will usually be litigation. At TLCG, we believe the fact that lawyers are making collection calls makes a difference because debtors realize the matter has been escalated and the creditor is no longer messing around.
When might litigation be necessary in a collection effort and how can factors avoid this outcome?
Magill: At TCLG, we are going to recommend litigation if all collection efforts have stalled (internal and external), we believe that the debtor is a going concern and the amount in controversy exceeds our minimum threshold. Being a going concern means the debtor is not intending to file for bankruptcy or to close their doors any time soon and they have the ability to stay open from a cash flow and operational standpoint. Litigation in a state or federal court is generally only appropriate when the amount in controversy exceeds $15,000 to $20,000. It generally does not make sense to litigate a matter for $1,000 because most of the fees will go to the lawyers, which means it does not make economic sense for the creditor. For example, if the collect matter is for a $1,000 matter and the lawyer handling the matter will earn a contingency fee of 35%, that means the lawyer would earn $350 on a $1,000 matter. For most hourly lawyers, that would mean they could only spend about one hour on the litigation to have it make economic sense, and the reality is litigation requires much more than one hour of a litigator’s time. So, litigation has to make sense from an economic standpoint for the client and the lawyer.
At TCLG, if we have a matter that we believe should be litigated, but the amount in controversy does not meet the threshold of what we think is appropriate, we will recommend that the client sue the debtor in small claims court, where it's a much easier process and they don't need a lawyer to initiate the action. In those cases, we're not going to be involved or receive any compensation, but we'll advise the client in terms of some of the nuances of initiating the small claims action.
In summary, when it comes to litigation, if we believe that the debtor's a going concern, the amount in controversy exceeds the threshold that we think is appropriate and the creditor has good documentation to document what transpired, the matter would be deemed appropriate for litigation.
Sometimes it may take some extra digging before litigation takes place. Let's say we have a situation where a debtor owes $100,000 and the notice of assignment is in place but there were no verifications, meaning the account debtor did not agree to pay the invoices without any set off or deduction. If such a matter came to us, we’d try to collect. If we contact the account debtor and they say, "The reason I'm not paying is because the goods that were delivered did not conform to the specifications that I required,” we're not going to litigate that matter because that's a question of fact that needs to be determined. If we did litigate that matter, it wouldn't be done on a contingency basis; it would have to be done on an hourly basis because the truth of the matter is we wouldn’t know if the client of the factor delivered goods or not. So that would be an example of when litigation might not make sense, at least from a contingency basis.
The other situation where litigation on a collection matter might not make sense is if the issue in question is a legal issue, such as if we have notice of assignment in place but there are other liens in place that gives the account debtor the actual or perceived right to take setoffs or deductions from what is due. It generally does not make sense to litigate a matter on a contingency basis where there is a of lien preference issue, but litigating this type of issue could be done on an hourly basis. But then the factor has to decide if they want to litigate and possibly spend lots of good money going after bad money. One of the advantages of litigation on a contingency basis is a client will know their legal fees are covered, but that is not the case when litigation ensues on an hourly basis.
Have factors such as rising interest rates and inflation had an impact on collection activity? If so, how and why?
Magill: Rising interest rates bring an interesting dilemma for factors. How are factors going to deal with the increasingly higher rates charged on their lines of credit? Are factors going to pass those increased fees on to their clients? I would imagine some may have to. Also, as it relates to clients, these higher fees, if charged, might make it more difficult for clients to pay, in which case internal and external collectors will have to work harder to avoid write-offs.
With a recession looming, how do you expect activity in the collection world to change this year?
Magill: The question basically comes down to what is the impact on collections in good times and bad, right? So, we're in bad times right now with inflation and higher interest rates. The interesting thing is that the collection business is really recession proof, although there's a caveat to that. In good times, let's say a client has 10 files a month that they might want to send to a third party. In good times, five of those will be really good files. In bad times, third party collectors may end up netting the same amount, but they may have to work on 15 files instead of 10 files to collect the same amount. So even though the collection business may in essence be recession proof, it just means that collection firms have to work a harder in bad economic times than in good economic times.