Chapter 6

Stayin’ on the Right Side of the Law: Knowing Your Rights and Duties

In This Chapter

Dealing with issues in bankruptcy

Complying with consumer credit laws

Avoiding debtor escape clauses in agreements

Drafting agreements to meet your needs

My dad used to say that a little bluff and bluster can win an argument — that it isn’t what you know so much as what the other side thinks you know. A little legal knowledge can give you the leverage (and sometimes the bluff) you’re looking for when dealing with customers who owe you money. (You’ll have to muster your own bluster.)

This chapter provides that bit of legal knowledge, covering federal law in some detail, and state laws in general terms. Use it to familiarize yourself with key legal issues and concepts and then refer to it as needed in the future. Indeed, you may even use this chapter to train your credit and collection staff on the basics of collection law.

As you delve into this chapter, you may think to yourself, “This book would make an awesome paperweight.” Collection and contract laws may seem boring, but . . . Okay, they’re pretty boring and technical. But your understanding of these laws is often front and center to your ability to collect a bad debt. And take heart: You don’t have to memorize everything in this chapter. You just need basic familiarity with legal concepts.

Basics of Bankruptcy and Receivership

The word “bankruptcy” conjures up all sorts of images that have one common thread: You, as the creditor, won’t be paid what you’re owed. Some folks use the word as a generic statement to argue that they’re uncollectible (“You can’t collect from me — I’m bankrupt!”). But it’s not a generic word. Rather, the term specifically refers to the filing of a bankruptcy petition in a federal bankruptcy court.

Bankruptcy offers debtors the opportunity to have a court grant them relief from their debts. Relief may come in a variety of forms, including full or partial discharge of the debt, or the imposition of a full or partial repayment program consistent with the debtor’s financial means. In receivership, an independent third party takes control of the debtor’s assets in order to manage and protect them for the benefit of creditors.

Types (chapters) of bankruptcy

The most common chapters (or types) in bankruptcy are Chapters 7, 11, and 13. A simple explanation of each chapter follows:

Chapter 7, straight liquidation: In a Chapter 7 bankruptcy, the debtor’s assets are divided into two categories:

• Exempt: A debtor’s exempt assets are protected in whole or in part from being taken to pay creditors. For example, exemptions protect formal retirement accounts, Social Security benefits, home equity, and some personal property. The rules of exemption are a bit tricky — exemption can be capped at different levels based on state law, and eligibility for an exemption may also depend on how long the debtor has owned the asset.

• Nonexempt: The debtor’s nonexempt assets are sold, or liquidated, and the cash proceeds are given to the bankruptcy trustee for distribution to creditors (the trustee being an individual appointed by the court to oversee that process).

Taxing authorities, former employees, and secured creditors (check out the information on filing liens to become a secured creditor in Chapter 3) get the lion’s share of the cash generated by the liquidation of the debtor’s assets. General unsecured creditors (creditors without liens) get very little, if anything. In bad economic times, most Chapter 7 bankruptcies are filed as no-asset cases, meaning that unsecured creditors get zilch.

Chapter 11, business reorganization: Sometimes a business that’s in financial trouble will want to try to stay in business, rather than go through liquidation under Chapter 7. The bankruptcy court allows the company to stay in business and to remain in possession and control of its assets, while implementing a plan to repay creditors based on the debtor’s assets and income.

A creditors’ committee is appointed to help the debtor determine what a reasonable repayment plan would be. After the repayment plan is drawn up by the debtor and the creditors’ committee, a proposal is made to creditors in writing. If you, as a creditor, have filed a proof of claim in a Chapter 11 bankruptcy, you’ll receive a proposed plan of arrangement, and you get to vote on it. If more than half of the unsecured creditors in number (more than half of the total number of creditors) and amount (creditors representing more than half of the total debt owed) approve the plan, it becomes binding on the debtor. As long as payments are made according to that plan, the debtor can remain in business.

Chapter 13, wage earner bankruptcy: This form of bankruptcy is similar to a Chapter 11 reorganization, but is limited to wage earners or nonbusiness entities. An ordinary individual or married couple with regular income, whose unsecured debt isn’t outrageous, can file Chapter 13 and enter into a repayment plan very similar to the plan described for Chapter 11.

The Chapter 13 debtor files a plan to repay a specified amount or percentage to unsecured creditors over a specified period of time, usually from three to five years, depending on the debtor’s monthly income.

Some bankruptcies are filed by creditors who gang up on the debtor when payments to those creditors are substantially delinquent. This is referred to as an involuntary petition. On the other hand, when the debtor files a petition for bankruptcy, that’s considered voluntary. Involuntary bankruptcy can occur under Chapters 7 and 11, but not under Chapter 13.

Features of bankruptcy

Bankruptcy operates in its own little world. It has its own court system and its own terminology. A bit of familiarity with bankruptcy jargon and procedures can be helpful. What follows is just the tip of the tip of the iceberg.

Automatic stay: The filing of a bankruptcy petition triggers a 120-day period during which creditors may take no action against a debtor or the debtor’s property. Under some circumstances, you may be able to get a bankruptcy court to grant relief from the automatic stay, but without court permission a violation can trigger contempt sanctions.

Filing a proof of claim: When you receive a notice of bankruptcy, stop your collection activity and file a proof of claim. By doing so, you will receive a dividend or a payment equivalent to what other unsecured creditors will receive. If you don’t file a proof of claim, you probably won’t receive additional notices or a dividend. There is an exception, however: The notice for a Chapter 7 no asset bankruptcy case will instruct you not to file a proof of claim because the debtor has no assets.

Preference payments: A preference is money paid to a creditor on the account while the debtor was insolvent and within 90 days of the bankruptcy filing. If you receive payment under those circumstances, the bankruptcy trustee may demand that you repay the preference amount. If you haven’t made any special deal with the debtor and he owes you the money, repaying the preference amount may not seem fair. But the theory is that a bankrupt debtor can’t pick and choose which creditors he wants to pay. (Besides, more often than not you won’t be the lucky creditor who receives payment, and it will somehow seem fairer that the money goes back into the pool.)

Getting stuff back from the bankrupt debtor: Within 45 days of a bankrupt debtor receiving your product, you may be entitled to demand its return if

• The sale was an ordinary sale that occurred while the bankrupt was insolvent, and

• You make your demand while the debtor is still in possession of those goods

After the debtor ships the goods to one of its customers, you lose the right to reclaim your product.

When you have the right to do so, make a written demand for the return of that product. As a practical matter, telephone the debtor first to let it know that the demand is forthcoming and then follow up with a written note.

Creditors’ committees: In some large bankruptcies, primarily Chapter 11’s, creditors’ committees are formed of the five or seven largest unsecured creditors. If your company is one of the larger creditors, you may receive a notice and an opportunity to sit on the creditors’ committee. Membership on a creditors’ committee is entirely optional and voluntary.

Dischargeability and nondischargeability: Some of the debts of a bankrupt debtor are dischargeable, and others are nondischargeable. Typical dischargeable debts include ordinary trade debt, ordinary credit card debt, utilities, unsecured bank loans, and other forms of unsecured debt. The debtor doesn’t have to pay any portion of a debt that’s discharged. The bankruptcy trustee reviews the debtor’s estate to identify assets that are nonexempt and thus can be used to pay creditors. When a dispute arises over dischargeability, either by a creditor who’s trying to recover money from additional assets or by a debtor trying to preserve additional assets, a complaint may be filed with the bankruptcy court asking the judge to determine if an asset is exempt.

Other forms of debt just never go away, and these are nondischargeable. The government, for example, gives itself a great deal of protection from bankruptcy. Taxes, court fines, and student loans are usually nondischargeable debts because they are due to or guaranteed by the government. Other examples of nondischargeable debts include child support and debts resulting from fraud or malicious acts taken against persons.

If you have a debt that you believe is nondischargeable, you may benefit from consulting a lawyer about filing a special action within the bankruptcy court to declare your debt nondischargeable. If the action succeeds, the debtor will still have to pay the debt, even after bankruptcy.

Reaffirmation and redemption agreements: Sometimes a debtor wants to keep secured collateral, such as a car or house that is subject to a lien or mortgage. Reaffirmation and redemption agreements allow the debtor to pay part or all of a debt owed to a secured creditor in order to keep the collateral.

• In a reaffirmation agreement, the debtor agrees to keep making payments on the loan in order to keep the collateral. Sometimes the terms of the loan are modified.

• In a redemption agreement, the debtor agrees to pay off the balance owed in order to keep the collateral. If the amount owed exceeds market value, redemption may occur after a motion with the court to permit redemption at market value.

Dismissal of a bankruptcy proceeding: Sometimes debtors file bankruptcy to get creditors off their backs. After the immediate pressure from creditors is removed, bankruptcies are sometimes quietly dismissed. Unless you were sent notice of the bankruptcy or otherwise are on the mailing list (called a matrix), a dismissal may occur without any notice to you. Dismissal lifts the automatic stay, permitting you to proceed against the debtor as if bankruptcy had never been filed.

The Bankruptcy Act is about a million pages long and includes about a million incomprehensible terms. Instead of trying to figure out the ins and outs of the law, your best bet is to file a timely proof of claim, wait, and see what happens. If you feel you have a special cause of action, such as fraud or the right to get your stuff back, consider talking to a bankruptcy attorney.

Verifying that your debtor has actually filed bankruptcy

A lot of debtors claim they’ve filed for bankruptcy when in fact they haven’t. They just want you off their back.

You have the right to follow your debtor’s bankruptcy case and to review schedules of assets, liabilities, and all written orders and other events that occur during the case. Following the case lets you know that your debtor has in fact filed for bankruptcy or that the case hasn’t quietly been dismissed.

Set up an account with the federal bankruptcy court through the U.S. Bankruptcy Courts’ Web site (www.uscourts.gov). Click “Electronic access to courts,” and follow the instructions to set up a PACER (Public Access to Court Electronic Records) account. Access to court records through PACER is simple, fast, and cheap, and allows you to easily determine if a bankruptcy was filed and its current status. In less than five minutes you can log in and find out about any bankruptcy filing. Use the notice from the bankruptcy court, or ask your debtor what name was used for the bankruptcy and what case number it was assigned. PACER will give you the rest.

Similarly, bankruptcies are tracked by Internet credit report providers such as Accurint (www.accurint.com) and Autotrack (www.autotrack.com), and may appear in their reports. Although they charge fees, setting up an account with either company will give you access to a great deal of information.

If the debtor has filed bankruptcy, you must stop your collections against the bankrupt or you’ll be accused of (and may be fined for) violating the automatic stay. Check with your collection attorney for counsel as to whether you may proceed with collection when your debtor claims that it filed for bankruptcy or has received some other form of legal discharge of a claim (such as a state or federal receivership).

Receivership

Although less common than bankruptcy, you may encounter situations where your debtor’s assets are under receivership. A receivership is set up to protect a debtor’s assets for a specific purpose, such as during the course of a foreclosure action. The creditor may ask the court to appoint a receiver to protect its interest in the debtor’s assets (for example, in a foreclosure, the assets would include the land, buildings, fixtures, and so on) until the action is resolved.

In appointing a receiver, the court accepts the creditor’s argument that the debtor can’t be trusted to preserve and maintain the value of its assets until the legal proceedings are over. The court then appoints an independent person, the receiver, to “receive” the debtor’s assets on behalf of the court and to exercise possession and control of the assets until the court ends the receivership.

Basics of Product Sales and Leases: The Uniform Commercial Code

Much of the law addressing ordinary business transactions — the daily buying, selling and leasing of goods and products throughout the country — is governed by one uniform law, the Uniform Commercial Code (UCC). So if you conduct business across state lines, you don’t have to worry about local commerce laws. How cool is that? Although the UCC is a state law (as opposed to federal laws that automatically cover the whole country), it’s been adopted by all 50 states.

The discussion in this section has to do with the UCC, which applies around the country in every state where you do business. (You’ll find some minor differences in the UCC between states, but none that are relevant to this chapter.)

When customers who owe you money nitpick your bills and look for any excuse not to pay, often their excuses can be dealt with and even refuted by reference to the UCC. Even if it turns out that a debtor is right on the money about an objection it raises, having this knowledge at your fingertips helps you deal with the objection head-on.

Product not as ordered, or not authorized

The UCC requires sellers to furnish conforming goods, goods exactly as ordered by the buyer. Any shipment of goods must be made according to the buyer’s authorization, a purchase order, or a verbal request for the product.

But that doesn’t mean that small errors will cost you the money you’re owed. Even if the product sold or leased wasn’t exactly what a buyer ordered, or if a buyer didn’t authorize a delivery of goods, you may still be able to successfully collect your bill for the delivery:

Ratification: If the buyer doesn’t return the goods it claims it didn’t order, the buyer must still pay for them. (Special rules apply to consumers who receive shipments of goods they didn’t order; if in fact no order was made for the goods shipped, they may be able to keep the goods without making payment.)

Acceptance: If the buyer fails to reject or return the goods in a timely manner, despite any nonconformity of the shipment, the buyer may be held to have accepted the goods. Under the UCC, goods that are accepted by a buyer must be paid for.

Delays in notification of any defects

If the value of a particular shipment is impaired (for example, a product arrives in damaged condition), the buyer must promptly inform the seller that the shipment isn’t acceptable. How promptly? That depends on the nature of the goods you sell and the practices of your industry, but generally, such communications should take place within a reasonable time of when the buyer knew or should have known about the defect. You must follow up by determining if the buyer’s claims are valid, and you need to take appropriate steps to remedy the problem, such as by replacing the defective product or accepting its return.

For example, your company ships goods in February, bills for them in March, and follows up with statements in April, May, and June. When met with a stern collection call, the buyer complains about the quality of those goods. Under the UCC, its objections are too late.

The Uniform Commercial Code requires a buyer to promptly reject a delivery. Quality problems raised for the first time in response to a collection call some 90 to 120 days later, after the buyer has failed to pay for the goods, aren’t considered timely.

The only instance where a buyer can rely on a delayed rejection is referred to as revocation of acceptance, where the buyer relies on you to cure or fix the defects in the delivery and you fail to do so. How does this work in practice?

Following a shipment of goods, you or somebody else at your company assures the buyer that any defects will be resolved through repair, replacement, or a credit. If your company doesn’t keep that promise, the buyer has the right to later revoke its acceptance of that delivery. However, even under this scenario, in order to exercise that right the buyer must bring the issue to your attention within a reasonable amount of time after any defects are discovered or should have been discovered.

Problems with shipment

Your debtor declares, “The goods never arrived, so I don’t have to pay for them.” Uh oh, sounds like a headache looming. But maybe not. When the goods were placed in possession of the shipping company, delivery is presumed, particularly when the shipping documents show the items were delivered. As the seller, your solution is to secure the delivery documents from the shipping company.

Shipping information is often available online. For example, goods shipped through UPS can be tracked online (www.myups.com) for delivery information, including the recipient’s signature. You can cut to the chase on claims of nondelivery by printing out proof of delivery and attaching it to your invoice.

What if your debtor complains, “You didn’t ship the goods the right way, the way I expected.” It doesn’t matter. Under the UCC, as a seller, you can use any reasonable substitute as long as the goods arrive on time. As long as there’s no material delay or actual loss of the goods, you have upheld your end of the bargain.

Forced to purchase from another supplier

Your customer claims that the goods you shipped weren’t conforming and declares, “I had to buy product from another supplier, so I’m not paying for your stuff.” Not so fast. Under the UCC, before your buyer can purchase replacement goods from another vendor and use that as a defense for nonpayment, two things must happen:

Your buyer must notify you that there was a problem with the product you delivered.

You must fail to provide a timely fix (cure) for the defects.

If after receiving proper notice you fail to fulfill your duty to cure, in addition to not paying for the shipment, the buyer can sue you for damages in the amount of the difference between the contract price and their costs of the substitute goods.

As the seller of products, you have an obligation to deliver, on a timely basis, goods that aren’t defective and that comply with the order.

Expired claim(s)

What if your debtor declares, “You waited too long to try to collect. I’m not going to pay you because I have no legal obligation to do so.” All claims arising from business agreements have an expiration period. Under the UCC, for the breach of a contract for the sale of your product, the expiration period (statute of limitations) is four years. Note that by contract, for commercial sales the UCC permits parties to a sale of goods can reduce the period of limitations to not less than one year, but they may not increase it.

Obviously, a creditor that waits more than four years to bring a lawsuit involving the sale of goods is likely to be met with the statute of limitations defense. Although technically the debt is still owed and collection demands may continue, after that defense is raised, the lawsuit won’t hold up in court. In most cases, that’s the end of the collection.

The UCC isn’t the only legal code that includes a statute of limitations, and time limits can vary by industry. For example, federal law requires that claims for charges or refunds of overcharges in the freight industry be brought within 18 months of the date the claim accrues, normally the date of shipment. Be sure you understand the laws that apply to your industry, even if it takes paying for a session with a lawyer to be coached.

Price and/or delivery terms

Your customer declares, “I’m not going to pay because you never told me the price you were going to charge or the terms of delivery.” Sure enough, no price or delivery terms were agreed to when you and the customer entered the agreement of sale. Did your blood pressure jump? Relax. Your customer’s wrong, and he still has to pay.

A seller and buyer don’t have to arrive at price or terms as part of an agreement to sell product. Although the agreement does have to include a description and quantity to be purchased, price can be presumed based on

A reasonable price at the time of delivery for those particular goods

Prices charged in the past to that customer for similar goods, or

Whatever the industry’s standard or market price is

Absent an agreement on delivery terms, the UCC presumes a buyer will pick up goods or arrange for delivery.

Even though the UCC doesn’t require it, including the price and delivery terms in your agreements is a good idea. Clarity and completeness of agreements help you avoid problems with your customers.

Warranty issues

Your customer complains, “You haven’t honored your product warranties, so I’m not going to pay you.” Imagine that.

A funny thing about buyers: They expect products to arrive in working order and to operate. If products are defective and break down, they refuse payment and demand immediate warranty service to boot.

A seller of goods must honor any express or implied warranties on its products:

Express warranties are those that are part of an agreement, usually in writing and prepared by the seller.

Implied warranties are warranties required to be honored by a seller under the UCC unless waived by the words as is or with all known defects. The two UCC implied warranties are

• Merchantability: Goods must be reasonably fit for the purpose for which they are sold. For example, a wood screw that fails to screw into ordinary wood violates the warranty of merchantability.

• Fitness for a particular use: The item fails to meet the standards a seller promised it could meet. For example, a seller promises its wood screws are strong enough to screw into a hardwood if predrilled, and they fail to do so.

What happens if the buyer hasn’t paid for that product when the defect is found? The seller refuses to honor the warranty until the buyer pays for the product, putting itself at risk for the original shipment plus the cost of repairs. But the buyer doesn’t want to pay until the goods are fixed, putting itself at risk for having paid for goods that aren’t repairable or that the seller fails to repair. You end up in a “which came first, the chicken or the egg” situation.

The UCC doesn’t provide a clear answer to this common issue. However, as a matter of good business practice, a seller is wise to fix a broken product and then worry about getting paid.

Leasing companies face unique issues concerning warranty claims where they are only sources of financing for the transaction, and are not manufacturers of the goods. The UCC provides that leasing companies may waive any obligations to the lessee that could be raised against the manufacturer. If a lessee defaults on the lease payment plan and starts making claims of defective goods, the leasing company has no further obligation, and the lessee must look exclusively to the manufacturer for all warranties and other remedies concerning the product itself.

Unfair terms in agreements

Your customer decides that the terms of a sale are unfair: “Your contract is overbearing, and I’m not going to honor it.” For transactions between commercial businesses, courts pretty much give free rein to the parties to contract for whatever they want. But what about consumer transactions, in which the goods you provide are primarily personal or household use? If your debtor is a consumer, she may raise a defense of unconscionability about a contract or a particular clause in a contract, contending that the contract provision is overreaching, oppressive, or “shocking to the conscience.”

Unconscionability claims usually arise in a situation where one party has a huge negotiating advantage over the other, such as a credit card or bank contract where the bank establishes the contractual terms and the consumer must either accept them or reject them without modification. There really is no negotiation. It’s simply “take it or leave it.” If a court finds that a consumer contract includes strongly unfair terms, it may refuse to enforce those particular terms as unconscionable. However, although a specific clause may be unfair, it’s rare that a court will toss out the entire contract over one unfair clause. In most cases, apart from the objectionable clause, the contract remains binding.

Understanding the Fair Debt Collection Practices Act (FDCPA)

The Fair Debt Collection Practices Act (FDCPA) is a key federal law that applies to debt collections. As a federal law, the FDCPA applies in all 50 states. The FDCPA has two primary limitations:

The FDCPA applies to collections of personal, household, or consumer debts, not commercial collections.

The FDCPA applies to third-party debt collectors, not individuals or businesses collecting their own debts.

When figuring out whether the transaction underlying a debt was a commercial or consumer transaction, ask yourself this question: Were the goods you (or your client) provided personal or household in nature? If they were, the act applies. If they weren’t personal or household, the debt is commercial, and the FDCPA doesn’t apply.

If you or your company is trying to collect your own debts, the act doesn’t apply. Under the FDCPA’s provisions, a debt collector is in the business of collecting debts owed to another. If you are a collection agency or a collection attorney, the act applies to you. If you are collecting your own debts, it doesn’t. (But similar state laws may still apply, so be careful.)

Even if you’re trying to collect on commercial debts, or you’re making collection calls for yourself or your company, we suggest that you read the following sections anyway. You may not have to follow the FDCPA, but it contains some good guidelines that you can apply to all debt-collection efforts.

Communications with third parties

Under FDCPA, a debt collector may not contact any third parties (the debtor’s relatives, friends, people who live in the debtor’s home other than possibly his spouse, the debtor’s employer, the debtor’s bank, and any other third parties) to discuss the debt. The only exceptions are

Communication with the debtor’s attorney

Communication with a consumer reporting agency

Communication with a third party when it’s reasonably necessary to enforce a judgment

Communication with a third party when the debtor has given permission for the communication

The only exception to these restrictions is that third parties may be contacted to verify where the debtor resides, but in the context of such communication, the collector may not mention the debt itself.

You should be cautious when you leave messages on voice mail or any kind of recording system when calling a debtor. Because such a recording could be heard by a third party in violation of the FDCPA, leave just your name and phone number and politely ask for a return phone call.

The key with leaving messages on recording devices is to omit any indication that you are calling to collect a debt. Interpret this rule broadly. If the name of your company includes words such as “Acme Debt Collection,” don’t leave your company name on the recording device because it will notify a third party of your intent to collect a debt, violating the FDCPA.

If you receive permission from the debtor to contact third parties, confirm that permission in writing with a quick e-mail, fax, or letter. That way, if the matter goes to court, you have evidence that the debtor gave you permission.

If the debtor is represented by an attorney, contact only the debtor’s attorney. Cease all direct contact with the debtor unless you first receive written permission to deal directly with the debtor.

Abusive language or threats

Whether or not the Fair Debt Collection Practices Act applies to you, refrain from using abusive language, threats, or harassment. Harassment and abusive language directed at debtors are generally not allowed and are always unwise because they

Violate laws protecting consumers: Such acts violate the FDCPA as well as additional consumer protection laws that exist in virtually every state.

Compromise your professional standards: Bad conduct reflects a lack of professionalism and, further, is generally not even effective in the collection of debts.

May go on your permanent record: When you communicate with a debtor, assume that the debtor is recording all contact and keeping copies of all communications. Phone calls can be recorded with the touch of a button. Even if you don’t break the law, you may be red-faced in court when your atrocious conduct is presented for a judge or jury, potentially shattering both your image and your credibility.

So what type of conduct is out of line? Screaming and swearing, obviously. But what constitutes a threat or harassment? Some common examples:

False or misleading statements: Misleading statements, including the threat of a lawsuit when you have no intent to sue, violate the FDCPA. Bottom line: Always tell the truth.

• Even an innocent mistake such as using the word “plaintiff” when no lawsuit is pending violates the FDCPA.

• It’s a violation to use the word “versus,” such as “your company versus the debtor,” in a letter to the debtor when no lawsuit is pending.

• Do not use any deceptive forms or letterhead designed to misrepresent who you are, such as implying that you’re a collection agency, a collection law firm, or a collector for the government — unless you are!

• No attorney letterhead can ever be used unless the attorney was actually hired and has reviewed the file.

• Never send anything to a debtor that looks like or could be mistaken for an official court notice. That’s a misrepresentation under the FDCPA.

The courts operate on a standard of the “least sophisticated consumer” when determining whether the customer was fooled or misled, or whether you made a misrepresentation. If your communication can be interpreted as a misrepresentation, it will be.

Threats to a debtor: In an extension of the rule “Always tell the truth,” never threaten a debtor unless you intend to carry out your threat. And never make an unlawful threat.

• Threats of physical harm: Does it need to be said? Never, ever threaten your debtor or your debtor’s property with harm.

• Threats of prosecution or jail: Never threaten prosecution, jail, or fines by the state. Even if you believe your debtor could be prosecuted over a bad check, don’t say something like, “The state is going to fine you $500, and you are going to spend two years in jail,” because you have no idea whether that’s true, and it’s a violation of the FDCPA.

• Other threats: Some threats are legal, but only if you intend to follow through. If you have no intent to follow through, even a threat to file a collection lawsuit violates the FDCPA.

Harassment: You need to be persistent and aggressive in collecting your debts, but don’t engage in harassment. Under the FDCPA, making multiple phone calls to the same debtor over a short period of time may constitute harassment. Don’t do that. Similarly, you may not threaten to publish a list of nonpaying debtors, nor may you advertise a debt for sale in order to coerce payment.

Don’t violate the FDCPA. Acts of harassment, abuse, misrepresentations, and other unfair collections practices will be held against you, and you can expect to be hit with fines and attorney fees.

Telephone calls: When and where

The FDCPA imposes some specific restrictions on your collection phone calls to debtors. Follow these guidelines:

Collection calls should be made during normal business hours to avoid harassing the debtor.

Normally, calls should be made between 8 a.m. and 9 p.m. However, if the debtor indicates in writing that he would prefer to be contacted at another time (he works nights for example), then you must respect that request to avoid harassment under the FDCPA.

If you are told in writing not to contact a debtor at work, you must stop calling the debtor at work.

Even on the phone, communications governed by the FDCPA must include the warning that you are “a debt collector attempting to collect a debt.”

Good practices under the FDCPA

If you’ve read the preceding sections, you know whom you can and can’t talk to, when and where you can contact a debtor, and what you absolutely should not do or say, according to the FDCPA. In addition to those rules, keep the following standards in mind:

Whether you’re subject to the FDCPA, or someone who just wants to be cautious enough to comply with the FDCPA when collecting debts, all written and verbal communications should state that you are a debt collector. If verbal, just say those words as part of one of your sentences: “Hi, I’m John Smith, and I’m a debt collector.” If in writing, include it in one of the sentences in the letter: “Our office is a debt collector.”

You may make demands for valid debts, even if it’s too late to sue on them (beyond the statute of limitations), but be careful not to threaten litigation. Because the claim has legally expired, a threat of litigation violates the FDCPA.

Don’t accept checks postdated by more than five days unless you notify the debtor in writing of your intent to deposit the checks. Your notice should be made not more than ten days nor less than three business days prior to the deposit.

If your debtor requests it, stop all communications concerning the debt except to inform the debtor that you may file suit. In other words, if you’re told to stop collecting and the FDCPA applies to you, with the exception of sending one more letter to the debtor that you may file suit, you must stop collecting the debt. And even for that exception, you can only imply that you’ll file suit if you do, in fact, file suits on your claims.

If you sue, you must file your lawsuit in a court at the location where the debtor resides (this is further discussed in Chapter 15).

If you file suit, with the exception of statutory amounts such as attorney fees authorized by state or local law, don’t claim any damages in the suit that aren’t specified as part of the contract because that will be misleading.

Be sure to maintain proper procedures for compliance with the FDCPA, as we’ve outlined in this chapter. By following proper procedures, you create a defense if you’re accused of violating the FDCPA because it shows the lack of intent to violate the law.

Using the required form language

You should adopt the form letter shown in Figure 6-1. Its use will avoid any violations of the FDCPA in your first written communication with a debtor. If your first communication with the debtor isn’t in writing, this letter should be sent within five days of your initial conversation. Basically, when the account becomes delinquent, send the letter. You can find a template of this letter on the CD that accompanies this book as Form 6-1.

Complying with state laws: Consumer protection acts

Your full compliance with the FDCPA goes a long way toward ensuring your compliance with state consumer protection laws. In fact, many state consumer protection laws are patterned after the Federal FDCPA. Even if you don’t think it applies, it’s wise to tailor your collection calls and letters to comply with the FDCPA. As they say, it’s better to be safe than sorry.

Most state laws protecting debtors cover only a third party collector that is collecting consumer debts. However, either by their language or as a result of court decisions, some state laws encompass additional collections activity, possibly including in-house debt collection. It’s important that you understand the collection laws of all states in which you attempt to collect debts.

Complying with the Fair Credit Reporting Act

The Fair Credit Reporting Act (FCRA) is the federal statute that keeps the “big three” credit reporting agencies in line: Equifax, TransUnion, and Experian. The odds are that each of these companies maintains a credit report on you and on most or all of your customers. If you have a contract with any of the big three to report credit information, make sure that

Your reports of credit information are accurate and that all disputes are noted.

You understand and follow the credit reporting agency’s guidelines for reporting delinquent debt.

You’re prepared to answer any questions about a debt if a credit reporting company asks you to verify that a debt was delinquent.

You promptly investigate any disputed information submitted by a consumer. You typically must investigate and report back within 30 days. Get right on it.

Failure to investigate a dispute can violate the FCRA, potentially triggering fines of up to $1,000, plus punitive damages and attorney fees. These sums can be significant, and awards can amount to tens of thousands of dollars or more if violations are willful. A lawsuit may be brought to enforce the FRCA as much as five years after the date of a violation.

Negative credit information, including delinquencies, bankruptcies, tax liens, and court judgments, go on a consumer’s credit report. Negative entries may motivate a debtor to contact you to make arrangements for payment. At some point in their lives, many debtors try to clean up their credit by paying off or making settlements. So don’t be surprised if, several years after you obtain a judgment that you’ve long deemed uncollectible, you get a call out of the blue from a debtor offering you money to settle the debt in order to improve his credit.

The Fair and Accurate Credit Transactions Act (FACTA) is an amendment to the Fair Credit Reporting Act and provides that consumers may receive one free credit report per year. Thanks to this act, your consumer debtors probably know whether you’ve reported them as bad credit risks.

Following the Requirements of the Equal Credit Opportunity Act

The Equal Credit Opportunity Act (ECOA) is yet another federal law, applicable in all 50 states. The ECOA applies primarily at the point where you extend credit, as opposed to when you’re collecting unpaid debts.

At the point of extending credit, give all credit applicants a fair opportunity to get credit terms. Never discriminate against any applicant on the basis of race, color, religion, national origin, sex, marital status, or age (except for applicants who are below the age of capacity, usually 18 years of age). (See Chapters 2 and 3 for more on extending credit.)

A common, subtle violation of the ECOA is to require a spouse to co-sign an application for the extension of credit. If either the husband or wife standing alone is creditworthy, your company can’t require the spouse’s signature. This is a touchy area because when it comes time to collect on a delinquent account, the primary asset owned by a husband or wife is typically the marital home. Because the marital home can’t be attached without first obtaining a judgment against both husband and wife, this creates a conundrum for creditors: “Do I violate ECOA if I require both husband and wife to sign to make sure I have a shot at collecting against the value of the marital home if the borrower defaults and I need to sue?”

Allow a spouse to individually apply for credit. The other spouse shouldn’t be asked to co-sign unless the first spouse doesn’t qualify for credit, or unless you’re extending credit to a business and the other spouse is active in the business. If you’re extending credit to a company and both husband and wife are officers of the company, you may request both spouses co-sign any personal guarantees.

Obeying Truth in Lending and Fair Billing Laws

If you’re a bank, retailer, bank card company, credit union, or other financial business that extends credit to consumers, tune into the Truth in Lending Act (TILA), another federal law applicable in all 50 states. TILA governs credit installment agreements and requires complete disclosure of all terms of credit, such as how much interest is going to be paid over the life of the loan.

A typical TILA disclosure for a loan or lease agreement specifies the amount that you have financed to the customer, the number of payments the customer is obligated to make, the amount of the payments, the interest rate, the annual percentage rate (APR), and how much total interest will accumulate over the life of the loan.

Keep in mind that TILA and state laws allow consumers to back out of (rescind) certain consumer loans, such as home improvement contracts, within three days, not including Saturdays, Sundays, and public legal holidays. Don’t put a loan on your books until the three days has run.

A handy form for compliance with TILA requirements is included on the CD that accompanies this book as Form 6-2.

Respecting Privacy Requirements

As you accumulate credit data on your customers, it’s important that you keep that information confidential. Several federal laws protect the confidentiality of consumer information, such as health or medical records and Social Security numbers. These laws include

The Health Insurance Portability and Accountability Act of 1996 (HIPAA): Federal legislation that created national standards to protect personal health information.

The Patient Safety and Quality Improvement Act of 2005 (Patient Safety Act): A federal law meant to encourage the sharing of information of events that harmed, or could potentially harm, patients while assuring confidentiality of any reports made.

If you send out a copy of someone’s application or other document containing confidential data, be sure to black out her Social Security number and other confidential information. Similarly, after you’re done with a consumer’s credit information, destroy it.

A Quick and Dirty Contract Law Reference

A solid understanding of contract law will give you confidence in your dealings with your customers and debtors, both in relation to entering and enforcing your agreements. You certainly don’t want to be bluffed into agreeing to something that’s against your interest or giving away rights that you should have.

Everything you wanted to know about contract law but were afraid to ask? That’s a bit more than we can fit into this chapter. But we can at least cover some important basics.

Understanding contract basics

The five essential elements to a contract are offer, acceptance, consideration, mutuality, and legality. The process of negotiating a contract starts with the offer, an invitation to enter into a binding contract. The person making the offer is the offeror, and the person receiving the offer is the offeree.

The contract process starts when the offeror makes an offer to the offeree. Each party offers consideration for the deal, value that supports their promises. If the offeree accepts the offer, the parties mutually agree to the terms of the deal, and if the subject matter of the contract is legal, you have a contract.

Acceptance occurs when the offeree states either that the offer is accepted or takes action that indicates acceptance. Typically you want to accept in an unambiguous manner. If you want to accept an offer but you’re unsure how to do so, simply use the same mode of communication that was used to convey the offer. For example, if the offer came by mail, accept with a letter.

The offeror may limit the amount of time the offer is open. If no time limit is set, the offeree has a reasonable time to accept. An offer usually can be withdrawn (revoked) at any time before it’s accepted. Common exceptions:

Contractual limitations: Your contract requires you to keep the offer open. For example, the offeree pays to keep the offer open a specified time.

Legal restrictions: The law requires you to keep the offer open. For example, certain restrictions are imposed on merchants under the Uniform Commercial Code. A statement in writing that “the prices in the enclosed catalog are good for the next 60 days,” signed by the owner, is a firm offer that can’t be revoked during the 60 days.

Consideration is the bargained-for exchange, value for value. In most business contracts, consideration to the offeror is the promise to pay money for the offered goods or services, and the promise of delivery of those goods or services is the consideration to the offeree. It’s not ordinarily a defense that somebody didn’t negotiate a good bargain as long as an exchange occurred.

Mutuality refers to the fact that both parties are bound to do something, or to permit something to be done, for the contract to be valid. For written contracts, this concept has faded somewhat in modern jurisprudence. It’s now most likely to arise in the context of a claim of an implied contract, where one party claims that a course of conduct or dealing with the other party creates a contract, but the other party denies the existence of a contract.

Legality concerns whether the subject matter of the contract is legal. You can enter into what looks like a valid contract for the purchase of crack cocaine from a street dealer, but the subject matter of the contract is illegal (the sale of crack cocaine is a crime), so no court will enforce the contract. A more likely example involves new national security legislation that forbids the international sale of certain computer technology. A contract for the sale of those chips, even though valid prior to the passage of the new law, could afterward become unenforceable on the basis of its illegality.

Making it clear who you are contracting with

It’s common sense, but still is sometimes forgotten: When you enter into a contract you should be clear on who the contract is with. For you, there can be no mistake, right? You start every business relationship with a credit application so you know, right off the bat, exactly whom you are dealing with (see Chapters 2 and 3).

But what happens if a wealthy customer contacts you and wants to buy some expensive machinery. You think you’re dealing with the customer as an individual, but maybe he’s planning to make the purchase through a corporation. If you’re about to close the deal and suddenly the customer wants the invoice made out to his corporation, make sure the business entity is creditworthy or get a personal guaranty. For reasons discussed in Chapter 2, if you aren’t careful, you may find yourself dealing with a deadbeat corporation and have no recourse against its wealthy owner.

Make sure the names on all contracts and other business documents, including purchase orders, credit memos, and debit memos, match and conform to the names on the customer’s credit application.

When oral contracts are legal

An oral contract (sometimes also called a verbal contract) is one that isn’t in writing. It’s a handshake deal. Most business contracts are verbal.

Every state has a law, called a statute of frauds, that requires certain contracts to be in writing and signed by the party against whom enforcement is sought. These statutes can vary a bit from state to state, but they apply in only a few circumstances. Typically those circumstances are

Real estate: Sales of real estate, or any interest in land, must be in writing.

Sales of goods of more than $5,000: Agreements for sale must be in writing unless the goods are shipped and received, in which case no written document is needed.

Suretyships and guarantorships: Promises to answer for the debts of someone else must always be in writing.

Contracts that can’t be performed in one year or less: The operative word is “can’t.” If your contract calls for a monthly delivery of goods for the next six years, it can’t be performed in less than six years. If your contract requires a single shipment, stalling on delivery won’t allow you to avoid your obligations.

Prenuptial agreements: Agreements between prospective spouses regarding the distribution of marital assets if they eventually divorce must be recorded on paper.

The term “statute of frauds” is a bit archaic. Basically, the statute is intended to prevent fraud. If you hear a lawyer declare, “That contract is void under the statute of frauds,” he’s not saying that you committed fraud. He’s just arguing that under the law, the contract you’re trying to enforce should have been made in writing.

Why written deals are better than oral ones

Your handshake deal is legal, so why does everybody tell you to “get it in writing”? That “if it isn’t written, it doesn’t exist”? The two main reasons are

Memories fade: You may have a very clear understanding of your agreement at the time you shake hands or hang up the phone, but what will your memory be in six months? What will your customer’s memory be? You may both, in good faith, have different recollections of your deal. How do you decide who’s right?

People lie: When your debtor denies that a contract existed, tries to change its terms, or misrepresents the negotiated price, you have no document that establishes the truth.

When you’ve made an oral agreement, it’s good practice to follow it up with something in writing. Even a quick e-mail or fax stating something like: “This confirms our understanding that you will pay $3,000 for 450 widgets to be delivered by next Friday to your plant. You are also responsible for freight charges.” If your customer doesn’t object, you have a paper trail that can later help you establish the agreement. If your customer objects, you can resolve any misunderstanding before it costs you money.

Contract modifications: Make ’em clear (and written)

Even knowing the foibles of oral contracts, you’ll sometimes do a deal on a handshake. Or, assuming your contract doesn’t prohibit oral modification, you’ll orally agree to change the terms of a written agreement. What’s important is to understand your risks and to control them by using written contracts in most situations.

But never lose track of this: The most enforceable contractual modifications are those that are put in writing. If an agreement is changed, use some form of written change order whenever possible. Have it signed or acknowledged by a person who has the authority to bind your customer so it’s enforceable later.

Whether the lapse of memory is real or feigned, you don’t want to find yourself in a position where your customer denies authorizing a change and refuses to pay for extras you’ve already delivered.

The best way to establish those extras, especially if you have to go to court, is to have written agreements showing that the changes were authorized. If that wasn’t done, at least have a history of confirming memos and e-mails that you can show were delivered to the customer, confirming the changes ordered and their cost.

Including key provisions

Business contracts often omit important details, such as who pays for shipping or when a delivery is due. Your written agreement should include all major components of your transaction so that, in the event of a breach by your customer, they can be easily proved. Typically, key provisions in a straightforward sale-of-goods or services contract include

A description of the goods or services

• For goods, a quantity and description of the goods sold

• For services, a description of the services to be provided

Price

Details of delivery (by common carrier, truck, and so on) and who is responsible for those charges

Late charges or interest that will be charged on past-due accounts

A deadline or statement that says, “time is of the essence,” to protect both the buyer and seller from any unreasonable delays

The time to outline interest, costs, and attorney fees is before you deliver your goods or services. These provisions should be included within your purchase order, credit application, or contract for sale. The document should state that if the account becomes delinquent, interest will be charged at the maximum legal rate and that collection costs, including the reasonable fees of collection agencies and collection attorneys, are to be paid by the debtor.

Even if you forget to include all of your key terms, as long as you’ve specified the type of goods or services and quantity ordered, your contract is enforceable. If price terms are omitted, they can be implied based on past dealings or prevailing prices in the industry.

Sometimes in the exchange of documents establishing a sale, a battle of the forms arises. The purchase order states the terms one way, a confirming memo comes back with a slightly different provision, and the invoice contains something else. These conflicts don’t void the contract, but they do make it more difficult to interpret.

Whenever possible, use your own forms. When working with your customer’s forms, start from the assumption that they’re loaded with language that will work against your company’s interests and make it harder to collect the money owed to you. Then negotiate the striking of language you consider to be unacceptable.

Knowing that your credit applications are contracts and your invoices aren’t

You must enter into a contract before your goods or services are provided, not after. Credit applications are entered into before you make delivery, and invoices come after delivery. That’s why invoice terms aren’t contracts.

Most courts consider invoices to be confirming memorandums of price, delivery, quantity, and description of goods. Many invoices contain all sorts of detailed contractual terms on the back, such as imposing an obligation on the recipient to inspect the goods in a timely manner before accepting delivery. You may be able to persuade a court to treat invoice terms as contractual, but most courts won’t.

Customizing provisions to meet your needs

Don’t assume that a standard contract is going to meet your needs. Sure, it’s easy to order preprinted forms from your office supply company. But some form agreements, invoices, and other documents won’t meet your needs because they don’t include some specific terms that are important to your business or industry.

For example, standard form language may assume that your goods aren’t perishable, that you’re delivering ball bearings, not eggs. If you think it’s important for the goods that you deliver to be inspected quickly, state that specifically in your credit application or contract, or in a confirming memo to a purchase order.

Boilerplate contracts often get used over and over again, year after year, and people neglect to update them based on the old maxim “it’s the way we’ve always done it.” Don’t let your form agreements get outdated. If you need to update interest rates or conform terms to changes in the law, make sure you change your forms.

Default provisions (Acceleration and other handy clauses)

When you draft a contract, you should incorporate standard clauses that clarify your intentions and simplify your life in the event of disputes or litigation. For example, clauses you normally want to include:

Acceleration: A provision that causes any balances payable on an installment plan to become immediately due in the event of default.

Automatic renewal: A clause that provides that the contract will renew for an additional term if the buyer doesn’t cancel by a specified deadline. For example, the contract may renew in one-year terms if written notice to terminate the contract is not received at least 60 days before the expiration of the current term.

Choice of law and venue: Where any litigation is to occur, and what state’s laws are to be applied to interstate transactions.

Costs of enforcement: A clause providing for your recovery of reasonable collection costs and attorney fees in the event of a default.

Damaged goods handling: Procedures for handling, returning, or replacing damaged goods.

Dispute resolution: Whether the parties must participate in alternative dispute resolution, such as mediation or arbitration, before resorting to litigation, and under what terms.

Form selection: When the terms of your forms conflict with theirs, whose forms govern.

Interest: A provision for interest on any past-due balance.

Returns: How and when returns may be made.

Shipping: Covering issues including who pays for shipping and who’s responsible for any risk of loss during shipment, prior to delivery.

Include in your agreements a statement of what happens if the debtor defaults. For example, promissory notes typically provide for payment in installments but that the debtor loses the right to make installments on the remaining balance in the event that she defaults. The balance has accelerated, and the entire amount becomes immediately due.

Dealing with contract mistakes (Yours, theirs, and mutual)

When you enter into a contract, you’re expected to understand its terms. Under most circumstances, a mistake made by a buyer or seller won’t invalidate a contract. Your customer says, “I know I wrote blue widgets, but I thought I was ordering green widgets, and the price we negotiated is too high for blue.” Too bad for him. That’s a unilateral mistake, a mistake by only one party to the contract, and you can expect a court to uphold the contract.

But what if both parties believe something to be true, and both are mistaken: a mutual mistake. The defense of mutual mistake can justify relief from a contract and should be treated seriously.

If both parties to an agreement believe that the product is of a certain type or quality, and it turns out that the product doesn’t meet that standard, the court could find a mutual mistake. If the court finds that the mistake undermines the purpose of the contract, the court will normally restore the parties to the position that they were in before they entered the contract (a rescission) unless the result of a rescission would be extremely unfair to one of the parties.

Avoiding debtor escape clauses

When you enter into a contract that obligates you to do something in the future, even if it’s as simple as paying for goods or services you’ve received, you may try to negotiate a condition that allows you to escape payment. Imagine that you’re manufacturing an expensive piece of machinery. You may attempt to negotiate a provision with your parts supplier that you don’t have to pay for parts until you’re first paid in full by your own customer. That’s a debtor escape clause (a huge one).

From the standpoint of a debtor, it’s easy to see the advantage of an escape clause. If your customer cancels the order or never pays for the machinery, you don’t have to pay your supplier. But if you’re the supplier, you end up taking on a huge risk that you can’t control. You’ve shipped a valuable product to your own customer, your customer used it, and you still can’t get paid.

When you’re negotiating contract terms with a buyer, particularly if the buyer has presented you with its own form contract, watch carefully for any debtor escape clauses. In most circumstances, vendors have no upside from agreeing to an escape clause.

Read contracts before entering into them. Some contracts contain provisions that you may not like. Before you sign you can renegotiate their terms or, if that’s not possible, you can refuse to enter into the contract. Sure, you can just go along with the contract and hope for the best, but that approach has a way of blowing up in your face.

E-sign contracts

For most contracts, electronically signed contracts are legal and enforceable under state and federal law. That’s not true of all contracts. Currently, with some variation from state to state, the following agreements still have to be on paper:

Eviction and foreclosure notices

Notices of cancellation of insurance contracts (even when the contracts themselves were e-signed)

Wills and trusts

Notices of cancellation for utilities services

Notices of product recalls

In most other contexts, an electronic acknowledgement, such as clicking an “I accept” button, can create a binding contract.

Legal Limits on Interest Rates

Usury is the legal term for charging an excessive rate of interest. Every state has usury laws — restrictions on the amount you may legally charge as interest on a debt. Usury laws may impose different rates of interest for different types of transactions, such as allowing a higher interest rate for a debt arising from a sale of land than for a loan or sale of goods. Typically, the laws limit you to charging simple interest (interest paid on the principal alone), not compound interest (interest paid on both the principal and accrued interest).

When you look up your state’s usury laws, you’re likely to realize that banks and credit card companies in your state charge higher rates than you’re allowed to charge. That’s because they’ve paid lots of money to lobbyists, obtaining federal legislation that overrides state interest limits and often getting special state laws that allow them to charge higher rates than other companies or individuals. Don’t make the mistake of thinking that the fact that your credit card company successfully charges a 24 percent interest rate means that you can do the same thing. Unless you’re similarly exempted from your state’s general usury laws, you can’t.

What happens if you charge an unlawful rate of interest? The specific consequence depends on the laws of the state where you do business, but common consequences include:

Application of interest to principal: The revision of your contract so that it becomes, in effect, an interest-free loan, with all interest payments made by the debtor applied to the debt’s principal balance.

Civil liability: State consumer protection laws may allow your customer to sue you for charging excessive interest. If you charge unlawful interest rates to a number of customers, sometimes the state attorney general’s office will investigate and sue.

Criminal penalties: If your interest rate is high enough, many states have criminal usury laws and can file criminal charges against you.

It’s important to know the maximum legal interest rate you may charge and to not include in your contract a provision for interest that exceeds the maximum lawful rate. You can postpone the inevitable by including in your contracts a provision for interest to be charged “at the maximum rate of interest permitted by law,” but sooner or later you’ll have to find out your state’s actual maximum rates. It’s sensible to take that step sooner and to stay explicitly within the law.