The process and considerations involved in transitioning a client’s debt to legal collections are comprehensively addressed in the chapter dedicated to collection management. The responsibility for initiating the transfer of a client to legal collections lies with the organization, with the collection department handling the actual execution. In this chapter, the focus is on the perspective of the legal collection manager, who typically reports to the Credit Risk and Collection Manager or the Chief Financial Officer (CFO) within the organization.
The legal collection department plays a crucial role in auditing and overseeing the transfer process conducted by the collection department. This oversight is critical to prevent erroneous transfer of customers to legal collections. The department’s audit and control measures include:
- Process Control and Feedback:
- Monitoring the process of transferring clients to legal collections and providing feedback to the collection department in cases where procedural flaws are detected.
- Sample Testing:
- Conducting selective tests on individual cases, tailored according to the case size or customer type, to verify the appropriateness of the transfer process.
- File Preparation Oversight:
- Ensuring the proper preparation and completeness of the case file for the claim, often referred to as a “Full Kit.”
Through these mechanisms, the legal collection department ensures that the transfer of clients to legal collections is conducted accurately and justifiably, thereby safeguarding the interests of both the organization and its clients.
Assessing the Economic Viability of Legal Collections
The decision to transfer a client’s debt to legal collections involves a comprehensive analysis of various factors. This chapter focuses on the economic feasibility of such transfers, considering both the collection rates from clients in legal proceedings and the associated expenses. An economic model helps in determining the viability of legal action based on the debt amount and the legal status of the client. For instance, an organization may decide to initiate legal action through external lawyers for debts exceeding $200 and file lawsuits for amounts starting from $1,000.
Factors Influencing the Decision:
- Debt Amount and Legal Complexity:
- The decision varies based on the debt size. Smaller debts might lead to cost-effective measures, ensuring proportionality between the debt amount and legal actions. Conversely, large debts, particularly those arising from complex contracts, require detailed preparation and specialized legal expertise.
- Document Quality:
- The availability and quality of documentation supporting the debt play a critical role. In cases with insufficient evidence, the likelihood of legal success and the potential financial and reputational costs must be carefully weighed.
- Debtor Location:
- The debtor’s known identity and location influence the approach. Unknown whereabouts may necessitate additional resources for location efforts, such as skip tracing or private investigators, or could lead to considerations of debt write-off or postponement of legal actions.
Economic Considerations During Legal Proceedings:
The economic aspect of legal proceedings requires careful deliberation at every stage. While some clients inevitably need to be transferred to legal collections to maintain the organization’s credibility and deter non-payment, the extent of financial investment in each case must be judiciously decided. Questions to consider include:
- The intensity of adherence to legal procedures, ranging from sending a warning letter to initiating court proceedings, execution of foreclosures, and, in some jurisdictions, considering imprisonment orders.
- Financial investment at each step, including debtor location, legal fees, foreclosure costs, and handling of foreclosed property.
The direct profit of writing off debts
We already discussed that perform some legal collections is necessary to prevent the market to consider that not-paying to the organization is a smart move.
On the other hand, there is a direct impact on the organization bottom line when debts are written-off.
In some countries, the organisation is able to receive a VAT credit for written-off invoices and in all cases, the organization can deduct the written-off debts from its taxable income.
If we assume a VAT rate of 20% and a company tax rate of 25%. Immediate recognition of bad debt as written-off could lead, for an organisation that pays taxes, to a direct reduction of taxes of 45% of the written-off debts (in the above example). Sometimes, it is preferable to invest in legal collections for a target recovery rate that would be under 45%.
These type of decisions depends a lot on if the Bad debt percentage is a crucial KPI or not for the organisation. For instance, a finance organisation, would be very sensitive to its bad debt expense rate, while a telecom company might be indifferent to it.
Strategic Decision-Making in Legal Collections:
The decision-making process encompasses not only the transfer to legal collections but also the level of effort and financial resources allocated throughout the process. This strategy must balance the economic viability with the broader goal of maintaining organizational integrity and a deterrent stance against non-payment.
In summary, the transfer of a client’s debt to legal collections is a multifaceted decision that requires a careful balancing of economic feasibility, legal strategy, and organizational reputation.
NEXT: Possibilities and considerations for managing debtors in legal proceedings