Practical Thoughts from a Creditor’s Attorney About Credit, Managing Risk and Dealing with Financial Distress

Posted by attorney Amanda Schlitz, March 21, 2018.

Financial difficulties are a fact of life and business, and can have a detrimental effect on those not adequately prepared. Since March is National Credit Education Month, the value of a solid understanding of good financial management – both personal and business – cannot be understated.

In a recovery action, creditors will often do as much as they can to recover all that they can as fast as they can – including the legal fees they have to spend along the way. Developing good habits early in life and business is critical. In fact, nearly half of American say that talking about money and personal finance is the most challenging topic to discuss (with death ranked as less difficult). Personal credit may have an unexpected effect not only on the ability to qualify for a loan for a car, house or business, but may also be used by employers and landlords. On the business side, troubled credit may affect cash flow and profitability by limiting a company’s access to funds, ability to borrow on favorable terms, transport products, lease space, purchase new inventory and so on. Since people and businesses are largely dependent on various forms of credit and literally have financial access at our fingertips, this is an ongoing challenge that makes awareness even more important.

The bad news: there is no fool-proof way to be fully protected against the effects of bankruptcy or financial distress. That is why it is important to recognize the red flags so risk can be managed, and to have solid best practices in place – both systematically and situationally – to minimize the negative impact. While these may seem self-evident, they are mistakes that I still see over and over and over.

The reality is that financial issues often arise without any fraud, dishonesty, mismanagement or fault. Changes in consumer spending, shifts in the market/industry, competition, weather, loss of a key employee, client, customer or supplier, an unexpected health crisis, job loss, or just plain old bad luck are a few things that can send a family or business into financial distress. While many are able to adjust, refocus their efforts and recover financially, it is not always possible or even advisable. One of the primary tenets of bankruptcy is it provides a “fresh start” to those “honest, but unfortunate” debtors (personal and business) that have gotten in over their heads. And this is not necessarily bad – we want to encourage innovation and those willing to take risks in order to facilitate growth.

Since financial issues are often unavoidable, here are some common mistakes I see from businesses and borrowers. During National Credit Education Month, an awareness of these issues can facilitate stronger relationships and better outcomes.

Common issues on the business side:

  1. Getting too big, too fast. This includes taking on too much debt without careful, structured planning of the cash flow needed to support expansion. Of course, growth is good, but the take-away is that it requires thought and planning that business leaders are often uninterested in doing since their focus is on doing what they do best.
  2. Not keeping good records. It’s easier to practice good record-keeping than to dig through unorganized papers and files (sometimes to no avail) when something is needed.
  3. Not reading the fine print (or the document at all). Understanding what you are signing, and why, is so important. Ask questions and seek advice if you don’t understand or have concerns.
  4. Not having good systems that flag issues before they become catastrophic, and not having good, lawful and consistent collection practices. Businesses need to be prepared to deal with these issues, including what do to in the event of bankruptcy – at some point it is much more likely than not that they will arise.
  5. Not communicating with a supplier, customer or borrower early or enough when issues arise. Of course, this is not fool-proof and won’t always work, but candid, professional communications can go farther than many realize, and may even result in stronger, more loyal business relationships.
  6. Too much DIY. With the resources available today, it is easy to save money by taking shortcuts. However, there are some matters – legal being one of them – where frugality usually does not pay. It is often much (much!) more expensive to fix, or damage-control, a situation than to have had it done correctly in the first place. An important side note here: if the dominant concern is cost, a good attorney should be like a business partner. They should offer solutions that not only meet your legal needs, but are practical, creative and allow you, as the business leader, to make better decisions about the risk that you are comfortable taking for your business. They should challenge you to think outside the box, consider issues and ramifications that you wouldn’t, and offer tailored suggestions and solutions. In the end, this should be much less costly compared to the alternative.
  7. Not asking for what you want. Simply put – you don’t get what you don’t ask for, and there is often no harm in asking. Businesses that are too shy to make reasonable requests can lose good opportunities.

Common issues on the consumer/borrower side:

  1. Not having any emergency fund, savings or retirement. This doesn’t need to be overwhelming – start small, but start somewhere. Additionally, retirement funds may be exempt from the reach of creditors, which can offer some further reassurance for vulnerable borrowers.
  2. Living large – too big of a house, car, vacation, etc. Highly leveraged borrowers leave themselves no room for error and are more vulnerable to financial issues in the event of something unexpected.
  3. Not having a good budget for monthly expenses. Often, the first time folks give this any real thought is when they have to complete a bankruptcy petition. Small purchases can add up faster than we realize, and an understanding of where money is spent every month is critical to good financial management.
  4. Selling assets in distress. Some assets are exempt from the reach of creditors, and some creditors are willing to work with troubled borrowers. Rather than selling assets and favoring some creditors over others, borrowers should seek legal advice (often available in free consultations) before doing things out of desperation.
  5. Not communicating with lenders. This may be the most common mistake I see in my practice. All too often, I see situations (that were capable of being resolved) referred to me for legal action because of an unresponsive (and often scared or depressed) borrower. Not yet have I seen the “head in the sand” or “just ignore it and it will go away” tactic actually work or make anything better for a borrower. Lenders are often willing to work with borrowers that are honest, proactive, and genuinely in need of a break. To the contrary, it may be too late for that once legal action becomes necessary. Borrowers should seek legal advice sooner rather than later to explore workout options. (Of course, a workout isn’t always possible or advisable, but it is almost always worth considering.)

QUESTIONS?

If you have any questions on this topic or would like more information, please contact us at 651-439-2878 or send us an email.

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