OUTSOURCING COLLECTION & RECOVERY OF “BAD DEBT”

The last item in our Recovering “bad debt” series dealt with engaging your own “IN HOUSE” collections department.

Now the issue for a serious auto finance company is understanding the value of outsourcing “bad debt” recovery and the key considerations affecting the selection of the “right” outsource entity or entities be it a Law firm or agency. You know them as “vendors”.

Here are the key considerations;

• Size (balance) of “bad debt” Account

• Reasons for delinquency

• Short vs. long term commitment to recovery

• Costs of outsourcing (oversight & legal court costs)

• Reputation of outsource “Vendor” & affect on your reputation

• Expertise in the field of Auto Finance Recovery

• Outsource entities incidental Value to Company

SIZE (BALANCE) OF “BAD DEBT” ACCOUNT

The larger the balance the more value recovery means. Account balance will be an important consideration for selecting the outsource entity (agency or law firm) and may also affect your decision to sell (see short vs. long term…. below)

Industry standards normally dictate that smaller balance accounts are better serviced by agencies. The collection “industry”, mostly driven by agencies, is split on how larger balances can be best serviced and collected. But time-tested collection strategies demonstrate that larger balance accounts fare better with law firms that are expert in the industry.

Larger balance accounts require a greater degree of legal pressure (law suits/judgments/garnishment) on the customer to compel repayment. Smaller balances, easier to pay and settle, and clearly not worthy of litigation, require the normal skills of dunning for which agencies are noted. These smaller accounts should be worked and resolved in relatively short periods of time (6-12 months). Larger balances determined to be suit worthy will take longer to pay but will payout (net of costs) substantially more over time (14 to 36 months).

REASONS FOR DELINQUENCY

Beware of accounts, small or large balance, with serious factual or legal defects. Too many lawsuits resulting in bad law for the industry involved very small balance accounts. A reasonable protocol to self-screen these accounts out is important and should leave over 95% of the remaining accounts to outsource.

Understanding the reason(s) for default is important. In most cases, it is certain that intervening events (i.e. lost job, illness, divorce) affecting the financial condition of the customer caused the delinquency. Working with that knowledge to collect short AND LONG TERM is a critical part of any collection strategy. But understanding that sitting on an account and waiting for the status quo to change is NOT a healthy collection strategy. Relate those circumstances to your outsource firm so it can use that information to best secure your entitlement to future repayment.

One of the more common customer reasons or rather, rationalizations for nonpayment is the customer’s mistaken belief that not possessing the vehicle excuses the need and responsibility to pay for it. The general consumer has little understanding of contract damages but even if he does, he often uses that rationale to stonewall any repayment.

Deficiency balances after repossession and disposition (private or public sale) are CONTRACT DAMAGES and legally represent money due and payable to the financing company. No agency will change this customer mind set. Neither is any agency capable of enforcing those damages due. Collection of these damages will not happen unless the account is sued.

SHORT VS. LONG TERM COMMITMENT TO RECOVERY

This important commitment will match the personal philosophy and management style of the auto finance company’s CEO/owner. If an owner sees no long-term value in a higher rate of recovery (over time) then he will encourage short term collection efforts and ultimately sale of bad debt. However, keep in mind that “Bad debt” has a legal shelf life of only four (4) years from date of default. Unless the account is sued, and judgment obtained, the account is legally “dead” and unenforceable after that time.

If one wishes to undertake a short-term view and strategy, initial attempts to collect and then selling no later than one (1) year from date of default should yield the best SHORT-TERM results (perhaps 2-3% gross recovery from agency and 3-4% gross price from debt sale).

A long-term strategy and commitment to recovery means a commitment to litigation on larger balance accounts that prove to be “suit worthy”. Those are accounts that are properly documented, have confirmed customer locations (a serious Firm will help with this) and a customer whose history indicates a likelihood of reemployment in the foreseeable future.

Generally, economically distressed customers will need some reasonable time to recover before repayment occurs. However, engaging them now and protecting your legal entitlement to recovery (Judgment) is a critical prerequisite to future recovery.

The real value to a long-term strategy is an emerging and constant flow of recovery monies to the Company. In most cases, this begins 14 to 16 months after referral and continues in most cases for years to follow (at least five (5) to six (6) plus years). Gross recoveries over 36 months will range from 12% to 16% and continue to liquidate over another three plus years to recover an additional 1-2% a year.

As importantly, your law firm will have obtained a cache of Judgments which increases the intrinsic value of your bad debt portfolio AND extends the life of that debt substantially. If selling is a part of your recovery strategy, those judgments (even uncollected ones) now have substantially greater value.

Where a finance company is consistent in outsourcing referrals, the long-term return will also be consistent and long term in delivering significant net returns; a continuing source of funds for reinvestment.

COSTS OF OUTSOURCING

The internal costs of managing any outsourced entity for a finance company cannot be avoided. Also, recovery fees (commissions) paid to agencies and law firms are normally similar as well as typically contingency in nature.

As for short term outsourcing to agencies, additional new outlays of money will be minimal. Agencies, as should law firms, will absorb the normal operating costs of recovery they incur including non-court investigative and data resources.

Selling debt, however, is another story. Court decisions and CFPB rules have added responsibilities that did not exist before. An example is documentary support for the balance, liability and ownership of the sold debt. While the CFPB is now under “new management”, there remains the idea that even after the “bad debt” is sold, the original creditor (in this case the auto finance company) is not entirely released from possible future liability. Thus, the reputation and established professionalism of the ultimate buyer of that “bad debt” are critical factors a company must consider when selling. Who ultimately owns and works that bad debt is an unknown risk that can affect a company's costs down the road. Note: If “tail” insurance is possible to protect the company from such future liability, it is to be considered.

The real and frankly most important “cost” to consider is the cost required for litigation, namely, “Court costs”. Court costs are not optional but are required to exercise the right to litigate. So does a company with much to gain from a litigation strategy, embrace the idea that reasonable court costs need to be incurred? This should be a resounding “yes” since there will be no recovery in most cases unless a company sues! Compelling recovery through litigation is and should be a major strategy consideration! The court costs are and should be considered “Seed” money, for the long-term recovery of “bad debt”.

And invariably, court costs are recoverable in litigation AND are recovered to the Company BEFORE a fee is taken. A relationship with a law firm that concentrates in auto recovery debt nearly guarantees a commitment by that firm to careful expenditures of court costs. Note: Over time, a law firm will also recover over 40-50% of court costs incurred.

The pursuit of litigation will be rewarded in resulting long term NET recoveries over time. The NET/NET return over time (gross recoveries less fees and less unrecovered court costs) will result in a significant and ongoing “return on investment” (ROI).

Note: Law Firms that concentrate and regularly work auto finance “paper” can provide metrics and details about its results for its clients in your geographic areas of service. Ask for that information. Many firms will provide you actual historical not theoretical information.

REPUTATION OF OUTSOURCE “VENDOR”

The critical need to outsource to a reputable “vendor” is rhetorical. Who would do otherwise? But in the recovery business, sometimes the commercial zest to hire the “best gun in the west” overtakes reason. In other words, a company wants a professional and proven effective recovery firm that will also protect the auto company’s good name and reputation in the process.

The most effective collection firms have weathered the test of time and have amassed other reputable clients along the way. Knowing and researching your prospective vendor/firm’s top leadership is also critical to understanding the level and quality of service to be expected. And, of course, that expertise should relate to the field of auto finance recovery (our next topic).

EXPERTISE IN AUTO FINANCE RECOVERY

Great credit card collection firms do not necessarily provide great auto finance recovery services. They are very different industries with very different issues. Look for objective signs (i.e. historical representation of other auto finance companies) to assess whether your outsource candidate knows the auto finance industry.

A firm’s existing relationship with auto finance clients and length of service to those clients is a major factor to consider. Your outsource prospect must have experience and knowledge of the auto finance industry and the recovery issues.

Auto finance recovery is a very different and special industry with very special and unique issues. Research your prospective vendor/firm for that expertise by meeting with the ownership and actually discussing the issues that are most important to you. It is important that you like the people with whom you contract, but it is more important that you trust the level of skill and understanding that firm will provide you day in and day out.

What’s more, do your outsource candidates understand the issues you face vis-a- vis compliance with regulatory rules. Do your outsource candidates understand the pressure government places on the auto finance industry, and can and will they provide you the needed assurances and protocols you require of your “vendors”? [Ask for Seidberg Law’s “Vendor Compliance” packet]

OUTSOURCE FIRM’S INCIDENTAL VALUE TO YOUR COMPANY

While you are “vetting” a recovery agency and/or law firm, you should consider what other services incidental to bad debt recovery your outsource agency/firm can provide to you. Some services are related to recovery and some services are distinctly different but deal with industry issues affecting the company. If you have selected a law firm expert and experienced in auto finance recovery, the value of that available expertise cannot be overstated. Those firm services extend to claim and delivery (replevin), government seizure and forfeiture and dealer issues. Knowing that the outsource firm knows your industry, speaks your “language” and can “counsel” you in other ways, will go a long way to making your overall recovery strategies successful.

CONCLUDING REMARK

A fair summary of the above considerations leads to the conclusion that collection strategies should consider using both agencies and law firms intelligently. There is no one means or strategy to best recover all “bad debt”. Multiple strategies must be considered and then actually implemented. Remember that time is ticking away. Time will very quickly diminish and ultimately eliminate the value of bad debt recovery unless you act. Your actions must be considered…. But action must be taken AND taken from the date of “charge off” if a company is going to be successful in maximizing its bad debt recovery. Once the legal time limitations lapse on your bad debt, that potential asset is gone forever!