Most people have experienced consumer credit from the debtor’s perspective. A person who wants to buy goods or services without paying for them immediately obtains credit from the seller of the goods or services and the buyer goes into debt owing the seller an account that is due at some time in the future. There is a written or oral understanding that the account will be paid in full or in installments according to the agreed upon terms.
What are Account Receivables?
Accounts receivable are an essential part of any organisation’s balance sheet. Often referred to as debtors, these are monies which are owed to an organisation by a customer.The most common form of an account receivable is a sale made on credit, via an invoice, to a customer.
The customer subsequently pays the debt within agreed credit terms, which may differ from customer to customer. Some companies offer discounts to incentivise early payment or privileges to customers permitting a direct debit to be set up.Typically, an invoice is raised and issued to the customer with the invoice amount being recorded as a debtor balance. Until the invoice is paid, the invoice amount is recorded on the organisation’s balance sheet as accounts receivable as illustrated below. Where payment is overdue, it is followed up by the credit control officer or team until the amount is recovered, or written off if no longer recoverable.
Receivables are often divided into classes based on the amount of time that has passed since the accounts first became delinquent or on the number of times that collection activities have been attempted on them. The various classes are often referred to as primary, secondary, tertiary, or quaternary. Though the collections industry is slowly agreeing on universal descriptions of the classes of accounts, the terminology continues to be less than static.
The current classification of receivables is as follows:
- Primary debt is between six and twelve months past due and has usually only been collected upon by the original creditor and possibly one third-party debt collection agency.
- Secondary debt is twelve to twenty-four months past due and is being worked on by a second collection agency.
- Tertiary debt is more than thirty-six months past due and/or is being worked on by a third collection agency.
- Quaternary or warehoused debt is over forty-eight months past due and/or is being worked by a fourth or more collection agency.
Charged-off Accounts and the Secondary Debt Market
The word “secondary” is also used in another context. Instead of sending debts out to a debt collector on a third party contingency basis, creditors will sometimes simply charge off accounts as being uncollectible by the company and sell their debts on what is called the secondary debt market.
Charging off and selling uncollectible accounts allows the credit grantor to obtain a certain and immediate return in an otherwise speculative situation. The amount of return is usually from two to ten cents on the dollar depending on the quality of the debt being traded. Properly done, the purchase and subsequent collection of charged off debt from the secondary debt market can be a very lucrative business. Not to mention the fact that it employs a lot of debt collectors.
Intentional vs. Unintentional Debt
- “Intentional debt” is the majority of consumer debt and is intentionally incurred by consumers who want to enjoy the benefits of goods or services without having to pay for them completely in advance.
- “Unintentional consumer debt” is a payment obligation that is forced upon consumers by unexpected adverse circumstances such as a sudden illness or a casualty to property like an uninsured car wreck or house fire.
It is important for debt collectors to recognize whether the accounts they are collecting are intentional debt or unintentional debt, because the approaches for these two types of debt are often quite different.
Secured vs. Unsecured Debt
Secured debt is created when the debtor grants the creditor a security interest in a particular asset as collateral to give the creditor some measure of guarantee that the debtor will repay the debt. The most common examples of secured debt are when a borrower grants a security interest in a house or a car to a lender in order to obtain a loan.
The vast majority of debt, however, is unsecured debt. The leading examples of unsecured debt are credit card debt, medical debt, and utility debt.
Delinquent secured debt is much easier to collect than unsecured debt. If a borrower fails to repay the loan, then the lender simply forecloses on its security interest in the collateral and takes and sells the collateral to repay the loan. If the value of the collateral is less than the outstanding balance on the loan, then the deficiency becomes unsecured debt.
Delinquent unsecured is more difficult to collect than secured debt, because the debtor has nothing to lose except the time and frustration that it takes to deal with his or her credit problems. Dealing with these problems may include putting up with collection calls, suffering harm to the debtor’s credit rating, and, in extreme cases, being a defendant in a debt-related lawsuit.
Secured debt is treated more favorably in bankruptcy proceeds than is unsecured debt. Secured creditors can usually recover the collateral for a loan out of a bankruptcy. Unsecured creditors almost never receive more than pennies on the dollar in bankruptcy cases.
In-Statute vs. Out-of-Statute Debt
A statute of limitations is a law that sets the deadline by which a person must bring a lawsuit about a claim. A lawsuit that is brought before the deadline expires is referred to as being brought within the statute of limitations. If the person wanting to sue someone else does not bring the lawsuit within the deadline set by the statute of limitations, that person’s claim is then outside of the statute of limitations and that person is forever barred from bringing a lawsuit on that claim
A debt is “in-statute” up until the date that the statute of limitations expires and is “out- of-statute” after the deadline expires.
There are two types of statutes of limitations. The first type of statute of limitation is called an “affirmative defense” statute, because it is used as an affirmative defense at the time of answering a complaint filed in a lawsuit. This means that the issue of whether a debt is in-statute or out-of statute does not come up until the creditor sues on the delinquent debt.
If the complaint in a lawsuit is filed after the statute of limitations deadline, then the debtor can claim as an affirmative defense when answering the complaint that the statute of limitations has expired. If the debtor can prove that the complaint was filed after the deadline, then the debtor will be granted what is known as a summary judgment and the debtor will not ever have to pay the debt, unless it is secured by an asset that the debtor wants to protect or the debtor is sensitive to having the unpaid claim appear on the debtor’s credit report.
The second type of statute of limitations is called a “claim-invalidating” statute, because it not only serves as a bar to bringing a lawsuit on a claim, but it also invalidates completely the claim itself.
The difference between “affirmative defense” and “claim-invalidating” statutes of limitation is very important. A creditor can take any collection activity to collect and out- of-statute debt in an “affirmative defense” state except for filing a lawsuit on the debt. A creditor cannot take any action to collect an out-of-statute debt in a “claim-invalidating” state after the deadline in the statute of limitations expires.
The vast majority of states have “affirmative defense” statutes of limitations. At the time of writing this book, only Wisconsin and Mississippi have “claim-invalidating” statutes of limitations.
In addition to statutes of limitations, some states also have statutes of repose, which are only similar to statutes of limitations.
Not all statutes of limitation in a particular state are the same. Some states have different statutes of limitations for different types of claims. In addition, some statutes of limitations may cancel others. For instance, a statute of limitations in the Uniform Commercial Code (UCC) for credit card debt is four years, which may trump a statute of limitations for contracts of six years.
Statutes of limitations may be tolled by certain actions of a debtor (such as leaving the state) and restarted by other actions of the debtor (such as making a partial payment on a debt).
When debtors move across state lines the issue often arises of “which state’s statute of limitations applies?” Does the statute of where the debt originated apply or does the statute of where the debtor now lives apply? Most courts state that statutes of limitations are procedural matters and, therefore, the statute of limitations for where the lawsuit is being filed applies. Because the FDCPA requires a lawsuit to be filed in the state and county where the contract was signed or the state and county of the debtor’s residence at the time of filing the lawsuit, this narrows the choices to two places. The essential answer is that the statute of where the debtor currently resides applies.
Even if the contract includes a choice of law clause, statutes of limitations will still usually be determined to be procedural and the statute for the state where the case is filed will apply.
It is important for debt collectors to know whether they are attempting to collect a debt that is in or out of statute. Threatening to bring a lawsuit on a debt that is out of statute is a violation of the FDCPA. An ideal way to let the debt collector know whether he or she is collecting in-statute or out-of-statute debt is to have a computerized collection management system determine the type of account and the latter of the delinquency date or the last payment date, then select an appropriate statute of limitations for such a type of debt from a state-specific look-up table, and calculate and display the most likely statute of limitations deadline date.
Nonetheless, most collection management systems are not that well developed. Therefore, the majority of collection agencies are left with the “hard way” of doing it, which is to post a list of statutes of limitations for each type of debt for each state and leave it posted in each debt collector’s workspace so that the collector can stay aware of the statute of limitations on a case by case basis.