A Reference Book on Credit and Collection

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Chapter 1 - A Little History

Credit has always served people even before financial institutions were part of our society.

Before money as we know it was invented, people still used credit has a means of providing resources to another party without having to pay on an immediate basis.

Although we can find the use of money for exchange of goods and services as far back as the ancient civilizations, there was a time when people used barter to trade for goods and services as well. Credit was practiced under different forms.

Eventually, they increased the debt by adding a profit. We know it today as interest.

Ancient times

The oldest texts on credit come from ancient Samaria; Sumerians were believed to be the first to have developed written language. They wrote on baked clay tablets that were durable, archeologists date some of them to be earlier than 3,000 B.C. before the great civilization of Egypt. The author writes:

…thousands of these tablets have been found in the temple compounds, proving the bureaucrats of Sumer had developed a complex commercial system, including contracts, grants of credit, loans with interest, and business partnerships…

Credit was established at different levels for different reasons; simply by necessity most of the time.

If credit was already part of civilization in ancient Samaria, it continued to exist in ancient Egypt, then Greece and became more complex and part of the legal system of the Roman civilization.

Banks and bankers were part of the financial structure of the times. We find that in 48-47 B.C. there is a mention that Aulete owed a debt to the roman banker Rabirius Posthume, a large amount as it were, and Caesar himself had to intervene and declare a third party, Potheios, responsible for the debt.

Caesar himself during his younger years owed creditors large amounts of money as it is written in Caesar by Plutarch: "…He was so profuse in his expense that, before he had any public employment, he was in debt thirteen hundred talents…" The currency mostly used in Rome was the Denarius; it was worth 4 sesterces. The talent consisted of 6.250 times a denarius.

Rome in Julius Caesar’s time had to finance wars; many wars were fought on credit as it is done today.

Moneylenders gave credit to a host of customers; Caesar himself was a customer of moneylenders to finance his wars; they loaned money to people of Caesar’s stature but also to people of commerce. They began charging tremendous amounts in interest on the capital owed. Blood feud ensued because large amounts of money were loaned and not repaid.

But Caesar himself felt the economy could not support such extremes in interest rates and was compelled to act in order to strengthen the failing economy.

Julius Caesar had to pass a law that interest rates would be set at 10% throughout the Empire for all loans, of any type, and for all institutions and individuals, because he thought it was destroying the moral fiber of their society at the same time it had a negative effect on the economy.

Many of our world leaders today could take Caesar as an example of social fairness. Our own governments and corporations here and now charge what many consider to be abusive interest rates when collecting late fees or taxes.

Even in our democratic country, some of our governments have ruled that an interest rate below 60% is not abusive.

We know of certain national corporations that charge fees of approximately 50% to their late-paying customers.

For the common people, credit existed in a different form. Credit then, was a service or a product that needed to be returned, for example, a man would offer to labor the earth when the time came for laboring in exchange for life stock that he needed now. A debt was created.

With expansion, cities became countries. Gold and silver coins had always been used as currency. Eventually, paper currency came in use, and credit became well-established as the commodity that all level of governments would use to implement projects.

Corporate law which defines the practice and structure of corporations started as early as the Roman and Greek empire and was based on the act of giving credit. This is our field of interest (no pun intended).

The first commercial organizations were created in the medieval period. The guild members were obliged to follow a set of rules established by the medieval guild.

Later on, royal charters were given to merchant adventurers in England, France and Spain amongst others.

In fact, the first efforts to colonize North America were done by corporations more than countries.

In our case, after Jacques Cartier discovered Canada in 1534 for the benefit of the royal court of France, no efforts were made to colonize the new world. It was only in 1608 that the first structure was built in the new land; a house called l’habitation on the shore of the St-Lawrence River where Quebec City stands today.

Eventually, the court of France gave a mandate to a newly formed corporation called La compagnie des Cents Associés (The Company of One Hundred Associates) which later was replaced by La compagnie de la Baie D’Hudson, the name still exist today as the Hudson’s Bay company.

They had the mandate to colonize the new world in order to exploit the resources of the land for the King of France, establish colonies and disguise it as a mission to convert the Indians to Catholicism.

In Europe there was an increase in business altogether and to capitalize on resources and manpower, companies with a social capital came to be formed around the sixteen century. Corporations would multiply rapidly from then on.

Very soon, institutions would rise to lend money to these new corporations that needed capital to engineer big commercial projects. These lending institutions represented investors with capital banding together to form what would become the future banking system that most countries now adhere to.

A few hundred years ago

In the 19th century, an industrialization period began in England and France and other Europeans countries that would eventually influence how finance and economy would be practiced in North America; the legal system employed in Canada derives from both the English civil code and the French civil code.

Ontario’s civil code derives from the Common Law code and Quebec’s civil code derives from the Napoleonic code, it is then expected that similarities apply in both cases even today.

In England, it was the act of 1844, the Joint Stock Companies Act that established that companies were formed by registration.

It was in 1855 that they introduced a new legislation called the limited Liability Act which limited the liability of the shareholders in the event of a bankruptcy: this meant that the shareholders of the company were not responsible and did not have, by law, to pay for the company debts in the event of a closure.

This piece of legislation would then be followed by the 1856 act of Joint Stock Companies Act that brought together the two sets of legislation. It was the first step in the creation of the modern company structures.

With corporate law came corporate credit.

In North America, we find that credit was used in the colonies when the United States and Canada were not yet countries.

Credit was used at the beginning of the colony because colonists depended on funds and products coming over from England for their early development; the merchants from England would ship goods to America for which the merchants in the colonies paid after a term of six months and sometimes a year and vice-versa.

Of course, the fact that the transportation of people, goods and mail took months in those days as they had to cross the ocean, may have made it impossible to give better terms.

There is another reason that credit was used on a larger scale in the colonies.

It meant of course, as it does today, doing more business for merchants since the buyers could not pay all of the merchandize bought with cash, but also, the people doing business wanted to avoid currency exchanges; a centralized money system was not to be created before the constitution was written, in fact it came in existence around the 1780’s. With many currencies in circulation, it became costlier and time consuming, credit was easier.

The modes of payment were quite different in those days also; cash was used when repaying debts, but bills of exchange and goods or labor were also a part of mercantile trade. People could pay off debts in exchange for their labor, be it manual or not.

Although credit existed, it did not exist on the scale it does now. Then credit was mostly used by governments and big corporations; governments contracted debts towards other governments or institutions such as world leading banks to pay for the big social projects or wars they needed to finance. Corporations also used credit for Imports and Exports.

Not everything could be bought on credit then. Only those who had assets; governments, corporations, rich individuals would have access to credit.

Companies who sold to distributors and retailers also gave credit to their best clients in the form of credit terms where the client could receive the merchandize bought today and pay only at a later date.

Slowly, credit became a marketing tool to increase sales, and eventually companies and banks found that if you wanted to increase sales with a definite percentage growth every year, credit had to be institutionalized and should be accessible to everyone.

For corporations and companies, which is our level of interest, credit is needed at two levels:

When a company is selling to customers who demand terms. To increase sales they accept to sell on credit: The terms for payment could be 30 days for example.

When a company cannot collect enough of the accounts receivables, (the sales that are left unpaid) to pay for the on-going expenses during the course of a month or a year: salaries, accounts payables, etc. They have to borrow from financial institutions.

Sixty years ago

Credit services have multiplied exponentially to become an industry in itself. Governments have instituted complicated monetary systems that support the economies of their countries. Everything is bought and sold on credit; from the big governmental and corporative projects to a supplier of goods selling with 30 day terms to a family buying a home or using a credit card. Credit is now the common denominator of business transactions.

The 60’s brought great changes to our society in general, the economy became less and less agricultural. Trends and fashions exploded, cities began expanding considerably and marketing and publicity was more and more prevalent in all aspects of business.

Although credit was present in all classes of society, sixty years ago, commercial credit was managed loosely;

Companies did not have credit files on each and every client. A sale was approved when the owner said I know that client, send him the merchandize. The sales were approved mostly by the sales manager who would not refuse even a debtor known for his bad payment habits.

Smaller companies did not always hire a credit manager. A clerk or a receptionist, whose main functions were not related to credit, was asked to call the late payers from a list of clients and a stack of invoices.

Collection of accounts receivables was done only on late accounts and very intermittently, not on a regular basis.

The application form was simple; the vital information: name, address, etc. Very few conditions were applied to the application form and it was not even signed in those days.

The risk evaluation was done by the salesman on the road who gave a recommendation to sell in most cases as his commissions depended on it.

The sales manager approved the sale, not the credit manager.

The late accounts were sent to lawyers at a very expensive cost, so much so that in many cases, instead of trying to collect, the supplier would write-off the amount as a loss. We will see later how much it cost to write-off an amount for a corporation.

Modern times

Governments set regulations and each country has its own currency based on their worth. Now each country has its own banking system, and credit is used at all level of business.

In our country, we have a federal bank that services governments and the chartered banks that deal directly with the consumers and companies. The chartered banks fix their own rates based upon those set by the federal bank. The chartered banks lend money to corporations and consumers and hold a guarantee in the form of assets.

The federal government has instituted laws that govern the role of our chartered banks in our society since the government must secure loans that banks offer to consumers, up to a limited amount.

Banks lend to companies who need cash flow in the form of a credit line. The credit line is used when the corporation cannot bring in enough cash flow from the sales done on the previous months to pay for salaries and expenses. Customers do not pay suppliers when receiving the merchandize.

They are allowed to pay 30, 60 or 90 days later than the date of the invoice or the shipping of the merchandize. Today, this simple act of according a time of grace to pay has created an industry in itself.

Today

Credit as we know it today is a monster. It has grown exponentially in the past thirty years to reach a stage where it is now the backbone of all our economic reality.

In Europe, in December of 1995, 17 countries decide to band together to create a new currency, the euro, to compete on an equal level with giant economies such as the United-States.

The euro is used daily by approximately 332 million Europeans; it is the second most traded currency in the world.

Why are we mentioning this? Because members of the Euro zone have to abide by strict rules; member states are not permitted a budget deficit of more than three per cent of their GDP and a debt ratio of more than sixty per cent of their GDP.

The sub-prime crisis that originated in the United-States was a direct result of greed and very bad credit decisions;

We all know that laws are passed at different levels of governments based on financial lobbying pressure from special interest groups not for reasons of justice or ethics.

In the past ten years, regulatory measures that governments had put into place to police the credit market to make sure the economy would not suffer and bring to the market a sense of ethics and fairness dissipated.

We have seen the dark side of credit, when in 2008, the economic system failed to react to the failure of one company.

That company was dealing in high-risk mortgages; mortgages were sold to people who had not been deemed credit worthy.

Of course, human nature being what it is; it attracted people who represented a credit risk and the results were that the failure of one corporation spread to other banks and financial institutions until it became a world-wide tragedy.

We have seen lately that the euro currency might not survive in Europe because of the world-wide crisis that has developed since the meltdown of sub-prime mortgages and we are seeing signs that the U.S. dollar could be badly devaluated in the near future.

In the past 10 years, our governments and governments of other countries have been paying their current bills by borrowing on the international markets. It has come to a point where all countries are indebted to one another through complicated exchanges.

The United-states has been living on credit since the second golf war. It cost the U.S. two billions per day to support the war. China has been its main creditor; the U.S. owes in excess of fourteen trillion dollars. Some fear that the U.S. will not recover and that the U.S. currency might devaluate to a point where they would default.

Still even though the world economy remains frail, there isn’t much you and I can do except keep on working to increase our respective businesses. It does not matter if you are an employer or if you are an employee. What matters is the effort and what you bring to the world by just following good work ethics.

If you are working in a medium size corporation, in the field of credit, what you do matters. It matters for you, your career and it matters for the corporation you are working for.

Credit has evolved and has become specialized; today a company is comprised of different departments: sales, marketing, shipping department, computer department, and of course there is the credit department.

In the case of bigger corporations, the head of the department will be a credit director who will be assisted by a credit manager or credit managers if the corporation has other sites or divisions.

These managers will in turn need credit analysts to work the customer files. The accounts receivables collection calls will be done internally, (though more and more companies choose to outsource the collection follow-up calls to specialized agencies).

In the case of medium size companies, there will be a credit manager and collectors and assistants.

In the case of smaller enterprises, a person will act as a credit manager and collector.

Today, a credit manager needs to be informed in many aspects of business; such as finance, sales, laws and legislations, accounting, the structure of companies.

For a credit manager, knowing the rights and obligations of a corporation, or its legal structure, can prepare him or her to face difficult situations that will eventually arise.

If a credit manager receives an order from a company that is a sole proprietorship, he might treat it differently from an order that came from a corporation.

Our readers are more concerned with the fate of their credit department than the world economy and since suppliers are selling to manufacturers, distributors, retailers or other types of corporate customers, then the structure of companies would be the place to start in understanding how it relates to the art or science of giving credit.

As we have mentioned before, corporate law gave rise to corporate credit.

It is in the interest of the credit person to understand the structure of companies since the articles of law regulate these structures. With this understanding, the credit person will be better equipped to deal with problems regarding such issues.

Corporate law is what gives corporations its legal structure. It has been around for centuries; as mentioned before in our little history tour, some forms of companies seem to have existed in ancient Greece and after that in ancient Rome; the earliest forms of joint commercial enterprise were made into law in the lex mercatoria.

The first identifiable commercial organizations were medieval guilds that had rules members had to abide by.

One of the most identifiable characteristics of a corporation is that it is a legal entity in itself, it has a personality; it is identified as a moral person. That legal characteristic was not established in English law before 1895 by the House of Lords.

Since then, the civil codes of provinces and States and the federal law concerning the structure of companies have evolved and changed in the last years.

What is, for the benefit of the credit person and our readers, the difference between a sole proprietorship and a corporation, between an incorporated company and a registered one? It has a bearing when trying to collect a debt or when a debtor fails.

Let us look more closely at the structure of corporations and see what impact it has for the credit person in the act of giving credit terms to a customer or collecting an outstanding debt.

Chapter 2 - Structure Of Companies

The law governing business, in Canada and the United-States originally derived from the Common Law in England but has evolved with time as everything does. We find the most common forms of companies are:

Corporations

Limited companies

Unlimited Companies

Non-profit organizations

Partnerships

Sole Proprietorships

We could add credit unions, cooperatives.

For our immediate needs, we will not go into the intricacies of each form of company. We will try to differentiate the three fundamental structures of commercial enterprises that credit managers will have to deal with:

The sole proprietorship enterprise.

The partnership

The corporation

The sole proprietorship

It is a business normally run by an individual; it is not a business as such as there is no legal distinction between the individual and the business.

The sole proprietorship pays personal taxes on the money made from his or her business, since all profits are his or her to keep.

But, the sole proprietorship is also responsible for all losses and debts. He or she is as liable as any individual for the losses incurred in the business.

For example, if the business has a need to borrow money from a financial institution, the sole proprietorship will probably be asked, depending upon the amount