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“TIPS, TRICKS & TRAPS”
THE LEGAL COLLECTION PROCESS
PREPARED BY:
JAMES M. LLOYD
LLOYD & McDANIEL, PLC
11405 Park Road, Ste. 200
P.O. Box 23200
(502) 623-9263
james@lloydmc.com
I. ESTABLISH A COLLECTION SYSTEM
The collection process begins prior to the point that a collection
problem is first perceived. In fact, it begins at the moment credit is
extended. It is important to establish a consistent set of operating
procedures to ensure the ability to move quickly and efficiently when
delinquencies occur. Those creditors who follow an established set of
standard operating procedures when dealing with delinquencies will enjoy a
greater return on the delinquent dollars.
The telephone remains the best collection tool and as any successful
collector is aware, the timing and the manner in which the initial telephone
demand is made is critical and may well establish in the debtor’s mind your
position of priority in terms of getting paid. Just as important as the
initial telephone call is the written confirmation to follow up the call.
There have been a variety of studies that indicates as much as 28% of a
verbal message is forgotten after one day, 48% after one week, and 70% after
one month. The written follow-up not only assures the account of your
persistence, but also establishes an important link in the paper trail that
may one day help establish your claim in court. Repeat calls on a consistent
follow up basis will improve your credibility with any slow pay customers.
In the course of a collection call, one cannot overstate the importance
of diction, voice strength, and a position of confidence. Most experts agree
that successful telephone contacts should include a brief opening wherein
the creditor identifies him/herself and succinctly describes the intended
purpose of the call, which is of course for recovery of the outstanding
balance. The strategic pause should be employed to shift the burden of the
conversation upon the account debtor to require an affirmative response and
hopefully a specific plan for payment.
Anything short of a specific commitment, which your customer is willing
to commit to in writing, is generally a pretty clear indication that the
customer has no real intention of following through. All telephone calls or
personal visits with an account should be followed with a written
communication, either mailed or preferably faxed to the attention of the
person with whom the conversation occurred. The correspondence should be
brief and direct, and in the best of all worlds should include a signature
line for your customer to sign or initial, and fax back to you for your file
as part of your overall record retention system.
II. ESTABLISH A RECORDS RETENTION SYSTEM
Many creditors establish a separate collection file for each delinquent
customer, while others employ the use of computer systems that enable the
use of an electronic “paperless” file. Either way, a set records retention
procedure is important to improve the creditor’s own in-house collection
efforts as well as to preserve the claim in the event that third party
intervention is ultimately necessary.
Notations or any memos regarding telephone contacts with the debtor
should be meticulously maintained, as should copies of all correspondence
with the account debtor confirming any telephone conversations or
representing confirmations of payment commitments or other acknowledgements
of the debt.
In the event a dispute is ever raised, an account debtor should be asked
to particularize the dispute in writing, detailing all circumstances
relating to the nature of the dispute. This will increase the likelihood of
distinguishing tangible disputes from instances where a customer is simply
attempting to create excuses for nonpayment. Efforts should be made to
resolve a dispute at the earliest possible time in order to defuse the
debtor’s possible efforts at inflating a relatively simple problem into
justification for withholding payment.
Once an account becomes past due, efforts should be made to preserve and
protect the “paper trail” of all transactions relating to the account. In
addition to notations and memoranda of telephone contacts, as well as
written follow-ups and other pertinent correspondence with the account
debtor, the collection file should also include copies of any purchase
orders, order acknowledgements, copies of original invoices, statements,
proofs of delivery (where available), any contracts, credit applications, or
other documents of any kind that would relate to the indebtedness. Probably,
the single greatest detriment in the legal collection process is the failure
of creditors to maintain an efficient records retention system. It is
important to understand that in a legal proceeding, the creditor, as
plaintiff, bears the burden of proof in establishing the validity of its
claim. The most successful creditors will be those who retain legible copies
of all pertinent documentation and who are able to demonstrate an
established course of contacts with the account debtor, by telephone, or in
writing. Consistent and persistent follow-up will go a long way toward
exposing belated disputes and other excuses employed by experienced debtors
attempting to avoid payment.
III. EARLY WARNING SIGNS
The extension of credit always involves a certain element of risk. Making
informed credit decisions at the outset are not always enough. Established
customers may begin to experience problems and may go to great lengths to
attempt to disguise the problems that are occurring. Possible early warning
signals for trouble include the following:
- Changes in ownership and/or management of the firm.
- Becoming the subject of lawsuits, or federal or state and local tax
liens. The daily record is an excellent source for this type of
information and is much simpler than a manual public records search.
- The loss of key customers or product lines.
- Frequently changing bank accounts. This is a sure-fire sign that the
customer’s bank accounts are being garnished or attached by other
creditors.
- NSF checks.
- Inability to meet commitments on schedule.
- Poor internal management, including poor internal financial practices
(including collection practices).
- Recurrence of problems which have previously been allegedly resolved.
- Slowness in submitting financial statements or other credit
information where previously freely offered.
- Purchases over and above standard buying practices or requests for
different payment terms.
- Changing addresses or trade styles for the business.
IV. SPECIFIC TOOLS
Once an account becomes delinquent and it becomes clear that there is
going to be a problem in collecting the account, the most persistent
creditors will enjoy the greatest long-term success. Remember that credit
has been extended in good faith to the customer with the anticipation of
prompt payment. Creditors should not be intimidated from requesting
additional security when an account is requesting additional time to pay
over and above normal established payment terms. While the general unsecured
creditor who has extended credit in good faith is not on the same footing as
the debtor’s bank or other secured lenders, there is no reason that the
creditor should not expect additional security for ultimate payment of its
claim as opposed to simply allowing the account debtor an unlimited interest
free loan. There are a variety of security devices that can be employed by
the unsecured creditor when faced with a customer who is unable to pay the
account. The following are some of the more common examples, and if properly
utilized, will greatly enhance the creditor’s prospects for full recovery.
(1) Cash in advance or cash on delivery.
Obviously this represents the ultimate security, at least insofar as
further sales to an account debtor who is currently in arrears. Many
creditors are content to continue to sell an account on cash terms with the
idea of “buying down” any possible loss on the existing arrearage by profits
on future sales. When the customer needs the creditor’s specific goods or
services, a good strategy would be to employ a plan whereby current sales
are made on a “cash in advance” or “cash on delivery” basis, with a
percentage or specific dollar amount over and above the current purchase
being applied to the balance in arrears. Again, the particular circumstances
of each case, especially whether or not the specific good or service
provided by the creditor can be obtained more favorably elsewhere, will
dictate whether or not “cash in advance” or “cash on delivery” terms will be
an effective remedy.
(2) Joint Pay Agreements.
These type of agreements are most commonly utilized on construction
projects. Normally, a debtor/contractor will agree to a joint payment
agreement with his creditor in return for a commitment from the creditor not
to file a lien against the project. As long as the parties all continue to
perform according to the construction contract, these type of agreements can
be very effective for protecting material suppliers and subcontractors.
Unless all parties to the construction contract are performing according to
contract and to the satisfaction of the owner, checks will cease to be
written. It is not uncommon that should the relationship between the
creditor and the contractor/debtor deteriorate for one of the parties to
refuse to endorse the instrument, thereby in effect preventing payment to
anyone.
Joint payment agreements are not limited to the construction setting and
may have application to other multiple party contracts where there is an
identified third party beneficiary to whom all parties look for ultimate
payment.
(3) Assignments.
In very simple terms, the assignment is a contract wherein the debtor
assigns or transfers over to the creditor an interest or property right that
the debtor expects to recover. The assignment must be in writing and must
reflect an intention on the debtor’s part to grant an interest in whatever
property right or interest is being assigned. Assignable interests may
include contract rights, perhaps the right to payment under a contract, or
the right to recover outstanding accounts receivable or other funds that may
be due to the debtor. Assignments can also be for a judgment interest such
as in a situation where the debtor is the holder of a judgment against some
other party or entity which has yet to be collected.
The most common examples of assignments are accounts receivable or
proceeds of a lawsuit. When considering accepting an assignment of
receivables, the creditor should make inquiry to determine whether or not
the debtor has previously granted a security interest in its accounts
receivable to any other parties such as its primary secured lender. An
assignment of such an interest would of course be subordinate to the prior
assignment. Written assignments of accounts receivable should include the
right to collect and should also include specific provisions to indemnify
the assignee from any loss for any alleged credits or counterclaims that may
be asserted by the accounts.
(4) Promissory Notes.
Promissory notes are an excellent device for trade creditors to further
secure themselves for payment of an outstanding debt. Debtors experiencing
cash flow problems will many times make proposals for payment over a period
of weeks or months. Many times they may simply ask for additional time
awaiting an improvement of their cash flow position. While these commitments
may be in good faith, the debtor’s financial condition may continue to
deteriorate. Creditors who have acquired a greater position of leverage will
be in a better position to receive the debtor’s undivided attention.
Promissory notes many times offer this additional leverage to the unsecured
creditor in view of the fact that the note represents an unconditional
written commitment for payment.
The author has found that a debtor who has committed in writing to a
specific payment plan is much more inclined to adhere to that payment plan.
The writing also establishes as a matter of law the legal right of the
creditor to recover payment. The note represents a nearly irrefutable
validation of the underlying debt. The promissory note may completely
eliminate the possibility of a later attempted denial of the claim after
suit is filed. Notes also represent an excellent opportunity to obtain a
specific rate of interest on the underlying liquidated debt if there is no
prior contractual agreement, such as a credit application between the
parties enabling the creditor to charge interest on the outstanding debt.
Notes also offer the creditor an opportunity to obtain a provision for
attorney’s fees if one has not previously been obtained. The note may
generally provide in its body that in the event of default in payment of the
note, that the creditor shall be entitled to its attorney’s fees and the
attorney’s fees should probably be characterized either as a dollar amount
or as a specific percentage of the outstanding balance. There are very
specific requirements for the proper execution of a note with which the
creditor should familiarize themselves. In essence, the writing must (i) be
signed by the maker or drawer; (ii) contain an unconditional promise or
order to pay a sum certain in money; (iii) be payable on demand or at a
definite time; and (iv) be payable to order or to bearer. See the attached
sample note.
The note is enforceable against its maker. If the debt has been incurred
by a corporation, the note should be signed by an officer of the corporation
duly authorized to make such a note. To alleviate any confusion later on, it
is suggested that the note should include both a signature line and a title
line denoting that the person is signing in a representative capacity for
the corporation. If there is any question regarding the signor’s authority
to sign on behalf of the corporation, the creditor may wish to request a
copy of a corporate resolution or other evidence authorizing the
representative’s authority to make a note on behalf of the corporation.
Creditors who are attempting to improve their position even further may
also request that a note be signed by the corporate representative, but also
individually which in essence will represent a guaranty of payment of the
instrument by the individual as well. Depending upon the persistence of the
creditor, and depending upon how much the debtor needs the creditor’s
continued goodwill, the note may offer the creditor an excellent opportunity
to improve its position by not only obtaining a specific rate of interest
and attorney’s fees, but also individual execution of the note by the
corporate principal.
(5) Guaranties.
Guaranties of payment are excellent means of further securing a
creditor’s position. The guaranty may be a personal guaranty executed
individually by the principals of a corporate debtor, or may represent a
guaranty of payment by one individual for the debts of another individual.
Creditors should take careful note of the very specific statute in Kentucky
relating to guaranties. KRS 371.065 provides as follows:
- No guaranty of an indebtedness which either is not written on, or does
not expressly refer to, the instrument or instruments being guaranteed
shall be valid or enforceable unless it is in writing signed by the
guarantor and contains provisions specifying the amount of the maximum
aggregate liability of the guarantor thereunder, and the date on which the
guaranty terminates. Termination of the guaranty on that date should not
affect the liability of the guarantor with respect to: (i) obligations
created or incurred prior to the date; or (ii) extensions or renewals of,
interest accruing on, or fees, costs or expenses incurred with respect to,
the allegations on or after the date.
- Notwithstanding any other provisions of this section, a guaranty may,
in addition to the maximum aggregate liability of the guarantor specified
therein, guarantee payment of interest accruing on the guaranteed
indebtedness, and fees, charges and costs of collecting the guaranteed
indebtedness, including reasonable attorney’s fees, without specifying the
amount of the interest, fees, charges and costs.
As set forth later in this outline, special caution should be made in
regards to guaranties in light of this specific statute. The most
conservative approach is to include a maximum aggregate value and a
termination date in all guaranties. While there may be exceptions to the
application of this statute, the only sure way to know that a guaranty will
be otherwise enforceable would be to include both of these provisions.
Special caution should also be exercised in the manner in which a debtor
signs a personal guaranty. If the creditor is attempting to obtain a
personal guaranty, the creditor should not allow the debtor to insert any
words after his or her name, such as “agent,” “officer,” or any other
capacity that could possibly render the execution of the guaranty ambiguous.
See the attached sample guaranty. A sample guarantee is attached hereto as
Exhibit “A”.
(6) Real estate mortgages.
While debtors may very rarely consent to a mortgage against their real
property, and while these interests are typically granted only to secured
lenders such as banks, there are occasions where unsecured creditors may be
able to negotiate for a mortgage interest.
These situations will obviously only occur in instances of where the
debtor is extremely dependent upon the creditor for additional goods or
services. Mortgages on real estate are extremely technical in nature and in
all likelihood should not be attempted without the assistance of an
attorney. Generally, the debt to be secured by the real estate mortgage
would be reduced to a promissory note, and the promissory note would in
effect be secured by a mortgage on the debtor’s real estate. The mortgage
instrument would be recorded in the county clerk’s office of the county in
which the debtor’s property is located. The mortgage, once recorded, will
obviously be subordinate to any prior recorded mortgages or other
encumbrances against the property, which could include other mortgages or
possibly state and federal tax liens.
While without question it may be difficult for creditors to successfully
negotiate for a real estate mortgage, creditors should not miss the
opportunity to at least request a mortgage interest from a debtor,
particularly in instances of extremely high exposure. As with all of the
tools discussed, a creditor will never receive further security for which
they do not attempt to bargain and negotiate.
V. EFFECTIVE USE OF THE CREDIT APPLICATION
Without question, the credit application can be the creditor’s best
friend. Many creditors will maintain that the particular circumstances of
their business or industry, including increased competition, prevent them
from successfully obtaining credit applications. Those creditors who
successfully obtain credit applications will dramatically improve their
delinquent recoveries and minimize delinquencies overall. There simply is no
substitute for the credit application when it comes to providing important
information about the account as well as establishing the underlying
contract between the parties. See the attached sample credit application.
The credit application not only helps establish specific terms and
conditions of the credit being extended, but also enables the creditor to
accumulate important information about the debtor’s business which may be
much harder, if not impossible to obtain once a full-blown collection
problem should occur. It is amazing how many creditors extend credit in good
faith without ever knowing the correct legal identity of the business to
whom they are extending credit.
The credit application offers an excellent vehicle to determine the
correct legal identity of the account, whether a proprietorship,
partnership, corporation, or possibly limited liability company. If
incorporated, the application should provide for the correct legal name. It
would generally be a good idea to have the account reveal the state of
incorporation, as well as to list any properly registered, or utilized trade
styles or d/b/a’s. An indication as to how long the business has been
actively engaged in business may be important information to know when
making a decision on the initial extension of credit. Many businesses employ
d/b/a’s or trade styles which may be very different from the correct legal
name as listed on the corporate charter and in the records of the Secretary
of State’s office.
Careful effort should be made to ensure that the correct legal name has
been provided. Creditors will find that some accounts will have several
different companies with very similar names, and in these type of instances,
confusions are inevitable. In addition to the correct legal name, the credit
application should include the corporation’s proper tax identification
number.
If the business is a proprietorship, the full name and address of the
proprietor, as well as the proprietor’s social security number, should be
included on the credit application. If a partnership, the names, addresses,
and social security numbers of all partners should be provided. In the case
of a proprietorship or partnership, preferably the home addresses of the
owners should be provided in the event that the business should close and
efforts need to be maintained to locate the former owners.
The credit application should include trade references, as well as
banking information. The credit application should include specific language
authorizing the references, especially the bank, to be contacted for further
verification of the information provided, as well as to inquire further
about the creditworthiness of the applicant. Creditors will find banks in
particular extremely uncooperative unless the bank can be provided a copy of
the authorization to release information. A sample application is attached a
Exhibit “B” which incorporates many of the suggested terms.
(1) A specific agreement for payment of interest or service
charges.
Generally, service or other interest charges are recoverable on a
liquidated amount of money from the date due, at the legal rate of interest
prescribed by the state where the debtor is located. In Kentucky and
Indiana, the legal rate of interest in absence of a specific agreement is
8%. However, it is generally not a good idea to rely upon the legal rate of
interest, as many courts seem unwilling to award any interest on a
liquidated account in the absence of a written agreement to pay these type
of charges. Accordingly, the credit application is an excellent place to
provide a specific term for payment of specific interest charges. Interest
charges of 1.5% to 2% per month seem to be fairly typical and are generally
charged from the date due, or perhaps 30 days thereafter.
(2) Agreements to pay attorney’s fees/collection fees in the event
of default of payment.
Collection charges and attorney’s fees are not enforceable in most
states, including Kentucky and Indiana, unless there is a specific agreement
to pay for these charges. These types of clauses have become standard fare
in virtually all credit applications. Generally, a court will only enforce
what it considers to be reasonable collection charges and/or attorney’s fees
and will not always mirror the actual charges that the creditor may have
agreed to pay its collection agency or attorney. The effective use of these
type of clauses will, however, provide the creditor with additional leverage
and may well enable the creditor to enforce collection in-house, without
placing the matter with an agency or an attorney by simply having this type
of clause in the credit application agreement. A suggested clause may read
as follows:
It is agreed and understood that in the event
of default, which shall include but not be limited to the failure to pay
outstanding invoices in accordance with the terms set forth thereon, that
all costs of collection, including reasonable attorney’s fees, shall be paid
by the applicant in an amount equal to 25% of the outstanding balance,
whether or not suit is filed.
(3) No unauthorized deductions or returns without prior
authorization.
The important point here is to ensure that an account in arrears simply
does not attempt to return goods without authorization or simply takes
deductions against an outstanding balance for alleged credits for defects,
late deliveries, etc. The credit application agreement should provide in no
uncertain terms that no deductions, credits or offsets are allowed without
prior written authorization by the creditor. Equally important should be a
statement to the effect that no returns of merchandise will be authorized or
accepted without the prior written consent and/or issuance of an RGA (return
goods authorization) of the creditor. This type of clause may not prevent an
account from attempting to take unauthorized deductions for credits and may
not dissuade an unhappy customer from simply shipping merchandise back to
the creditor. However, this type of clause may provide important leverage in
court when it comes time to enforce the obligation.
(4) Change of ownership or character of business clause.
Many times an account may be opened as a proprietorship and later
incorporate. The law is clear that when this occurs, unless the account has
made some effort to conceal the fact that it is incorporated, that the mere
incorporation of the business is a matter of public record and, accordingly,
the creditors of the business are on constructive notice of the fact that
the business is now incorporated. There may be very subtle cues when this
process occurs, such as a slight change in the name of the business on its
checks or other innocuous changes relating to the manner in which business
is being conducted. To help protect against instances where substantive
changes in the ownership or nature of the business should occur without the
creditor’s knowledge, this type of clause should be utilized to
affirmatively require the account to provide notice of any substantive
changes in ownership or the nature of the business. A suggested clause is as
follows:
It is understood and agreed that credit is
being extended to the applicant based upon the information provided in this
application, and based upon the creditworthiness of the current ownership.
In the event any changes in the ownership or character of the business
should occur, applicant agrees to provide notice of any changes by certified
mail, return receipt requested to the creditor. Examples of change in
ownership shall be deemed to include but not be limited to the following: (i)
a proprietorship or partnership subsequently incorporating; (ii) a
partnership that is dissolved or which adds or reduces any partners listed
herein; (iii) the sale of a proprietorship or partnership interest; or (iv)
the dissolution or revocation of a corporate charter in the event that
Customer is an incorporated entity.
VI. COMMON TRAPS TO AVOID
(1) Restrictively endorsed checks.
A common ploy utilized by sophisticated debtors is to send a check for
less than the full balance on an account with a restricted endorsement such
as “cashing constitutes payment in full,” or other language, the essence of
which is to attempt to bind the creditor to acceptance of the tendered
instrument as settlement of the outstanding balance in its entirety.
Pursuant to the legal doctrine of accord and satisfaction, acceptance of
such an instrument may in fact constitute settlement in full of the
outstanding balance and bar the creditor from any further attempted recovery
of the remaining balance. Accord and satisfaction essentially provides that
when there is a good faith dispute, and where the creditor is aware of the
dispute, the parties can agree upon a mutual settlement, which is the
accord. The satisfaction of the mutual agreement to settle completes the
process and represents a full and final resolution of the controversy. A
necessary element is, of course, the existence of a good faith dispute and
an agreement, or tacit understanding between the parties to resolve the
dispute.
The Kentucky Court of Appeals had to wrestle with the issue in the case
of Ditch Witch Trenching Co. of Kentucky, Inc. v. C & S Carpentry
Services, Ky. App. 812 S.W.2d 171, where a restrictively endorsed check
was tendered to Ditch Witch for less than the full balance with the
restrictive endorsement “cashing constitutes payment in full.” There is no
question but that the parties were both cognizant of a dispute by the party
that tendered the check, yet when Ditch Witch received the check, it simply
crossed through the restrictive endorsed language, sent a letter notifying
the payor that the check had been accepted as partial payment, and promptly
cashed the check.
The Kentucky Court of Appeals ultimately ruled that the doctrine of
accord and satisfaction in Kentucky had been superceded by pertinent
provisions of the Uniform Commercial Code, specifically Article 1, Section
207, which provides for a reservation of rights between the parties. The
court suggested that by crossing out the restrictive endorsed language, or
in the alternative by the inclusion of the words “without prejudice”or
“under protest” or similar language, coupled with notification to the party
tendering the check that the check had only been accepted as partial
payment, would be sufficient to enable the creditor to preserve their rights
to pursue the remaining balance due on the account.
While the Ditch Witch case is certainly creditor-friendly, and would
appear to allow creditors to cross through restrictive endorsed language on
a check or otherwise “reserve rights,” the case has been tempered somewhat.
Article 1, Section 207, of the Uniform Commercial Code now provides that the
concept of reservation of rights does not apply in instances of an accord
and satisfaction. In addition, there have been more recent cases including
Weickert v. Alliant Health Systems, 954 S.W.2d 314 (1997), where the
Kentucky Supreme Court distinguished that case from the Ditch Witch case and
found that acceptance of a restrictively endorsed check at the creditor’s
depository bank lock box, did in fact represent settlement and satisfaction
in full of the outstanding controversy. It is important to note that in that
case, while there was a bona fide dispute between the parties, the
restrictively endorsed instrument was tendered to a lock box depository. The
Supreme Court of Kentucky found that the creditor’s depository bank lock box
was an agent of the creditor and the mere deposit and acceptance of that
instrument in the lock box account represented a complete accord and
satisfaction, and barred the creditor from any further recovery. The lesson
to be learned from this recent case is that if a creditor utilizes a lock
box, invoices should direct that any communications concerning disputed
debts, including any instruments tendered as satisfaction of any disputed
debt, be sent to a separate address than the lock box. This may appear to be
an onerous burden but creditors will bear the loss where restrictively
endorsed instruments on disputed debts are forwarded to a lock box and
inadvertently accepted.
In summation, while the Ditch Witch case has not been specifically
overruled, creditors should exercise extreme caution when tendered a
restrictively endorsed check. Careful examination of the record should be
made to determine whether or not there is a good faith or bona fide dispute
on the account. If there has been no previous record of any dispute other
than the tender of a check for less than the full balance, the creditor may
be safe in simply crossing out the restrictive language and placing the
words “with reservation of all rights” on the instrument prior to cashing or
depositing the instrument. Immediately upon receipt of the check and at the
time that the deposit is made, the creditor should forward a letter to the
debtor notifying the debtor that the instrument has been accepted as partial
payment and that the creditor reserves all rights to collect the remaining
balance.
In instances where there is a good faith or bona fide dispute and the
creditor is aware of this prior to receipt of the check, or if the check
should be tendered with a specific letter outlining a dispute, the creditor
should not accept and deposit the restrictively endorsed instrument without
recognizing the very real possibility of being barred on any further
recovery.
(2) Missing Mechanic’s Lien deadlines.
Anyone who has supplied labor or materials for the improvement of real
estate should not miss the opportunity to perfect a lien on the property
improved. Mechanic’s Liens can be a very effective remedy to securing
payment in the construction industry. Mechanic’s Lien law is a very
technical and complex area of law, and while the author has prepared lengthy
outlines on the subject of Mechanic’s Lien law, the topic is addressed in
this outline simply to remind businesses who supply labor or materials in
the construction setting to be aware of the deadlines and not allow the
deadlines to expire without taking the appropriate steps to perfect a lien.
In Kentucky where the amount involved is over and above $1,000.00, any
persons who have supplied labor or materials but have not contracted
directly with the owner of the real estate, must provide a written notice of
intent to file a lien within 120 days from the last date of supplying labor
or materials. On instances where the amounts involved is less than
$1,000.00, the pre-lien notice is to be provided within 75 days. Special
note should be made that the pre-lien notice period of 75 days applies to an
owner-occupied single or double family dwelling. Until July 2002, the
required pre-lien notice for owner-occupied single or double family
dwellings was 45 days from the last day that material or labor was
furnished.
Remember that the pre-lien notice is only required in instances of where
labor or material have not been provided directly to the owner. If the
creditor has dealt directly with the owner of the real estate, then pre-lien
notice is not required and the creditor can simply proceed to file the lien
statement. Regardless of whether a pre-lien notice is required, the lien
statement must be filed in the county clerk’s office of the county in which
the real estate is located within six months after the last date that labor
or material is furnished to the property.
Once the lien has been filed, it will represent an encumbrance against
the real estate for one year from the date of filing. Unless a foreclosure
suit is filed to foreclose upon the lien, the lien will expire as a matter
of law one year from the date of its filing. This in essence means that the
lien will no longer be effective for purposes of collection. Creditors
should understand that liens are not absolute. They are extremely technical
and must be perfected according to the black letter of the Law. Even when
properly perfected, liens will not always result in payment. Many times,
timing is everything and even if properly perfected, there could be defenses
to the lien. For instance, in the instances of owner-occupied dwellings,
owners are exempt from the lien to the extent that they have already paid
their contractor for the labor or materials represented by the attempted
lien. It is important to note that this exemption only applies to
owner-occupied property and not projects which may otherwise be commercial
in nature. Creditors should also recognize that while given six months to
perfect a lien by filing in the county clerk’s office, that a conveyance of
the property will eclipse the lien since bona fide purchasers take the
property free and clear of any liens not perfected prior to the date of
purchasing the property. Accordingly, creditors should not wait until the
eleventh hour to attempt to perfect their lien interest. A lien information
sheet is attached hereto as Exhibit “C”.
In addition to Mechanic’s Liens, creditors should be aware that many
construction projects, particularly commercial projects, will include
payment and performance bonds. These may enable the creditor additional
relief and efforts should be made prior to final completion upon the project
to inquire about and obtain copies of any applicable payment bonds that may
offer additional protection. Creditors should take particular notice of the
fact that every state has different lien laws, and if you are providing
labor and/or materials in the construction industry, special note should be
made of the different pre-lien notice and lien filing requirements among the
various states within which the creditor operates.
(3) Reclamation of goods.
A seemingly under-utilized remedy by creditors is the opportunity to
attempt to effect reclamation of goods sold to a buyer who the seller
discovers to be insolvent. Article 2, Section 702, of the Uniform Commercial
Code provides that where a seller discovers a buyer to be insolvent
subsequent to the time that the buyer has received goods on credit, that the
seller may reclaim the goods upon demand made within ten days after the
receipt. If the debtor has made a misrepresentation of its solvency
in
writing within three months before the delivery, then the ten day limitation
does not apply. The most important thing to remember is that timing is
everything in regards to an effort to make a reclamation claim. Creditors
will not often face this scenario but it is certainly possible to ship and
deliver goods, and within ten days of receipt of those goods, to receive a
notification of bankruptcy or other evidence indicating that the buyer is
insolvent. Should this occur, an immediate written notice should be made
since reclamation will only affect the goods delivered within ten days of
the time that the creditor makes the demand. The demand should be made in
writing and should be provided via courier, facsimile, or any other manner
enabling immediate delivery of the notice. The Bankruptcy Code provides that
if notification of bankruptcy is received within the ten day period after
the insolvent buyer’s receipt of the goods, the creditor’s time for
attempting to make demand for reclamation is extended an additional ten days
to effect reclamation.
Creditors should understand that rights to reclaim goods are subject to
the sale of the goods by the insolvent buyer in the ordinary course of
business or other good faith purchasers. Other good faith purchasers can
include properly perfected secured lenders, such as banks and other
financial institutions. While reclamation may be somewhat of a limited
right, creditors should not miss the opportunity to attempt to effect
reclamation if and when the opportunity presents itself.
(4) Improper execution of instruments.
A common debtor tactic, particularly when signing a promissory note or
personal guaranty, is the inclusion of additional words after the
individual’s signature, such as “agent,” “officer,” or any other capacity
such as “president,” “vice-president,” etc. While it seems ridiculous that a
debtor would later attempt to argue that the note or guaranty was signed
only in a representative capacity for the corporate principal, creditors
should understand that this argument is made all the time throughout the
courts of Kentucky. Any ambiguity in regard to the manner in which a note or
guaranty is executed will very likely be resolved in favor of the debtor.
Guaranties in particular are considered somewhat of an extraordinary remedy
under Kentucky law and any confusions or other ambiguities will likely be
resolved against the party attempting to enforce the guaranty.
(5) Unenforceable guaranties.
Creditors should understand that in Kentucky, there is a very specific
statute regarding the enforceability of guaranties. KRS 371.065 would on its
face require any guaranty to include a termination date as well as a maximum
aggregate liability. The statute seems rather poorly written in view of the
fact that it would seemingly exempt any instrument written on or which
refers to the instrument or instruments being guaranteed. Since the term
“instrument” is only defined in the Kentucky Revised Statutes as referring
to a negotiable instrument, arguments could easily be made that a guaranty
of anything other than a negotiable instrument must include a maximum
aggregate value as well as a termination date.
Possible exceptions around the statute could be guaranties that
specifically provide that the guaranty is to be construed according to the
laws of some other state than Kentucky. Many guaranties utilized by
creditors around the country will include a choice of law provision, and
while there are no cases directly on point that have decided the issue in
Kentucky, it would certainly make sense that the parties should be entitled
to contract that another state’s law specifically govern the enforcement of
the guaranty.
Another possible exception to the statute may be guaranties that are
incorporated onto credit applications. There are no cases directly on point
but the author believes that arguments can be made that a guaranty
incorporated onto a credit application satisfies the “written on or refers
to” language of the statute. While the statute specifically uses the term
“instrument,” no court has ruled for certain that the term “instrument” is
to be limited to only negotiable instruments. The legislative intent of the
statute seems to protect guarantors who are remote to the transaction and
who may not otherwise understand the extent of the obligation to which they
have guaranteed themselves.
Nonetheless, creditors should be very caution when obtaining execution of
personal guaranties. The most conservative and easiest resolution is to
provide a maximum aggregate value and a specific time limitation within the
guaranty. This does not require that the guaranty necessarily be enforced
prior to the expiration date, but only means that any credit extension
subsequent to the expiration date or in excess of the maximum aggregate
value will be outside the scope of the guaranty.
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