What is going on in your debtor's head?
This article first appeared in MG Business in February 2009
I've just had a big burst of reading credit management-related court cases over the holidays. It's important for me to keep up with new credit law decisions, but in reality, the main reason I read them is for the stories of debtor and creditor behaviour so I can better understand what's going on in their heads.
For example, over the last couple of days, the debtors I've read about have ranged from, at one extreme, a man whose wife was badly injured in a car accident in Queensland. A brain injury has kept her "in a persistent vegetative state" since the accident. The husband became insanely obsessed with writing letters seeking "justice" from an insurance company. A $300,000 payout he received has disappeared; no-one knows what happened to it and he denies that he ever received it. The case was about government agencies taking control of the remaining assets of a man who refuses to look after himself.
A completely different case was an Auckland property developer who had guaranteed projects worth $28 million and who claimed to have assets of only $15,000. His creditors had voted in favour of a formal scheme of arrangement to let him off half of his debt and let him pay the rest at some time in the future. One of many problems with this was that he and the insolvency practitioner he had appointed had failed to tell some of his major creditors about the meeting.
Here's another tale of a debtor, this one from real life. I've disguised important details to mask identity. "Mrs Smith" is a nice person, and intelligent, but always struggling for money. She was always badly in debt and was often pursued by creditors. When I knew her well, as far as I could see, she tried to do the right thing by them, at least as she got older and more responsible.
She worked very hard - long hours in several jobs, with a few little business ventures on the side. The reason she was always in debt was that she was always buying things. Her purchases were often wonderful bargains, but they weren't always things she needed right at that time, and they were never things she could easily afford. She saw most of them as long term investments or things that she would need and use some day. Although she was intelligent, she had blind spots, and she was always able to rationalise the purchase of "investments" even though her pressing issue was immediate cash flow, not long term security.
Banks refer to people who buy using their credit cards but pay off the card before the interest kicks in as "freeloaders". Mrs Smith was never a freeloader. Her credit cards were always close to the max and she paid huge amounts of interest on them. She found it very hard to pass up a bargain. Her friends tried to help but there was an addictive element to her actions. The obvious answer was to stop buying things. Sometimes, when things had got particularly desperate, she'd stop buying for a while, but then she'd catch up a bit and start spending again. Good advice wasn't enough to change her behaviour.
Another option, of course, was to sell some of the things she had bought. Instead of working so hard and getting nowhere, she could have cleared her debts by selling some assets. However, she found it hard to part with her treasures. Also, she was too busy working to find the time to do it! She sold a few things but when it came to the really valuable things, she was more likely to give them as presents ("heirlooms") to her adult children than to turn them into cash.
Finally, it reached the point where a shrewd creditor insisted on a substantial payment and pinpointed a particular asset that needed to be sold. She stopped working long enough to see what was required, worked through the process and sold this asset, which had appreciated considerably. For a brief moment, her debts were cleared and she had cash in the bank. Soon she found more treasures to spend the money on, but let's end the story there.
My first point about this tale is that if you were one of Mrs Smith's creditors, you couldn't have easily understood what was going on. The temptation would have been to categorise her as a ratbag, or lazy, or something else which she wasn't. In order to work out that there were saleable assets you would have had to have asked more questions and talked to her about her situation for longer than most of her creditors did.
Over the next few years, creditors will have to try very hard to understand their debtors. They will be seeing a lot of debtors, business and consumer, who have never had financial problems before. Credit staff have to invest time and attention to try to understand what's going on in their lives and in their heads, so that they can then try to push them towards workable solutions.
My second point: there are going to be many people and businesses who, although not necessarily for the same reasons as Mrs Smith, will be asset-rich but cash-poor. There will be many people who have valuable assets - a vintage car in the garage, a block of land by the beach, equity in their own home, their prized collection of 1000 Matchbox cars - but banks aren't lending and people aren't buying. They can't immediately sell it or borrow on it to pay the bills that were due yesterday, but that doesn't make it worthless. Credit staff need to understand this opportunity. You would obviously prefer the cash, but if you can't get it now, a security over something that can eventually be turned into cash is the next best thing.
One last important point: understanding your debtors, negotiating deals, and setting up securities is time-consuming stuff. Businesses have to give the credit team the support to do this. That may mean more staff. The way many businesses will deal with this in tough times is by moving underused sales staff into temporary debt collection roles.
Peter Hattaway - www.hattaways.com - is a director of Hattaways, specialists in credit management training and consulting.