The Bad Debt Trap

 Businesses in Cayman are grappling with the economic situation. Many companies find it hard to generate new business and struggle to maintain the status quo. With cash flows depressed and loans hard to come by, Cayman’s economy is facing a vicious cycle caused by a phenomenon that gets increasingly worse during a recession: bad debt – the inability or unwillingness of clients and contract partners to pay invoices on time or in full.
   When businesses do not pay their bills the knock-on effect is often severe for the creditors, who in turn might default on their liabilities or find themselves in a position where it becomes difficult to pay wages, pensions or healthcare. At the very least businesses that are owed money will face higher financing costs and a strain on their cash flow.
   Bad debt, whether as a result of an economic downturn or a general disinclination to settle debt, quickly permeates through the economy gradually increasing the problems.
   Local businessman Sam Small says he has two firms, a consulting firm and a contracting firm: “The consulting firm is owed close to $100,000. Most of my colleagues, they tell me that’s very good. And the construction firm is owed about half a million.”
   After having spoken to other firms and suppliers, Small believes it is a wider problem that affects more than just his own business.
   “I have spoken to a friend of mine who is the principal at an architectural firm. They are owed over a million dollars in fees.”
   Especially the gentlemanly type, he finds, “the type that did the handshake the old-fashioned Caymanian style, some of them are owed a million to two million dollars.” Often this debt has built up over many years.
   Small does not ascribe the problem to the difficult economic situation alone. He believes some people are taking advantage of businesses with less stringent credit policies and also from the fact that business in Cayman is based on giving credit.
   This is precisely the reason why the Cayman Islands National Credit Bureau advocates that businesses need to implement a sound credit policy, says its Director Rayal Bodden. “In today’s business environment you definitely need to have agreements in place with your clients, to set out your terms of engagement.”
   The Credit Bureau, a private organisation, provides debt collection services and credit reporting to member companies. Member companies inform the Credit Bureau on their delinquent debtors and share this data with other members. Companies planning to extend credit to someone can contact the Credit Bureau for a credit history of the potential clients or customer.
   Given the current economic climate, Bodden agrees that demand for debt collection has picked up.
   Asked whether there are also debtors who are savvy at trying to exploit how difficult it can be to collect bad debt, he says: “I suspect it is a combination of the two.” He adds that another reason for not paying is that people don’t believe that they get value for money. Particularly in the construction industry the costs involved are often misunderstood and underestimated, he says.
   Mr Bodden, who has experience in construction, says that difficulties in collecting debt in the construction industry were part of the motivation for starting the Credit Bureau.
   “The construction industry is unregulated in the Cayman Islands in the sense that anyone can get a construction licence,” he says, explaining that there are people who do not understand how to run a construction business and who initially charge very low prices. These costs then either increase or lead to questions of overcharging with regard to established, reputable construction firms that produce high quality work.
    “But the construction industry is much more technical in nature. You have to get experts involved to assess what the true costs,” Bodden says and insists that the Credit Bureau does not serve the construction industry in particular, but any type of industry.
   In Sam Small’s experience it is always the last payments that get delayed or dodged entirely. He lays out a typical scenario, according to which the construction firm does its job and a certificate of occupancy is issued to the customer. “Once [customers] can occupy their building, they are in no hurry to pay you. So it does not matter how well you have protected yourself, it is getting the last final payment out of the person, which may be somewhere between $50,000 and $100,000.”
   While it may be possible to reduce that debt over time, he says, as soon as it reaches the $5,000 to $10,000 range some customers just don’t pay. “It does not matter how many emails you send and how many phone calls you make.”
   In other cases, the debt stays just above $20,000, making it much more difficult to enforce a debt, due to the structure of Cayman’s legal system.
Going to the courts
   One of the problems with bad debt is that unless a debt is enforced through a collection agency or through the courts, paying late does not carry a penalty, in terms of legal or debt collection fees that are added to the debt. Delaying payment is therefore an often employed strategy.
   If a debtor is taken to court by the creditor a debt of less than $20,000 will be referred to the Summary Court, whereas cases involving amounts higher than $20,000 tend to be heard before the Grand Court.
   “If you have to go to Grand Court you [potentially] have to risk $50,000 of your money to recover $20,000 or $25,000 of debt and some people know this and they just refuse to pay you,” says Small.
   Taking the matter to the Summary Court is more straight-forward, but by no means cheap. Small, who has successfully taken several cases to court says in his experience it costs between $1,500 and $3,000 in legal and court fees to take someone to Summary Court, of which most but not all will be refunded if the case is found in favour of the creditor.
   In all it cost him, Small says, citing three cases, $2,000 to recover $15,000.
   One of the most crucial factors a claimant must take into consideration when deciding whether or not to pursue a case is that, even if the court finds in favour of the claimant not necessarily all of the legal costs will be paid by the defendant. The debtor will only be responsible for reasonable costs.  “The issue of what is reasonable is often determined by the Taxing Officer.  The courts are reluctant to award significant costs for insignificant debts and so the person may find themselves in a situation where they are worse off financially even though they may have won the case,” says Jamal Young, managing partner at Goldfield Cayman.
   Bodden says it is possible to get a judgment fairly quickly, if the defendant does not respond. “But then you have to enforce the judgement and that involves going to Grand Court to get a garnishment of wages or some other similar arrangement. That is where it becomes tricky.” For example, if a garnishment of wages is enforced and someone changes their job, technically, the creditor has to apply to the courts again for a new garnishment of wages for the new employer. This will once again involve the payment of application and administrative fees.
   Young agrees that the litigant’s worries are not necessarily over when a judgment has been obtained. “There is still the possibility that the order will not be obeyed by the defendant. Then the Grand Court may have to be called upon to assist a successful litigant to enforce compliance by their opponent when they have failed to comply with a judgment made against them.” There are, however, many ways of enforcing such judgments, he says.
   Bodden finds that an advantage of filing a case in court is that it becomes public record and that is often motivation enough for the debtor to settle the debt.
   However, Young says that he always advises clients to take into account the costs and fees associated with going to court prior to initiating proceedings. “I would advise the client to think long and hard before going down the route of litigation.” This applies particularly to cases where the debt is so nominal that ultimately the costs will eclipse the money owed. Inquiries should also be made into the solvency of the defendant, he says. “If the Defendant simply has no money or no assets, litigation can prove to be an exercise in futility.”
How to recover debt
   The Credit Bureau recommends having a sound credit policy in place. This begins with a credit application that has to be signed by the debtor, giving the creditor the right to verify the information submitted by the debtor to check the credit scores of any new customer or client.
   In Cayman the only service that provides credit reports is the Credit Bureau. Based on the report the creditor can set appropriate credit limits, but when no credit report is available, setting the limit must be based on other information such as bank references.
   Once a credit limit has been set, it is advisable that initially at least all outstanding invoices must be settled before a credit limit can be extended. The credit limit should then be updated regularly, by re-checking the credit scores.
   In addition a business should set out the credit terms, which typically are 30 days from the date of invoice. If the payment is not received by the due date, a late charge of for instance 1.5 per cent per month, i.e. 18 per cent per year is added to the payment amount. These late fees or finance charges can only be applied if they have been set out in the credit terms.
   The company’s clients should be reminded of the credit terms from the outset. At the same time services rendered by the creditor should be defined as well.
   Some bad debt is settled when a finance charge is added, says Small. Even though the finance charge does not get paid, it often springs the delinquent customer into action to pay the invoice, he finds.
   “If that does not work you carry on for another 90 to 180 days and refer it to the debt collection agency,” says Small.
   “We recommend getting in early as a debt collection agency, because the older the debt is the more difficult it gets to collect that debt,” says Bodden.
   According to him, the Credit Bureau typically encounters three types of debtors. There are those that will pay once the Credit Bureau is engaged, he explains. Then there are debtors that are willing to pay, but they are unable to settle the debt in full. For this type of debtor the Credit Bureau must find a different arrangement such as a payment plan that ensures the debt is recovered over time. The last group, however, is the type that either has left the Island or continues to ignore attempts to recover the debt, even going to great lengths such as changing address or switching jobs.
   He says the Credit Bureau always advises member companies on the collection probability and the status of individual cases.
   Membership of the National Credit Bureau costs $500 and individual credit reports range from $10 to $50, depending on how extensive they are. The debt collection services of the Credit Bureau are performance based and added to the amount that is owed and deducted from the collected debt. Essentially this means the charges of roughly 25 per cent of the recovered value are only charged if a debt is collected. “So there are no charges to our members during our efforts,” says Bodden.
   There is, however, one catch to that. The creditor members must have a clause in their agreement which allows them to add debt collection fees if due invoices are not paid within a specified time frame. Their client must have signed off the agreement in the terms and conditions.
The main issue with bad debt is that much of the business culture in Cayman, just like elsewhere, is built on credit. Some creditors believe that if they collect the debt too forcefully, they will not receive any follow-up contracts or work, says Small. Companies therefore might find it difficult to implement certain credit terms, because they feel that business may be lost if the market is not ready. While it is certainly important to check the practices of competitors, this type of thinking is the root of the problem.

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