We recently received a claim for quite a large amount at about six months passed the due date from a regular client we have supported for many years. During our long relationship, I’ve become good friends with the credit manager who has worked at her small distribution company for decades. She is very involved in the credit risk management industry and is deeply knowledgeable and experienced on many credit issues. 

When the claim arrived, the credit manager included a note with the email asking me to call her so that she could give me the “unofficial” background story. Since this was the first time for me to receive this kind of communication from her, I was very curious.

So naturally, I immediately called to hear what’s behind this claim. In a slightly hushed voice, the credit manager explained that we are to tread very lightly, and the reason has to do with the relationship between her president and the debtor. 

It turns out that the debtor has been a longtime friend of the president. They were in the military together, they were at each other’s wedding, and they have often vacationed together with their children. As much as possible the credit manager tried at the outset to persuade the president that the amount of credit being provided be reduced. In her opinion, the friend was not a very good credit risk. The president however was determined to “help out his best buddy.”

I asked the credit manager what the particular problem was, and she responded that the debtor had two other companies declare bankruptcy within the past 5 years. Since the relationship between the president and his friend was long, deep, and still intact, the credit manager wanted us to be as soft with our collection efforts as possible. 

I responded that there is no reason to worry since all of our collection activities and efforts are very professional and that her advanced notice is greatly appreciated. Providing a personalized and customized approach is always part of our service. But I also inquired as to why the debtor was not able to fulfill the obligation and was told that “sales with the friend’s new company did not meet expectations.”

Although that was not unusual, what worried the credit manager (and me) had to do with how this claim is being handled internally. Apparently, the president would like to reclassify this past due A/R as a loan to his friend’s company, rather than a current asset in order to extend the time frame in which the loan could be paid back. In hearing that, I was bewildered. 

I gently inquired as to how this A/R was going to be credited out on their books and reclassified as a loan. Was there going to be a loan agreement drawn up? Her accounting manager was trying to work this out since there are several accounting transactions involved — reversing the entries to sales and A/R, as well as setting up and debiting the customer loan account and crediting cash, or some other asset account that could also be acceptable. It was getting complicated.

To make matters even more confounding, their bank is going to be auditing their financial statements in about one month to support their current revolving loan needs. Trying now to backtrack on this transaction, attempting to account for it other than a bad sale, appears to be entering into a zone of legal precariousness. 

Upon hearing the background and revelations concerning this claim, I expressed to the credit manager that perhaps we need to hold off on any direct collection efforts for the time being. I instead offered a couple of ideas for consideration. 

1) Since the credit manager has worked at the company a long time and assuming she has a good relationship with the president, I suggested that she, and perhaps with someone of her rank or above, try to talk frankly to him about the proper way to handle this situation. In view of the upcoming audit, attempting to rewrite the whole transaction could impact their creditability and borrowing capacity. Moreover, it could open themselves up to serious financial and legal repercussions. 

2) I would be very pleased to talk with the president’s friend to find out why sales didn’t meet expectations and under a consulting arrangement, try to offer ideas, and perhaps even a sales route, that could get sales moving. Or discuss other ways that might improve the business situation. Perhaps out of embarrassment, the friend hasn’t discussed many of the details with the president that an unrelated third party might be allowed to hear. 

Whether a company is large or small, personal relationships can have a direct impact on how internal protocols and controls are maintained. Sometimes it’s alright to stretch the envelope a little bit, if the materiality is something that will not raise any eyebrows and bring about any legal risks. But when the envelope is stretched to the point of tearing, it’s time to take a step back and reevaluate the potential damage that a personal relationship may cause. 

Your questions and comments are most welcome (nseiverd@cmiweb.com).

All Rights Reserved

Nancy Seiverd, President, CMI Credit Mediators, Inc.

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