The National List of Attorneys - Buying Charged-off Accounts
The article below was published in The National List of Attorneys
May 2008 Developing A Collection Practice booklet
Advice for Attorneys Who Want to Start Buying Charged-off Accounts
By: Jacques A. Machol, III
Linebarger Goggan Blair & Sampson, LLP
It was 1999, a year in which I watched in amazement as my debt buying client purchased a Rolls Royce! Understanding the reasons for my surprise requires knowledge of related events that occurred a few short years earlier. At that time, I was working in a collection practice with my father and Randy Johannes. The law firm was growing and collectors were routinely being hired. A well-qualified individual applied for a collector position within the firm. He was offered the position but didn’t accept it because he wanted several hundred dollars more per month in base salary than other the collectors were being paid. Experience has taught me that such a practice has negative consequences in the long run and I stood by my decision.
A few months later the same individual contacted me, offering to hire me for the purpose of collecting charge-off accounts that were in the process of being purchased by a newly formed group, I accepted the work. In a short time, the volume of placements and the firm’s collections increased. Witnessing the success of this individual in this endeavor and being particularly impressed with the Rolls Royce he purchased, I asked him to assist me with entering the debt buying business myself.
An investor group was formed in 1999 and $500,000 in working capital was raised. The funds were spent on a single purchase of three branches of debt all of which fell into primary, secondary and tertiary categories. Collections started out slowly, causing panic in the group. We learned later that the accounts had been re-traded several times and extensive front-end collection work had been done already. The solution to this problem was a decision to step up skip tracing and litigation efforts. I am happy to report those efforts were successful and resulted in the portfolios yielding a significant multiple of the initial purchase price. That in turn, spawned the formation of many investor groups and continued the refinement of the debt buying and collection process.
Advice for those contemplating a similar purchase:
- Don’t “put all of your eggs in one basket” nor buy just one egg. If my first purchase would not have been successful, my debt buying effort would have ended because all of the money raised was expended in a single purchase. It is important to purchase a large number of accounts to spread the risk inherent in a debt buying effort. For example, if 20 accounts are purchased and two are collected, the collection rate is 10 percent. If those same two accounts filed bankruptcy instead of paying, the bankruptcy rate would have been 10 percent. The point here is that purchasing too many or too few accounts increases the risk. Consistent monthly purchases will produce the best results.
- Purchase only the type of debt with which you are familiar collecting. There are plenty from which to choose because a wide variety of debt types are now being sold: credit card accounts, payday loans, bad checks, overdraft checking accounts, installment loans, auto deficiency accounts, first and second mortgages, and defaulted health club memberships are a few examples. Evaluate your office’s client collection data and determine what types of debt your office is familiar with.
- Purchase accounts with media available. Many courts are expecting debt buyers to provide supporting claim documentation. Some credit card issuers are now selling portfolios to their largest debt buyers, which come with statement copies and account applications. Inquire about media availability and be sure that the seller makes clear representations in the sale contract about media availability.
- Ask questions. Obtaining a seller survey is common practice. Key considerations include: How were accounts originated? Are the accounts prime or sub prime? What prior collection efforts were applied? Were the accounts scored by the seller and highest scored accounts excluded from the sale? What settlement letters and discounts were previously offered? How many months have passed since charge-off? What balance ranges make up the portfolio? Look at the date of last payment. Accounts that do not list a date of last payment are likely to be accounts where the debtor never made the first payment. Such accounts may possibly indicate fraud.
- Learn the many facets of debt buying. The debt buying industry is extremely friendly and willing to share information; all you have to do is ask for help. Visit the offices of debt buying attorneys or agencies to see how the process works. Speak with debt brokers to learn more about the industry; do not forget to ask to be introduced to other debt buyers. Debt brokers and debt buyers will be pleased to answer questions and share information. A large number of debt broker options exist. Online resources such as www.narca.org or www.dbainternational.org will help you to find them.
- Be aware of contract and licensing. Hiring an experienced attorney to review the purchase contract is one of the best investments you can make. Don’t forget to form a separate legal entity to purchase the debt. Some states now require debt buyers to be licensed.
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Develop your collection plan. Does your collection process include the following?
- Scrubbing the portfolio for bankrupt and deceased accounts?
- Using an account-scoring product? Credit bureaus and specialized analytical companies offer different scoring products to select the accounts that are most likely to pay.
- Skip tracing? Finding debtors and assets are keys to success in the collection effort. This is especially true for debt buying.
- Phone calls, letters, and litigation? All aspects of the collection process must comply with applicable debt collection laws, including the Fair Debt Collection Practices Act.
- Re-trading a portion of the accounts that you purchase? This will boost your internal rate of return.
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Placing the accounts with other collectors or collection agencies? If your office has exhausted every reasonable effort without success, hand it off to another collector or collection entity.
Start out with low profit expectations and plan on making mistakes. Be sure you make only small mistakes and learn from those mistakes.
Executive Summary
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There are plenty of risks associated with the purchase and servicing of charge-off accounts that can be minimized or avoided altogether with good planning and diligence.
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Many new debt types are now being sold on the market, expanding the universe of choices available to firms.
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Online resources are available to answer questions and augment customary avenues of help and assistance for firms and others engaged in or desiring to get into this practice.
About the author:
Jacques A. Machol, III graduated from the University of Denver in 1977 and has been licensed as an attorney by the State of Colorado since 1977. He frequently speaks to lawyer and creditor groups about collection matters and debt buying. As a founder of Harvest Credit Management, LLC and later Option Card, LLC, Mr. Machol has extensive experience in purchasing and collecting debt portfolios.