A good compliance system can help protect a business from dishonest debtors | In Principle

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A good compliance system can help protect a business from dishonest debtors

Pursuing claims and recovering debts is a legitimate right of every creditor, as is checking partners’ credibility. But this should be done wisely and prudently. Not only money is at stake, but also reputation, says Jarosław Szeląg, legal director and compliance officer at a financial institution operating in the automotive market.

Adam Studziński: You agreed to talk to us about problems that, from the point of view of compliance rules, may arise for a business affected by debtors’ dishonesty.

Jaroslaw Szeląg: Yes, as in my opinion, the topic is timely and important.

First, a general remark. Conducting a business, regardless of its scale, naturally involves incurring debts and, on the other hand, awaiting payments by counterparties. Frequently, lesser or greater delays occur. Unfortunately, there are also those who consider delaying payments to be a natural form of financing, and those who do not intend to pay at all, unless they are forced to do so by a really dire situation.

Therefore, we constantly have to ask ourselves how a potential (or current) creditor should behave in order not to be wrongfooted in a clash with such a dishonest debtor. It should also be looked at from the risk management perspective, i.e. non-compliance, the negative consequences for the creditor due to lack of compliance with legal regulations, regulators’ expectations, good market practices or ethical principles.

Should the compliance rules somehow affect the behaviour of a creditor exposed to a dishonest debtor’s behaviour?

Especially in the case of larger businesses, compliance with broadly defined standards of proper conduct requires a holistic and systemic approach, creating an internal system of rules and procedures covering all key areas of the company’s operations. This is especially true for relationships with potential and actual debtors, from establishment, through ongoing management, to termination, whether in a natural manner or requiring more resolute actions on the creditor’s part.

At the outset, a properly designed compliance system should specify how the company will check potential and actual partners or customers. There are many methods for doing so. Their availability and usefulness will depend on many aspects specific to the company and the market in which it operates. Internal procedures should specify in detail which methods should be used, and at what point (e.g. at what stage of the relationship with the debtor), reflecting the nature of the business partner or client (especially when the client is a consumer with special legal protection), the type of goods or services offered, and the duration of the relationships established by the business.

Can compliance rules prohibit certain risky business relationships even if they are generally legal?

Yes, among other things, a system of compliance standards should indicate types of business partners who should be rejected in advance, so no relations are established with them at all. The reason for rejection might be listing of the potential debtor in the National Debtors Register or a specific score from the Credit Information Bureau. The exact criteria will depend on the business’s appetite for risk of non-payment, but also on the compliance policy defined by management. It can and should preclude a business from entering into relationships with entities for which credible information from independent sources (as defined in the company’s procedures) shows they are unreliable at paying their debts, or have ties to other dishonest debtors or, more generally, problems with obeying the law. In short order, general problems with legal compliance can translate into problems with making payments, for example if the entity is subject to high and immediately enforceable administrative fines for violating consumer or competition law or money laundering.

Apart from the company’s concern for its own debt portfolio, prior clear and precise definitions of the criteria for accepting (or excluding) potential debtors may protect the company from getting entangled in a relationship that, beyond tangible financial losses, may harm the company’s reputation on the market or in society. Especially now, when negative opinions about an entity can spread on the internet at the speed of light, this aspect cannot be overestimated.

Can a compliance system reduce the risk of dishonest behaviour by debtors with whom the company already has business relations?

By all means, internal compliance regulations should promote the monitoring of debtors’ behaviour throughout their cooperation. Again, according to the partner’s characteristics and the subject of the relationship, defining the right methods and criteria for this purpose will enable detection of negative signals regarding the debtor’s financial condition early on, and anticipation of their possible behaviour, including potentially dishonest actions. Compliance procedures in this area should also specify in detail what kind of provisions should be included in the contract at the beginning of the relationship to help ensure appropriate standards of cooperation, e.g. precise payment terms and the consequences of failure to meet them (with possible escalation in the event of prolonged delay), the obligation of the other party to regularly provide reliable information on its financial condition, and the creditor’s right to conduct inspections at the debtor’s premises and obtain additional data, or demand additional security in contractually defined situations.

This way, by appropriately formulating the contract proposed to a partner, the company informs them in advance that it is aware of, or will learn about, the partner’s financial condition and, for example, previous repayment history. Just knowing that one will be verified can discourage at least some who do not fully intend to act fairly in the future. Here, full transparency is not necessarily recommended—it is definitely worth keeping to oneself the details of the criteria or evaluation methods to be followed, or the level of our appetite for risk. But a clear message alone, given early enough, signalling “I trust, but I verify, and I do it effectively,” is the most advisable towards every counterparty. This is true even when in the particular case, the signal is something of a bluff, as for example when the expected scale of the dealings would not make it profitable to order a business intelligence report on the counterparty.

Can compliance rules determine the procedure to be followed if problems with debtors materialise? Perhaps they should?

The compliance system should also detail the methods of dealing with debtors who fail to meet their obligations, especially if they do so in a dishonest and unfair manner. In my opinion, these rules should promote amicable methods of dealing with partners who openly and well in advance raise issues about potential payment problems, and cooperate with the creditor to establish mutually agreeable terms of repayment. At the same time, these standards should imply an intolerance of dishonest behaviour aimed at the debtor’s concealing or stripping assets to the detriment of the creditor. If such unlawful or unethical behaviour is identified, these procedures should lead to the involvement of third parties relevant to the given stage, from professionals specialising in protection of creditors (law firms, business intelligence agencies, debt collection companies) to law enforcement authorities, and in justified cases also for example, in Poland, the General Inspector of Financial Information (when there is a suspicion of money laundering, which cannot be ruled out in a situation where the debtor tries, for example, to transfer fraudulently obtained assets to other people).

Here, too, as part of broader loss prevention and encouragement of honest behaviour by counterparties, I believe it would be appropriate to inform counterparties in advance of principles and procedures used for dealing with debtors—naturally, only to the extent necessary to show what values and attitudes on their part we will support and what we will not tolerate.

Interview by Adam Studziński