Its Trial Time Do You Know What Your Documents Say
You're in bankruptcy court. You're watching an attorney valiantly litigating a claim objection. The attorney is trying to show that the creditor is owed around $1 million. As is growing more common in these electronic times, only one piece of paper documents the entire transaction. The company filing the proof of claim is not shown as the seller and the debtor is not listed as the buyer (although affiliates of each were). The company shown receiving the merchandise is not the debtor and the terms of the sale and balance owed are disputed. The attorney struggles to have the witness describe "the deal," while the trustee's attorney impersonates a jack-in-the-box by standing and objecting to every question.
This is not a pretty sight. It is uglier when you are the claimant watching your attorney. It gets even worse when the claim must be allowed for your company to survive (or maybe just your hope for a bonus). It is not a pretty picture.
I was in bankruptcy court last week watching something almost that scary. Feeling sorry for the attorney came quite easily. We have all been in a similar situation at one time or another.
For some reason that may never be fully understood (even if it could be explained), the documents created at the time simply do not match one party's understanding of the deal. It could be that the customer name has changed many times (through acquisitions or simple name changes) and the credit department never updated the file. Perhaps the credit department was never told or it never did any follow-up work to confirm the customer information since its database was created. Or, it could be that the sales representative was more interested in booking a sale than getting clean documentation. At this point, it does not matter because you will bear the consequences of collecting the account or writing off a substantial receivable.
It should be second nature for a credit department to periodically verify account information. Public companies have their auditors verify certain receivables' information for selected accounts each year. This annual review frequently catches problems such as these. However, credit managers cannot abdicate this responsibility to auditors. Contrary to popular belief, auditors are more responsible for opining that the financial statement fairly presents how many horses actually left the barn rather than keeping them from leaving in the first place.1
Procedures are only as good as those implementing them. This is where training and consistency work to your advantage.
An overview of the Uniform Commercial Code's documentation requirements will help.2 First, the general rule is that "...a contract for the sale of goods for the price of $500 or more is not enforceable by way of action or defense unless there is some writing sufficient to indicate that a contract for sale has been made..."3 There are a number of exceptions to the general rule that credit managers must keep in mind.
A confirming document between the parties can show that a contract existed if both are "merchants."4 UCC §2-201(b). The recipient of the confirmation must dispute it in writing within 10 days or will be bound by the terms in the confirmation.
If, for some reason, none of these exist, there are still three ways to prove the agreement between the parties. To prove an oral agreement, you must show that (a) the goods are specially manufactured for the buyer, are not suitable for sale to other customers and the manufacturing process is underway or is acquiring the material to begin; (b) the defaulting party admits in a court filing or testimony that an agreement existed; or (c) where either payment was made and accepted or the goods were received and accepted. UCC §2-201(c).
UCC §2-201 incorporates the "Statute of Frauds," which, in one form or another, dates back to the English Statute titled "An Act for the Prevention of Frauds and Perjuries" and enacted in 1677.5 As its name implies, it was enacted to prevent fraud by requiring that certain contracts be written during a time when few were literate.
Assuming that you can pass this substantial hurdle, you then must deal with UCC §2-202. This is known as the "Parol Evidence Rule,"6 which is a fancy way of dictating when you can and when you cannot have testimony about a written agreement. If there is a confirmatory memorandum (which was not objected to) or a written agreement with the "final terms" of the deal, the documents may not be contradicted by evidence of a prior agreement. It may not be contradicted by "contemporaneous oral agreement," which is the classic "handshake deal" where the parties write down one thing, yet one says that they will do something different.
The Parol Evidence Rule does not prevent evidence to explain or supplement the written terms. This can be provided in the form of what is common in the industry or between these parties ("usage of trade" or "course of dealing"). Parol evidence of additional terms that are consistent with the written terms is permitted unless the court finds that the writing was intended to be the exclusive statement of the parties' agreement.
Forms must accurately identify the parties and the terms of the "deal." This should be the easiest part to control since each company should generate only accurate and complete forms.7
Procedures are only as good as those implementing them (or as good as the punishment is severe for not following them). This is where training and consistency work to your advantage. Perhaps even convincing the folks in the big offices to require the sales department to attend trials involving their bad accounts (like the one we started with) instead of sending the credit manager to suffer alone would be a good start. It might even help get the forms completed correctly the next time.
1 While auditors can, and frequently do, make recommendations to improve companies' financial controls, their primary responsibility is opining on whether the financial statements fairly present the financial condition and results of operations as of a certain date using generally accepted accounting principles. Return to article
2 The Uniform Commercial Code (UCC) has now been adopted by all 50 states. However, some states modified various provisions of the UCC (which makes the term "uniform" an interesting anachronism). Return to article
5 Restatement, Second, Contracts, Chapter 5, Statutory Note. Interestingly, the Statute of Frauds also applies to require written contracts for transactions affecting real property, those not performable in a year and those promising marriage. Return to article
6 This term is pronounced like, yet should not be confused with "parole," which is when a person is serving part of a criminal sentence out of jail. It refers to evidence in the form of both oral testimony and written documents. Return to article