Brief Introduction About Collection Agreement
When the debt owed by a person or a company remains unpaid for a long time and appears uncertain, the lender can either assign that debt or sell a part of the entire debt to a collection agency or a collection individual. They are known as the collector. The lender enters into a collection services agreement or debt collection agreement with the collector for the collection of the debtor’s account receivables.
What is a Collection Agreement?
A collection contract is a legally binding agreement between the client (usually the lender) and the collector. Through this agreement, the client assigns the collector to buy or recover the debt that the former has advanced. It lays down the conditions of the arrangement under which the collector works for a certain fee. They may also enter into a collection account management agreement as a part of the collection contract. Under this agreement, the debt that is collected is kept for an accounting of all the transactions that take place between the debtor and the collector.
Purpose of a Collection Agreement
The collection agreement acts as an effective tool for restructuring the debt for the client. When a part of the debt or the entire debt is sold or assigned to the collector, the client does not lose further time or money on collecting the debt itself. This ensures that it can concentrate on running its primary business efficiently. With the collector having the sole business of collecting debts, the client can get better returns, which it would otherwise not have gathered had it recovered the debt itself. Selling or assigning the debt to a third party under this agreement also improves the client’s balance sheets.
Contents of a Collection Agreement
It generally includes the following key terms:
- Names of the parties
- Date of the agreement
- Definition of terms used in the agreement
- Scope of work- this clause should mention the accounts to be recovered, and the time and manner in which they should be recovered.
- Details of the accounts to be recovered.
- Term of the agreement
- Payment details
- Representation and warranties by the parties
- Obligations of the parties
- Confidentiality of information
- Mutual indemnification
- Independent contractor relationship
- Notice requirements
- Dispute resolution
- Governing law of the agreement
- Signature of the parties
How to Draft a Collection Agreement?
The following points should be kept in mind while drafting the agreement:
- Since it may involve an individual or a company, their legal names must be correctly mentioned along with their registered business address.
- All the terms, as well as other documents, agreements, and accounts referred to in the agreement, must be clearly defined. There should be no confusion about the meaning of a term.
- Under the ‘Scope of Work’ clause, it should be clearly stated that collectors shall use best efforts, keeping in mind the reputation of the client, to recover the account.
- The payment details should be clearly mentioned- whether it has to be a one-time payment or duration-based or linked with the number and value of the accounts recovered.
- The client’s accounts carry vital information about their financial status. There should be a confidentiality clause so that the collector can keep the information of all the accounts of the client confidential.
- Since the recovery of an account is not certain and depends on various contingencies, both parties should chalk out a definite plan to indemnify each other in case of losses.
- The relationship between the parties should be clearly defined. The collector should act in an independent capacity and not as an employee or agent of the client, for carrying out the recovery smoothly.
- The ‘governing law’ clause should mention the state whose law will be used by the parties to interpret the agreement. In case there is a dispute, a claim can be filed in the local court of the state.
[Also Read: Debt Restructuring Agreement]
A debt collection contract such as this may have huge sums of money at stake. Thus, it is pertinent that both the client and the collector negotiate with utmost care and diligence.
The client should make sure that it gets the best return for the uncertain account (or accounts) in the minimum span of time. It should compare the payment to be given to the collector with the value of the account or accounts attached. On the other hand, the collector should compare the risk associated with the accounts to be recovered and then negotiate accordingly. Accounts carrying higher risks should warrant higher fees and vice versa.
Benefits and Drawbacks of a Collection Agreement
- It allows the client to effectively manage its lendings and uncertain accounts and concentrate on its primary business activities.
- It allows a whole new business avenue for collectors where they can collect debts and charge a fee.
- Sometimes, the account may not be recovered. Thus it would be a loss to the collectors when they buy or get assigned to such accounts.
- The client may lose the accounts sold or assigned to the collector in case the entire account gets recovered to the fullest.
What Happens If the Agreement Is Violated?
In case of a violation, the aggrieved party can terminate the agreement(1). The proceedings will continue, as mentioned in the agreement. The agreement will generally state what relief a party can seek from the courts or tribunals. The relief may vary from injunction to specific performance, or any other relief agreed between the parties.
A collection agreement serves as an important document to enable the parties to work efficiently. It must comply with all applicable federal and state laws(2). While the parties can draft it themselves, it is better to get it reviewed by a lawyer or use the document from a credible source.