iiihi Mercantile Credits A Series of Practical Lectures Delivered Before the Young Men s Christian Association of Los Angeles^ California BY M. Martin Kallman; Alfred K. Care; J. M. Elliott; Herman Flatau ; E. R. Purdy; C. A. Parmalee ; W. C. Mushet; N. P. Conrey ; Lee C. Gates; W. J. Ford; F. C. DeLano; W. T. Craig; Warren C. Ken- nedy; Frank G. Finlayson NEW YORK THE RONALD PRESS COMPANY 1914 Copyright, 1914, by THE RONALD PRESS COMPANY PREFACE The mental equipment of the successful business man of today can hardly be too complete. The amount of in- formation requisite for the proper conduct of his business exceeds that required by the business man of any other age. His information must be accurate and must cover a wide scope. What he knows he must know well. He is constantly called upon to pass upon questions of great importance, and he must decide without delay. His de- cisions must be based: First, upon the business wisdom of accepting or refusing the opportunities offered. Second, upon a hurried review of the legal problems involved. It is impossible to keep an attorney constantly at his elbow to pass upon every trans- action, and therefore he must have a working knowledge of business law. Third, upon keen judgment of human nature and human character. The aphorism of Alexander Pope, "The proper study of mankind is man," applies with greater force to the business man than to others. The National Association of Credit Men labors un- ceasingly to educate its members in all those subjects which are so vital to their success. By bulletins, letters, lectures, and debates, the propaganda has gone forward. But the older members of the Association have found it iii 304795 iv PREFACE extremely difficult to secure junior clerks who have even an elementary knowledge of the basic principles of busi- ness and credits. In an endeavor to inform and assist the members of the Los Angeles Association, and to place in training young men who might thereafter be available for positions of trust in credit departments, the Los Angeles Credit Men's Association requested the Young Men's Christian Asso- ciation of Los Angeles to establish a lecture course on these subjects, and agreed to extend all possible co-oper- ation. The very excellent organization of the Young Men's Christian Association took hold of the work with great enthusiasm, and the result was a series of lectures which, it is believed, will be helpful to all young men en- gaged in active business, as well as to those contemplating such a career. The subjects were chosen to cover as nearly as pos- sible the fundamentals of business practice and business methods ; and it is hoped that those who faithfully fol- lowed this course of lectures, and those who now study it in its present form, will derive a fund of practical in- formation from it that will not only be of direct value, but will give them a better understanding and appreciation of the basic principles of three essentials of business suc- cess good judgment, legal knowledge, and an under- standing of human nature. NEWMAN ESSICK May i, 1914 CONTENTS CHAPTER PAGE I SYSTEM AND EFFICIENCY IN THE CREDIT DEPARTMENT . . 7 By M. Martin Kallman, Efficiency Expert; President Ma- comber Motors Co. II CREDIT DEPARTMENT METHODS 20 By Alfred K. Care, Credit Manager Cudahy Packing Co. III BANK CREDITS 50 By J. M. Elliott, President First National Bank of Los Angeles. IV FINANCIAL STATEMENTS, THEIR FORM AND ANALYSIS . . 64 By Herman Flatau, Secretary M. A. Newmark & Co. V COMMERCIAL AGENCIES AND REPORTS .... 87 By E. R. Purdy, Superintendent Los Angeles Office, Brad- street Co. VI CREDITS AND COLLECTIONS 102 By C. A. Parmalee, Vice- President Parmalee-Dohrmann Co. VII AUDITS AND INVESTIGATIONS 118 By W. C. Mushet, C.P.A., Secretary Los Angeles Credit Men's Association; President Mushet Audit Co. vi CONTENTS CHAPTER PAGE VIII LIENS ON PERSONAL PROPERTY 136 By N. P. Conrey, Judge of the Superior Court for Los Angeles County. \ IX LIENS ON REAL ESTATE 159 By Hon. Lee C. Gates, of the California State Senate, Chief Counsel for the Title Insurance and Trust Co. X FRAUDS 179 By W. J. Ford, Assistant District Attorney for Los Angeles County. XI AMICABLE ADJUSTMENT WITH INSOLVENT DEBTORS . . 196 By F. C. DeLano, Secretary for the Los Angeles Whole- salers Board of Trade. XII BANKRUPTCY . 223 By W. T. Craig, Ph.B., Attorney for the Los Angeles Wholesalers Board of Trade, Lecturer on Bankruptcy in Law Department of the University of Southern California. XIII INSURANCE IN COMMERCIAL AFFAIRS 246 By Warren C. Kennedy, Secretary Baker Iron Works; Treasurer California Iron Works; Vice-President Chamber of Mines and Oil ; ex-President Los Angeles Credit Men's Association. XIV CORPORATIONS 265 By Frank G. Finlayson, Judge of the Superior Court for Los Angeles County. Mercantile Credits CHAPTER I SYSTEM AND EFFICIENCY IN THE CREDIT DEPARTMENT* BY M. MARTIN KALLMAN Importance of the Credit Man's Position Credit is the basis upon which commerce and nations subsist; or, to put it another way, credit is the foundation upon which business is built upon which its very exist- ence is dependent. This being so, it is interesting to in- quire what sort of men bear the responsibility of granting or refusing credits. We shall find them in widely varying positions. Sometimes the credit man is a partner in the firm, sometimes a salesman, oftentimes merely a book- keeper. But whatever his rank, the results of his work are equally important. No one is in a better position than the professional business systematizer to know how much is demanded of the credit man; for the credit desk is the first place to which he is conducted when he begins an engagement. He is first taken there because the credit man is supposed to * By permission of Mr. Kallman. 8' ' MERCANTILE CREDITS know something about everything upon which the other officials of the establishment are not compelled to be informed. The Credit Man's Routine Whatever the house has in the way of an accounting system is generally the work of the credit man, and though the result is not always deserving of unqualified praise, the fact still remains that upon his shoulders has fallen the burden of meeting the requirements of accounting progress. Again, if a blank or a special form is needed in any department, the task of drawing it up usually falls to the man at the credit desk. Then, too, the larger prob- lems of house finance are almost invariably submitted to him. Quite frequently, indeed, the credit man is the ac- tive financial head of the house. Again, particularly in small houses, he is often charged with the buying of the house stationery and numerous petty details of a similar nature, which, in addition to his main routine duties, make him the most overworked member of the house staff. Yet the credit man needs, more perhaps than any other official, to have the advantage of that liberation from the slavery of petty details which it is the mission of modern business system to bring. If any man in the organization of the modern business house should have time in which to think, and to think without interruption or annoyance, it is the credit man. The poorest possible economy in which an establishment can indulge is that of so crowding the man at the credit desk that he has to work his pencil more than his brains. The Duty of the Credit Man The credit man really earns his money by the skill with which he handles a comparatively small percentage EFFICIENCY IN CREDIT DEPARTMENT 9 of the total number of accounts under his care. In mak- ing this statement I have little fear of contradiction. Let us say, for example, that at least 90 per cent of the ac- counts passed upon by the credit man of average experi- ence and ability are sound and, broadly speaking, above suspicion. Then the real value of his services to the house rests upon the judgment and diplomacy with which he passes upon the remaining 10 per cent of accounts which cannot quite meet the standard set up for Caesar's wife. System as an Aid to Efficiency It will require no unusual acumen to see that, if the task of scrutinizing the 90 per cent of sound accounts can be reduced to so small a minimum as to demand com- paratively little of the credit man's attention, both he and his house will be immensely the gainer, as he will have far more time and energy to devote to those accounts which really call for the exercise of his best energy, judgment, and protective powers. This is only another way of say- ing that the traditional routine duty of passing upon the 90 per cent of solid accounts has often compelled the credit man to treat the dubious 10 per cent in a hasty and perfunctory fashion, and occasionally to commit errors which have had serious consequences. How shall the conditions be so readjusted as to permit the credit man to concentrate practically all of his atten- tion upon the doubtful 10 per cent of accounts, knowing that the substantial 90 per cent is being adequately cared for and protected without his constant and specific atten- tion? System alone can solve this problem system which "flags" orders on any account in the least degree doubtful, and at the same time allows the right of way to all orders on accounts in a proper condition. io MERCANTILE CREDITS In other words, a right method makes it possible for any member of the credit department having the intelli- gence of an ordinary clerk to pass upon the credit of cus- tomers obviously in condition to take care of their orders. At the same time, it makes it impossible for a single ex- tension of credit to be made on any account not deserv- ing it. Operation of a. Credit System By way of illustration, let us suppose that the credit man of Merchant & Company goes out to luncheon and meets his friend from down the street, whose house sells goods to many of the customers of Merchant & Company. This friend inquires : "Do you sell Jones, of San Diego ?" "Yes," answers our credit man, "he has a very good line with us." "Well," responds the friend, "that may be all right, but I have just heard from a reliable neighbor of his that he has been speculating rather freely of late, and is be- lieved to have suffered severe losses; in fact, my informant declares that he is pretty deep in the hole, and that he is likely to have a rather hard time of it for several months to come. Very likely, though, he will be able to pull through all right, unless some of his creditors or backers get scared and begin to shut down heavy on him." Now, if the credit man of Merchant & Company has his office organized under a right system, the first thing he does after he has returned to the office and hung up his coat and hat, is to take from the card record of house customers the particular card bearing the name of Jones, of San Diego. On this he pencils his own initials. This initialling is a signal which automatically stops all orders and transactions, and immediately refers them to his per- sonal attention. Every employee of the office knows that to allow an order to pass this signal without being specifi- EFFICIENCY IN CREDIT DEPARTMENT n cally referred to the credit man, is to violate a cardinal rule of the house, and to incur a severe penalty. But this is not all. In an appropriate space on the card which bears the record of all the transactions of Jones with the house, he notes the reason for such sum- mary action in altering the line of credit which the cus- tomer has previously enjoyed. The card then shows a complete statement of the conditions. On the other hand, let us suppose that this credit man is a representative of the old school. He prides himself upon his ability to carry "under his hat" the key to the credit of his customers; and, so far as his written records are concerned, there is no change in the standing which Jones, of San Diego, enjoys with the house. The credit man of the old school knows that he is go- ing to tighten the line so far as Jones is concerned, and he feels that it is enough that he knows it. But it happens that our credit man suffers from an attack of indigestion a day or two later and is compelled to stay at home to recuperate. If he has an assistant, he has forgotten to tell him the story of what happened to Jones in the ups and downs of the market for credit men sometimes do forget. While our old-style credit man is dieting at home, Jones sends in an uncommonly heavy order. There is not a scratch of a pencil, or a black mark of any kind, against his name; and consequently the order goes through, the goods are shipped, and by the time the chief of the credit department is convalescent and back at his desk, Jones, of San Diego, is a successful bankrupt and the house is the loser. Instances of this kind, as every credit man knows, are happening every day; but they cannot occur in any estab- lishment where a credit department is operated under an adequate and thoroughly modern system. 12 MERCANTILE CREDITS Result of Lack of System One of the most marvelous things in the history of merchandising is the amount of dearly bought experience required to teach the average business man that his "Cus- tomers Ledger" is not an inspired volume invested with miraculous infallibility, and that the credit man who car- ries his knowledge of his customers "under his hat" is, sooner or later, bound to have his hat and all that is under it in the wrong place at the critical moment a fact which makes him a mighty poor and inadequate supplement to the customers ledger. Some years ago, when the bicycle habit was at its height, the half-owner and credit man of a big Eastern jobbing house was called from his desk to attend the funeral of a friend. While returning from this sad mission he chanced to be in the same conveyance with an acquaint- ance from a smaller city in a neighboring state. This friend asked: "Does Mr. Blank, of my town, still deal with you?" "Yes," was the answer, "we sell him a big line of goods; in fact, his business is increasing right along, and he is among our best customers." "Well, I like him all right," replied the friend, "but I happened to learn something yesterday which I feel in duty bound to tell you. As yet it is little known, but I can vouch for the fact that he is transferring his real estate holdings to his wife. This, to my notion, means that he is fixing for a first-class failure and that you will do well to get from under." When this credit man returned to the office he punctil- iously consulted the ledger and looked at the account of this particular customer; but the ledger showed that Mr. Blank had recently remitted a sum which balanced the account. The other partner of the house had exclusive control EFFICIENCY IN CREDIT DEPARTMENT 13 of the merchandising and selling end of the concern, but never ventured to interfere with the affairs of the credit department, nor did he permit his associate to interfere with his own branch of the business. Now, while the credit man was absent attending the funeral, Mr. Blank had called at the establishment and personally placed an order for several hundred bicycles. Of course, the partner at the head of the selling depart- ment consulted the ledger and found his customer's ac- count in excellent condition. The order was put through and the goods shipped in haste, in accordance with the special instructions left by the visiting customer. The day following the funeral which the credit man had attended, the merchandising partner was called out of the city and did not return for several days. As a result, before the big order for wheels was posted on the ledger and came under the eye of the credit department chief, the shipment had been received by Mr. Blank, disbursed, and that enterprising retailer had gone into bankruptcy. Scores of other incidents along this line might be cited, all emphasizing as pointedly as this the moral: "Customers ledgers are not sacredly infallible guides" and the further fact that the credit man who carries his information under his hat is as useless to his house at times as he will be eventually when there is crepe on its door and the partners and heads of department are at- tending his funeral. This kind of a credit man leaves his money behind him, but his information dies with him, and all the ledgers in the world will not save it particularly if there is a few days' delay in the matter of posting, as is likely to be the case in a house where so little of modern system obtains. Perhaps you are inclined to ask how this disaster could have been prevented under the operation of an up-to-date I 4 MERCANTILE CREDITS system. Just as soon as the customer came into the house and made application for so large a draft upon his credit, someone from the selling department should have quietly visited the credit desk. Finding the credit partner absent, and failing to find any specific data, aside from a clear balance on the ledger, he would have drawn the card of Mr. Blank from the record and placed it upon the credit man's desk, together with a memorandum of the order. Immediately upon the return of the credit man this in- formation would have been forced upon his attention and, as a result, the shipment of the goods would have been stopped. System as an Aid to the Salesman Another practice common in poorly organized busi- ness houses is that of encouraging customers to buy their goods before the house definitely determines whether, un- der existing circumstances, the invoice involves a larger line of credit than it desires to extend. For example, a cus- tomer comes into the wholesale house and spends half a day in buying a large bill of goods. This also involves half a day's time on the part of the salesman. After he is all through selecting his goods, the order gets up to the credit desk, and it is discovered that the customer's ac- count is not in condition to warrant the new bill. Then, after the customer and the salesman have both wasted their time, the buyer is told that his line of credit will not stand the additional strain of the amount involved in his purchase. Naturally, this causes disappointment and makes bad blood. Very often, too, it results in the per- manent alienation of a good patron of the house. If a proper system is enforced, the first thing in order when a customer enters the house and signifies his inten- tion of buying, is to send to the credit department records EFFICIENCY IN CREDIT DEPARTMENT 15 and get his number. This at once tells the employee or salesman precisely the line of credit to which he is entitled. Thus forewarned, the salesman is in a position of ad- vantage, and by the exercise of a little diplomacy the giving of a little sound advice regarding the extent of the customer's purchases he is able to keep the order within the proper credit limit, thus avoiding disappointment, waste of time, and perhaps the permanent loss of a cus- tomer. It is a safe rule that the house salesman should learn the exact amount of credit to which the customer is entitled before he begins the actual process of taking that patron's order. And this can always be done without the customer's knowing that the salesman has this informa- tion. Advantages of Personal Contact As the present chapter is intended to offer practical and helpful credit suggestions, I shall not hesitate to in- dulge in a word of criticism. One of the most serious weaknesses of the average credit department is found in the comparatively slight personal intercourse between the credit man and his customers. To a very large extent their communications are not only written, but of a formal, cut-and-dried nature. While it is true that the credit man does see certain of his customers quite fre- quently, it is equally true that he has no personal acquaint- ance at all with a very large portion of them. The cause of this condition has already been indicated. The head of the credit department is tied down to his desk by an elaborate network of details which, under an adequate system, are safely and expeditiously taken care of by inex- pensive help. It is my conviction that every credit man should come into personal contact with each one of his customers at 1 6 MERCANTILE CREDITS least once a year, and oftener if possible. And the right sort of a system will make it possible for each customer of a house to be personally seen once a year by some person in a position of authority in the credit department. If Mahomet will not visit the mountain, let the mountain visit Mahomet. When the customer cannot be induced to call upon the credit man, let the credit man call upon the customer. In no department of business does the per- sonal equation have greater weight than in the credit de- partment; and it is absolutely impossible for the personal equation to be accurately determined except by personal contact. The Credit Man as a Selling Factor Another conclusion which has been forced upon me is that, generally speaking, the credit man does not realize his power as an active selling factor. He is in the habit of thinking of the credit department as purely protective instead of as a possible productive factor. His relation to the effort of the house to make more sales should be as constantly in his mind as the effort to see that the sales actually made are safe. Very few letters should go out of the credit department without containing some refer- ence to more orders or further orders from the customers. The credit man should know at once when the purchases of any good customer are falling off, and should take steps to learn the reason for this change. Of course, this must be done with tact but tact and judgment are two neces- sary qualifications of the credit man. The Credit System as a Character Record A good credit system is so sensitive that it indicates, with automatic precision, the character of the customer. Toy do not need to be told that kicks and complaints EFFICIENCY IN CREDIT DEPARTMENT 17 the favorite weapons of customers who believe that they have some advantage to gain by sharp practice with the house from which they get their goods. It does not gen- erally occur to such a customer that the house will remem- ber that he has registered a kick a month ago; but the little card bearing his record indicates at a glance every time a complaint was entered. Let us suppose that a new customer sends in his first complaint. Under the right kind of a system this is im- mediately indicated on his card record. At once instruc- tions are sent out through the house to double-check his next shipment, and to exercise especial care in every detail relating to it, even to seeing that the packing of the goods is done in a manner beyond criticism. If this customer enters another complaint next month, he is then considered a subject of suspicion, is placed under surveillance, and a special effort is made to arrive at his motive for the com- plaint. In the same manner the good system takes care of the matter of slow pay and of all other elements enter- ing into the customer's relationship with the house. Proper Use of the Mercantile" Agency A frequent element of weakness in credit departments is the too implicit reliance upon mercantile agency ratings and reports. Do not understand me as attempting to minimize the great value and usefulness of the agencies. They are an absolute necessity for the safe conduct of business under the complex conditions of our modern commercial life. On the other hand, you will hardly question the statement that they are the crutch upon which both the weak customer and the weak credit man are inclined to lean too heavily. The country merchant who is not financially as strong or as sound as he would like to be, takes especial pains 1 8 MERCANTILE CREDITS and goes to any length to build up his ratings in the com- mercial agencies, while the credit man who is either timid or inexperienced, and who has not the advantage of a sys- tem which stores accurate and available information re- garding all his customers, is disposed to base too many of his decisions upon the reports of the agency. In doing this he is sometimes in danger of giving too short a line of credit. Many a house organized on a small capitaliza- tion does not show all of its strength in its statements to the commercial agency, for the very good reason that as- sessors and tax-raising bodies, as well as merchants, have access to agency information and know how to use this information to the increase of the tax returns. For ex- ample, a certain Eastern house, capitalized and rated at $100,000, actually does a business of more than a million dollars a year. It is scarcely reasonable to suppose that so large a business as this is done upon so small a capital as that represented by the rating of the house in the mer- cantile agency report. There are many other reasons why the credit man should be in a position to render his judgments practically independent of the agency reports, or at least to use them by way of verification. And this he cannot do unless he has a system which provides the right information and crystallizes it into permanent office records in such a manner that it is instantly almost auto- matically ready for application to every case and every customer. Results of System These hints will be sufficient to show how a thor- oughly modern system in the merchandising house, and especially in its credit department, makes it possible for the credit man to concentrate practically his whole atten- tion upon the matters which need his attention, instead of EFFICIENCY IN CREDIT DEPARTMENT 19 squandering his time and energies upon a mass of details which daily pass over his desk simply because long usage and tradition so decree. By taking advantage of the economy wrought by well-devised modern office methods, any credit man can enormously increase the power and in- fluence which he exerts in the house organization, giving his best efforts only to those matters which are really worthy of them. That the proper systematization of the operations of the credit department will effect a much-desired economy of the time, labor, and energy of the credit man is a truism ; but to what extent system will be made an accom- plished fact in connection with credit work is very largely dependent upon the interest the credit man exhibits in this subject. If he advocates such a policy, and adopts and promulgates the forms and methods required to carry it into effect, half the battle is won. Of course, individual systems will differ according to individual needs, but it is greatly to be desired that certain forms should be pre- pared for general use, and certain uniform lines of action adopted, with a view to liberating the credit man from slavery to details, and leaving him free to make his indi- viduality the power that it should be in the house organi- zation. CHAPTER II CREDIT DEPARTMENT METHODS BY ALFRED K. CARE Importance of Credit Methods Factory methods, sales methods, and accounting methods are now made the subject of careful study by the up-to-date manufacturer and merchant. Credit depart- ment methods are surely of equal importance. In fact, the success of a business house depends largely on the wisdom, judgment, and courage of its credit man, and the methods adopted by the credit man are what he depends upon to bring results. Confidence is the basis upon which the whole business structure rests, for in order to carry on business at all, men must trust one another. Bank notes and greenbacks, popularly called money, are merely promises to pay; and their acceptance is an expression of confidence in the abil- ity and willingness of the government to pay their face value on demand. Unfortunately, however, confidence is sometimes mis- placed; and in the past we have often been too liberal in the extension of credit. Sufficiently close investigation of the applicant for credit has frequently been neglected, and this neglect has led to many business failures. The im- proved methods, now being adopted by credit men, are greatly reducing the losses of their respective houses, which are thus enabled to meet competition with more 20 CREDIT DEPARTMENT METHODS 21 success and to do better by their customers. It is obvious that these methods are worthy of careful study. Cooperation with the Sales Department One of the first points in the consideration of credit department methods is the relation between the credit department and the sales department, which in the past have not always worked together harmoniously. The desire to sell goods is uppermost in the mind of the sales department, and too frequently the conservatism of the credit man is overruled by the head of the house in his desire not to lose business which a competitor may take over. In more recent years, however, the credit man has been given greater authority; and in most business houses of today, his decision is final. He has achieved this rec- ognition by careful study of his subject, and by adopting various methods to get all the information possible, not only as to prospective customers but as to those who may have been on the books of the firm for many years, thereby placing himself in close touch with the financial condition of all the clients of his house. It is this positive knowledge which gives weight to his opinions. Work of the Credit Man The first duty of the credit man is to obtain all the in- formation possible regarding the applicant for credit; the second, to analyze the information obtained and here is where his experience, ability, and judgment are brought into full play. He should be an accountant, or at least should have sufficient knowledge of accountancy to be able to analyze intelligently a customer's financial statement. At times he may even be required to inspect a customer's books and draw off a statement; and without a knowledge of accounting this would be impossible. 22 MERCANTILE CREDITS Gathering Credit Information The credit man cannot obtain too much information regarding his customer, and he should instil into the minds of his salesmen the desirability of informing him of every circumstance affecting the customer, whether it be favorable or unfavorable. Every salesman should be required to carry a block of forms similar to those shown below, one of which is filled out for each new customer. The salesman is not expected to ask the customer any of the questions on the form, but to obtain the information in the course of conversation with him or others. All this information is properly noted and filed with the records. Ill ; J -f : v S S- J ill -2^ 1 ||l|l | ^5 ^.G O Salesman's Report on New Customer (First Form) The first question after name and address, is "How long in business ?" Now, the question of experience is an important one, as the length of time a man has been in business or has worked for others, enables one to gauge his ability to some extent. CREDIT DEPARTMENT METHODS 23 Another very important question as to the value of stock is easily answered according to information ob- tained from the man himself, confirmed or corrected by the estimate of the salesman, who ordinarily is a good judge. The condition of the stock is open to observation. The name of the customer's banker and names of firms buying from him are also readily obtained. When we come to the question, "What amount of credit do you recommend?" the salesman should be in a position to answer with assurance ; and my experience has been that as a rule he is fairly conservative in his views. W I Salesman's Report on New Customer (Second Form) Commercial Agency Reports The salesman's report is sent in with an order, we will say from John Smith, Lansing, California, and duly reaches the credit department, which at once proceeds to gather all the information it can with reference to John Smith. Here we discover the usefulness of commercial 24 MERCANTILE CREDITS agencies such as Bradstreet's and R. G. Dun & Co. An inquiry is made of one of these agencies possibly both for a report on John Smith, Lansing, California. When it is received, you find that according to Smith's own state- ment he is married, and therefore can exempt real estate to the extent of $5,000 in that state; that he has a stock of $10,000; outstanding accounts, $3,000; fixtures, horses, wagons, etc., $2,500; cash, $500; real estate, $2,000 clear of encumbrance; homestead, $3,000; and in- surance for $8,000. His liabilities consist of trade in- debtedness, $4,500; indebtedness to bank, $1,500; other borrowed money, $2,000; and he considers himself worth $10,000 over and above all debts and exemptions. The report then proceeds to give the result of the agency's investigation of his statement, which is practically con- firmed; it also states that the various houses interviewed report him prompt in his payments, and that he is reck- oned, from the standpoint of credit, at an estimated net worth of $5,000 to $8,000. All of this being favorable to Mr. Smith, his order is OK'd for credit. Other Sources of Information Those unfamiliar with credit work will say, "Why, how easy!" and it certainly would be easy if Mr. Smith's case were a fair sample. But, unfortunately for the credit man, when he most desires quick information on his cus- tomer, the agency is without any, or what it has is of little value. On the other hand, he may receive the information that Mr. Smith's statement is not confirmed, that his in- debtedness is much greater than he states, and that his payments are very unsatisfactory, which is certainly valu- able information. However, we need not depend entirely upon the agency report. Our salesman has furnished us with the name of Mr. Smith's bank, and those of the prin- CREDIT DEPARTMENT METHODS 25 cipal firms from which he is buying; and we have com- municated with these parties either by telephone or letter, the result being favorable or otherwise, as the case may be. A commonly used form of credit information letter is as shown on page 26. If the information is not entirely favorable, we im- mediately write Mr. Smith, thanking him for his order and asking him for a financial statement and for refer- ences, basing our request on the fact that he is a stranger to us. And if Mr. Smith furnishes us with a signed state- ment of his financial condition (even though the outside information may not be quite as favorable as we could desire), we are inclined to grant him a line of credit, for the reason that he would, under certain conditions, be criminally liable if he made a false statement. In the first case we apparently took no risk in granting Mr. Smith credit; in the second case, there was an element of risk which we partially overcame by obtaining the finan- cial statement. By keeping in close touch with Mr. Smith's condition at all times, we could possibly continue to grant a line of credit with safety. It must be remembered, however, that credit is not always based solely on a man's assets. Often credit is extended largely on the known honesty and integrity of the customer, and on the knowledge or belief that he would not incur a debt he did not see his way clear to pay when due. This is the moral risk, and the credit man must depend on his own judgment to handle it successfully. 26 MERCANTILE CREDITS MICHAEL CUDAHY, President EDWARD A. CUDAHY, Vice-Prest. 4 Genl. Manager CHICAGO, ILL. SOUTH OMAHA, NKB. PAC K//V LOS ANGELES, CAL. Credit department Los Angeles, Cal., I 9 I 4- Dear Sir: Will you kindly give us your opinion of the financial standing and general reputation for prompt- ness, responsibility and integrity of the under name d ? Your reply will be held confidential and we will gladly reciprocate at any time. Yours truly, The Cudahy Packing Co. M_ What do you consider his net worth ? Credit Information Letter CREDIT DEPARTMENT METHODS 27 Financial Statements There are various forms used for financial statements by different houses. Good statement forms used by prom- inent concerns are as follows : 1 1 I 1 s 2 H 3 | 9 1 ' 5 o -J i 1. i |j I ijrea, as follows How Pya ortgages, as follows >aia idorser on Notes jretv on Bonds I TOTAX, QQ 6 1 i 1 i 2 5 INANCI 3INESS AT Owing for Merc fit 1 1 j i Chattel Mortg S i Whe4)uo i a LiablHty as E Liability as S All Other Lial i 5 a 1 ! I S i 1 t i 1 I X z c 5 1 h L. I 1 1 u ID s 1 * "o fe * h U E <0 n I 3 1 O 2 ' 1 OtberB 1 S 1 1 1 Ld (0 CO 3 B O 1 i? 9 1 1 1 W s I 1 1 1 I H n > 4 * a K ~ 3 1 U) a 1 1 o 1 | t 1 a -g : i i Cash on hand 1 Merchandise, at 1 1 1 Personal Prope as Follows. Real Estate in C I Description I 1 .as shown by sa The above stateme Witness Financial Statement The National Association of Credit Men has a very simple and effective form of property statement (shown 2 8 MERCANTILE CREDITS PROPERTY STATEMENT Made for the purpose of obtaining Aline of credit from Cudahy. Name of Applicant. ...... i . ....,.,.., , Address __ . City,....-. -. ......*.,. State. Details of Ownership. Individual > r .__. If Tirm, give names of Members If Corporation, give State under which formed Date I...... L > If more than one place of business give details. _ . Property Statement (page i) in Chapter IV) ; and in it are these statements which are so true and so much to the point that they may well be quoted here: "Large assets are not always necessary to the creation of credit. A merchant's capital is the sum of his net available resources plus his credit. A merchant CREDIT DEPARTMENT METHODS 29 FINANCIAL STATEMENT A* per Books of Account as of Date.. RESOURCES Merchandise on hand, at actual cost ,. ... Shop fixtures, furniture, and tools, present value - Notes and accounts, good ,. Notes and accounts, doubtful -. ....... Cash in Store Cash in what Bank and amount No. of Horses No. of Wagons Fair value ofBoth No. of Automobiles _ Fair value All other personal property other than household goods, and what it consists - of and fair value - Real Estate (give details in Schedule "A" (see page 4) *Ia any part of same a homestead? If so, what is value . Amount of Life Insurance To whom payable *Do not include two above items in total. TOTAL- . Property Statement (page 2) who desires to serve his own best interest should recognize that his most valuable possession, apart from his actual assets, is a sound, substantial, and unquestioned reputa- tion as a credit risk, and that under the prevailing condi- tions and demands of business, the most effective and MERCANTILE CREDITS LIABILITIES Give names of parties to whom owing for merchandise, and amounts Are any of the above accounts past due? . . . i . i..... Name them Have you any suits pending against you? Amount? Do you owe any judgments?. Amount? Do you owe for tools and fixtures? _ Amount? Do you owe anything for wages past due? Amount? Do you owe any rent on business premises?. Amount? _ Do you owe anything to relatives, and-to whom? When payable How secured Other borrowed money? From? Amount? When due? How payable How secured .. Any Bank overdrafts? ...Amount? Judgment notes? ..If so, state amounts and to whom given. -- r .- Amount liability as endorser on Notes -or Surety on Bonds? All other liabilities TOTAL Net Resources (deduct total liabilities from total resources) Property Statement (page 3) eminently the best way to prove his basis for credit is to be willing to submit a statement of his financial condition.* 1 Value of Bank References Personally, I do not place much confidence in a bank reference, as human nature is the same everywhere. If CREDIT DEPARTMENT METHODS 31 Real Estate Owned, Schedule "A" Lot Title in Value .,... Insured for Lot. .' ..title in... ,.v Value.,,.. 1 Insured for Lot... Title in ..Value..'. Insured for. Lot -Title in Value Insured for. Any Real Estate Mortgages? Amount? .... ON WHAT PROPERTY AMOUNT Schedule "B" Any chattel mortgages on your stock, fixtures, horses and wagons or other property?. ON WHAT TO. WHOM OIVEM AMOUNT Rent of store per month's Other business expense per month.. Insurance on stock and fixtures $..< ,.. ..Insurance on building?. Name Fire Insurance Companies . ,.. Does homestead include store building? When did you commence business?. Gkrttfirate ...191. Gentlemen: For the purpose of obtaining credit with your Company for Merchandise which applicant may now or hereafter obtain and purchase of you I hereby certify that appli- cant keeps books of account of all transactions of the business and that the foregoing statements are true and' represent the financial, condition of applicant as shown by said books, and that the other statements above contained are true and correct, and that I am duly authorised to make this statement on behalf of applicant. Dated this... v day of-. , ...... .191 -at fr . in the State of *-. Authorized signature firm or corporation ... Signed by (member of firm or authorized Officer)..- ^ -- Witness: Property Statement (page 4) the merchant happens to be a customer of the bank, the latter will naturally recommend him for credit; whereas some other bank in the same town might either give an unfavorable report, or so word its reply that you could 32 MERCANTILE CREDITS infer anything you wished. In the reference of the whole- saler or jobber, however, I place every confidence. Personal Judgment as to Credit Standing We will now take a case where James Brown calls at your place of business to place an order. He is introduced to the credit man, who, in the course of conversation, ascertains that the business is a small one and that the amount of credit desired is light. The formality of a written statement is therefore not required, but the figures given by Mr. Brown as to his assets and liabilities, and the names of the houses with which he does business, are all jotted down, and form part of the record which is kept of all customers, further details of which are given later. In case Mr. Brown is likely to desire considerable credit, a financial statement is required, which, when verified or corrected, can be filed with the other credit records. Occasionally unfavorable information reaches you in reference to one of your established customers, and every effort must then be made to ascertain the facts. If the party is in the city, someone is sent to make a personal call and get at the truth; incidentally, of course, collecting all the money he can. In the meantime you have made a credit call through the local wholesalers board of trade, or some other similar association, the purpose of which is to secure information as to the total amount owing by the merchant to its members, the total of what is past due, and also the manner in which the party makes his pay- ments. On receipt of this you may find that your custom- er's indebtedness is heavy, and the amount past due suffi- ciently large to embarrass him. Your next move is to col- lect what is owing to your firm, or, failing in this, to persuade him to call a meeting of his creditors, at which CREDIT DEPARTMENT METHODS 33 his affairs can be discussed and an extension agreed upon by all the creditors, or an assignment made for their benefit. The Personal Touch Make it a point to see the man to whom you are ex- tending credit, if possible, and preferably at his place of business. Get in close touch with your customers at least once a year. Many is the time that I have met an insol- vent customer for the first time at a creditors' meeting, and often have I felt that had I only seen him before, I should not have been present at that meeting. A good credit man should always be a good mixer, and should have a good understanding of human nature. I had an instructive experience only a short time ago. One of our country customers had been a little slow in his pay- merits, and very touchy when written to on the subject of his delinquency. I had an opportunity to visit him at his place of business, and was in his store fully twenty minutes before I was given any attention. In the meantime I noted the condition of his stock, the appearance of his help and of the store in general, and decided that if I could collect our account, there would be no more credit for him. On introducing myself the first thing I heard was a tirade against the house, the goods, and finally myself. I took it all good-naturedly, and when he said, "I'll give you a check for my account and never buy from your house again," I accepted his check, told him he would probably think better of it, but registered a vow that he would never buy again on credit Six weeks later there was a call from the local board of trade, and his affairs were put in their hands. Needless to say, I was not a creditor. 34 MERCANTILE CREDITS Trade Reports When the credit man receives trade reports, he ex- amines them carefully, and notes such as are of special interest to him. His assistant cuts out all items pertaining to the customers of his house, pasting them neatly in their respective folders. Watching Details One of the failings of the embryo credit man is in trusting too much to memory; another the failure to note details, such as the size of an order. I have a distinct recollection of one such error where a credit assistant mistook an order for a car of eggs for a case of eggs and OK'd it. In the shipping department no such error was made, the order being rightly understood as calling for a car of eggs. The car was shipped, and sold by the cus- tomer, who left the country within twenty-four hours after, and the house sustained a loss of several hundred dollars. We are all liable to such errors, and the only way to guard against them is to surround yourself with all the safeguards available. Recording Information Collecting data with regard to his customers, and keeping it in such a form as to be readily "get-at-able," are exceedingly important features of the credit man's work. The method adopted by myself is to have a numbered folder in which all information regarding the customer is kept, including the salesman's report, mercantile agency reports, reports of references, credit calls, information obtained from court records as to transfers of realty, mortgages, etc. ; copies of all letters written requesting payments, with replies, if any, also memoranda of all CREDIT DEPARTMENT METHODS 35 o i to 0) . I . D CO W ^ W R 3C .S Jl C 1 s S S "S w !i! 1 I 1 s 2 S S w X H 5 1 O .u. J- Q '3 1! 1 1 i S 4 S C *c 6 1 4> <- | j fe 0. ' -5 (A 0> ? l! s 1 jj T | c ^ S 8 . i ' o 1 t .5 1 i; SB G C *e c c i 1 . 3 " 8 I 1 9 o C * ^o u 1 s a j a" p ' S- - |= a ' n S o o 1* *- 1 . g S o c a 1 * - | : 1 | u s- | I 1 ^ E g : * "o M g % 'I i , ? 8 ! i o g X c fill i 8 2 r e |*l 1 I O A S C ^ c5 *c "S 11 i g S> 8 M 1 S 1 1 I? I .5 = -B g f I - 1 I '- < s 1 1 1 < X _c O ^ f O *C y? P 8 : E f- t , 8 S c .S " i 1 1 S S H i j: "2 S x f 1 1 Guaranty of Payment (Form 2) 48 MERCANTILE CREDITS * o i r 1 3 o .2 a -d 8 P ? f I! i *- -n 3 -a ^ * ;^i H! "8-2 si 2 ag w e answered, insert ciphers in absence of any amount. When the words "Yes," " No" or " None" will correctly answer the questions, write them in their proper places. Property Statement Individual or Partnership (page 3) FINANCIAL STATEMENTS To RICH, MANN & CO., New 71 For the purpose of obtaining credit now and hereafter for goods purchased, we hero- with submit to you the following statement of our resources and liabilities, and will im mediately notify you of any material change in our financial condition. In consideration of your granting credit to the undersigned, we agree that in case of our failure or insolvency, or in case we shall make any assignment for the benefit of credit- ors, bill of sale, mortgage, or other transfer of our property, or shall have our stock or plant attached, receiver appointed, or should any judgment be entered against us, then all and every of the claims which you have against us shall at your option become immediately due and payable, even though the term of-cfedit has not expired. All goods hereafter purchased from you shall be taken to be purchased subject to the foregoing conditions as a part of the terms of sale. City . . County State.. BUSINESS 4 Value of Merchandiseon hand at c If manufacturing, raw material, $... ASSETS ost Dollars Cents finished, $ Notes and accounts, cash valu Cash in hand Bills or accounts receivable, due from office Patents and patterns -v Total real estate, cash value Total encumbrances on real Total Active Busit BUSINESS LIABILITIES. Owe for mdse., open acct., of which $ is past due $ istate, $ ess As. Equi sets. ty II I IJ Dollars Cents Owe for bills for paper sold Owe others for bor'd money Mtgs. on fixt's and mach'y Total Business Liabilities- Total net worth . II 1 i .11 || i 1 |. 1! Please state location and description of each parcel of real estate, and cash valuation !(, and encumbrances on, each Property Statement Corporation (page 2) 72 MERCANTILE CREDITS ' Accommodation indorsements ^ Contingent Liability^ '.Indorsed bills receivable and outstanding. OFFICERS. Name in Full Address President ... Vice-Prest ... Secretary ... Treasurer ... DIRECTORS. Name in Full Address Authorized capital Subscribed Paid in How paid in: Cash, $ _ Other property Description of other property, and how valued In whose name is title to real estate held? Incorporated in what State and under what general laws or special act? Nature of business? Date of charter? -..Suits pending, and of what nature? Are any merchandise creditors secured in any way? Amount of annual business Annual expenses 'Annual dividends When was last dividend declared ? Rate Insurance carried on merchandise Fixtures and machinery Real estate. Regular time of taking inventory... Keep bank accounts with .............. t ................................... Keep- following books of account _ If you have pledged or transferred outstanding accounts or property remaining- under your control, state amount thereof and amount received, or to be received, on account of such pledge or transfer Buy principally from following firms : Name Address What Hne of business ? The above statement, both printed and written, has been carefully read by the undersigned, and. is a full and correct statement of our financial condition as of Corporation Signature By Date .................. -. ....................... - ...... All questions must be answered, insert ciphers in absence of any amount. When th* words "Yes," "No" or "None" will correctly answer the questions, write them in their proper places. Property Statement Corporation (page 3) FINANCIAL STATEMENTS 73 It will be noted that the corporation statement differs from the other in the character of the questions asked. These indicate how important and intricate is the organi- zation of capital in corporations; and the facts intended to be elicited are of particular interest and importance to the credit man. Reports of the Commercial Agencies Now, while these statements contain considerably more information than the ordinary statement covering only assets and liabilities, yet, coming from the applicant direct, they cannot and do not enlighten us as to his own moral and mental make-up. For this information we gen- erally look to the commercial agencies ; and it is here that their importance becomes apparent to the credit man. The agency report is considered at length in another chapter. The Credit Risk Having now before us a standard form of financial statement, let us briefly consider the line of reasoning the credit man must follow and the business knowledge he must have in order to be able to analyze such a statement properly and reach a wise decision as to the giving or re- fusing of credit. There is more or less risk in all credit transactions, and to discriminate between different degrees of risk is the difficult task of the credit man. If his duty were simply to avoid losses, then he would merely have to decline any account that was in the least doubtful. But this, of course, would reduce the volume of business of his house to a minimum; and since the ever-increasing competition cuts down profits and raises expenses, a wholesale house must do a certain volume of business every year in order to 74 MERCANTILE CREDITS show a fair amount of net profit. Hence, it becomes the duty of the credit man to secure the maximum volume of business with the minimum amount of losses. Qualifications of the Credit Man To be able to do this he must have experience and ability. He must be a good judge of human nature able to form a correct estimate of those moral and Intellectual assets of an applicant which are of even greater import- ance in determining the credit risk than are the financial assets. He must know how to analyze and to strike a bal- ance of the moral and financial standing of a customer. He should have a good knowledge of accounting, so that he can detect the weak spots in a statement, and, if neces- sary, verify the figures by a comparison with the books of the applicant. He should have a fair knowledge of the laws affecting credits in the various states in which he is doing business, and should especially be posted as to the amount allowed under exemption laws. He should be fairly well informed as to values of merchandise, so that he will be able to approximate the amount of stock a mer- chant carries. Finally, he should be familiar with local conditions in the different places where his customers are doing business. Character of Applicant When we apply the rules of analysis to business, we find that success and safety are dependent upon the exist- ence and proper combination of certain elements. Each one of these is an important factor in the consideration of credit, though some are of more consequence than others. Among the most important are the character, honesty, and habits of the applicant for credit; and deficiency in any one of these makes the risk dangerous. Therefore, the credit FINANCIAL STATEMENTS 75 man should carefully inquire into the personal record of the applicant. A man whose character is bad, who is dis- honest, or who is addicted to drink, is not entitled to our confidence. We give a man credit because we have con- fidence in him, and we base our confidence in him upon his character, honesty, and habits; therefore, if these are not good, there remains no basis for credit. Ability as a Credit Factor But, though good personal character in an applicant is of the greatest importance to the creditor, this alone does not assure the success of a business. There are many cases >n record where men of fine character and habits and absolute honesty have failed in business because of the lack of ability. Consequently, to insure the safety of credit transactions, the factor of ability must be added to those already mentioned. A merchant's ability is deter- mined by the efficiency and the economy of his business or- ganization; by his knowledge of the cost of goods; by his selection of the articles that his trade requires in quanti- ties that will not overstock him ; by the amount of business he does and the profit he makes ; by judicious selling on credit and prompt attention to his collections. If the credit man is absolutely certain of the existence of all these qualities in the applicant, he need but give pass- ing notice to the items on the financial statement. In fact, many a merchant got his start upon no other assets but these. But, unfortunately, these moral and mental en- dowments are not always present in an applicant in such measure as to warrant the acceptance of the risk. And thus it is necessary to make a close analysis of the items comprising the physical assets and liabilities before reach- ing a final decision as to the amount of credit to be given. 76 MERCANTILE CREDITS Careless Bookkeeping In making any such estimate of the net worth of a retailer it is well to bear in mind that some merchants are careless in their method of keeping their books, and that others do not keep any at all; thus the amounts of the various items on their statements are not always correct, and sometimes represent merely an appraisal of assets and liabilities. Therefore, when we have reason to believe that the statement received comes from a man who is care- less in his bookkeeping, we must be more liberal in our allowance for shrinkage in the assets and for growth in the liabilities. Credit men have often had occasion to note the generous manner in which some merchants estimate the value of their assets, and how niggardly they are in stating their liabilities. Valuation of Stock But let us assume that the statement is compiled from books correctly kept. The first item for analysis will be : "Merchandise on hand at cost." In appraising the value of a stock with a view of granting credit, we must bear in mind the possibility of a failure, especially when the net worth shown by the statement is only of moderate amount. Experience has indicated that in cases of failure a stock consisting of staple goods, such as groceries, etc., located in a place where it can readily be sold, will bring from 60 to 75 cents on the dollar of invoice price. The stock of a going concern, of course, is worth more; therefore, an allowance of say 15 to 25 per cent on a staple stock will give us a conservative figure. But in considering the amount that should be deducted to arrive at a safe valu- ation, we must also notice the character of the merchan- dise, the condition it is in, whether it is slow-selling or can quickly be turned into cash. FINANCIAL STATEMENTS 77 Notes and Accounts The next item is : "Notes and accounts." If we com- pare the amount outstanding with the amount of monthly credit business, we shall be able to judge whether the mer- chant is a close collector or not, and upon this will depend the amount that should be retired on account of age. At any rate an allowance of 30 to 40 per cent should be made for shrinkage. Cash The next item is : "Cash in hand." This, of course, is not subject to any depreciation if it consists of actual money, and not of checks that are dated ahead or have been returned on account of lack of funds. Then comes: "Cash in bank." In regard to this item, we must bear in mind the fact that, if the merchant is indebted to the bank where he deposits, such bank has the legal right to retain any cash or other personal property in its possession be- longing to the debtor, and to apply it toward the payment of the debt. "Quick" and "Slow" Assets The foregoing items merchandise, notes and ac- counts receivable, cash in hand and in bank comprise what are generally called the quick assets, so named be- cause they can be more quickly turned into cash than the fixed or slow assets, which usually consist of fixtures, store furniture, machinery, horses, wagons, etc. While these latter may, and often do, represent a considerable outlay of money, yet as a basis for credit their value should be considered nominal. A deduction of 50 per cent, at least, should be made. ;8 MERCANTILE CREDITS Liabilities Now, when we come to consider the liabilities, we know from experience that every dollar listed means 100 cents that must be paid, and often more than that. The amounts "Past due for merchandise" and "Owe on notes for merchandise" should be carefully noted, as these gen- erally indicate unsatisfactory payments. An indebtedness for back rent, or a chattel mortgage on fixtures or horses and wagons is a sure sign of financial weakness. Outside Assets The various items heretofore mentioned are called the business assets and business liabilities. We now come to "Outside assets," such as, "Total real estate." Real property, no doubt, strengthens the assets, pro- vided it is free of encumbrance, stands in the name of the applicant, brings a fair return on the investment or is at least self-supporting, and is not subject to homestead ex- emption. Credit men are sometimes misled by the sched- uling of a store building under assets, when as a fact the building is used for business and also for dwelling pur- poses, which latter fact brings it under the head of ex- emptions. If the real estate is mortgaged, the equity as a rule is not worth considering from a credit standpoint. Personal Property and Other Assets The next items, "Personal property" and "Other as- sets," are generally of such a nature as to be of little or no interest to creditors. The object of the other questions, such as : "What portion of real estate described is home- stead?" or, "Have you any other debts than herein men- tioned?" is, of course, plain. FINANCIAL STATEMENTS 79 Names of Partners or Officers Then comes: "Full given name and surname of each partner." It is certainly of great importance to the credit man to know who is responsible for the debts of a busi- ness ; therefore, he should carefully note that this question is satisfactorily answered. The name of the firm does not always indicate the actual person or persons interested in the business, and as each partner in a partnership firm is responsible for the entire indebtedness of the firm, it is well to know the name of each one. Some stores operate under an assumed or fictitious name, in some cases re- sembling that of a responsible business man. In order to safeguard credit grantors, a law has been enacted in some states requiring that every person or partnership conduct- ing business under a fictitious name, or a designation not showing the names of the persons interested as partners in such business, must file with the clerk of the county in which his or its principal place of business is situated, a certificate stating the name in full and the place of resi- dence of such person, and also stating the names in full of all the members of such partnership and their places of residence. If the business is incorporated, a complete list of all the officers should be obtained, together with a list of the number of shares each one owns, and, if possible, the names of other large shareholders. In some states each stockholder in a corporation is responsible for a per- centage of the indebtedness proportionate to the number of shares he owns. Personal Status The next facts required are: "Age" and "Married." The age of a merchant is not an unimportant element in determining his claim for credit. After a man has passed his prime, his energy and ambition as a rule are on the 80 MERCANTILE CREDITS decline. If he has not been able to accumulate at least a fair amount of capital during the best years of his life, it is, with few exceptions, due to the fact that he is a failure as a business man. And again, if a man is very young, he lacks in most instances the experience which is necessary to conduct a business successfully. It is also important to know whether the merchant is married or single, for upon that depends the amount to which he is entitled under the exemption laws. Insurance The next information required is: "Insurance on stock, fixtures and real estate." Among the elements con- sidered by credit men in determining the credit risk, per- haps none has received less attention than that of fire in- surance. The ability of the retail merchant to pay his debts in case he suffers a heavy loss by fire, depends usually upon the amount of insurance he carries. If his stock, fixtures, or buildings are not sufficiently insured, or perhaps not at all, the loss, in the absence of outside means, usually falls on the creditors. The National Asso- ciation of Credit Men, whose principal object is to im- prove credit conditions, has presented many articles on the subject of insurance in the Bulletin of the Association, and has thus gradually impressed upon its members the im- portance of knowing something about the amount of fire insurance carried by their customers. It has also urged upon them and upon the commercial agencies the necessity of persuading the retailer to protect his credit by carrying reliable fire insurance of sufficient amount. Considerable improvement in this respect has resulted from the cam- paign of education. FINANCIAL STATEMENTS 81 Sales and Expenses The next information required is : "Amount of sales last year" and "Amount of expenses last year." By com- paring the total of expense with that of the sales, we can judge if the expenses are in proper proportion to the aver- age gross profits in other words, whether the retailer is making a net profit. The merchant who keeps his ex- penses within proper limits is generally careful in all other matters. Then, again, a comparison of his average monthly sales with the amount of stock carried will indi- cate whether he is a careful buyer. Overbuying is often the cause of failure. Credit Sales Next comes : "What proportion of sales is on credit?" Many retail merchants get into difficulties on account of selling too much on credit in proportion to their business capital. The amount of their credit business should not be so large that they cannot meet their obligations when due. Inventories The next fact required is : "Date of last inventory." It is surprising how few of those engaged in the retail business seem to understand the importance of an annual inventory. A financial statement coming from an appli- cant who seldom or never takes an inventory cannot be reliable, as it merely represents a guess ; but if he is in the habit of taking an annual inventory, the indications are that he is conducting his business intelligently. The care- ful merchant will want to know at least once in twelve months his exact financial condition, and his profits in pro- portion to the amount of business he has done. The reasons for the other questions on the statement 82 MERCANTILE CREDITS are perfectly clear, and further comment is unnecessary. It should be carefully noted that the statement is properly dated and signed, as otherwise it is of little value, and entirely worthless in cases of fraudulent failure. Character Comes First When we have in this way carefully analyzed the moral, mental, and financial worth of the applicant, we come to the point when we must decide upon the amount of credit to which he is entitled, always remembering that, as before stated, the credit man must inevitably be gov- erned almost as much by the moral and intellectual make- up of each individual applicant as by the amount of capital he has. Experience only, and a close study of human nature, can give us the ability to judge how far we may safely go. There is, however, one fundamental rule which will apply to all cases, and which credit men should always bear in mind when gauging the credit risk, and that is, that character and ability come first. Legal Punishment for False Statements The practice of exacting and giving property state- ments has become more or less established; and an effort is now being made to throw such sanctity about this instru- ment as will give the safety that credit granting demands. While every state has some form of statute for the punish- ment of offenders who obtain money or property by means of false pretenses or representations, such statutes have proved inadequate in most cases where the fraud was per- petrated in connection with a false statement of condition. Experience having thus shown that a special statute upon this particular subject is necessary, the American Bank- ers' Association and the National Association of Credit Men have joined hands to secure in every state a law FINANCIAL STATEMENTS 83 penalizing the giving of a written false statement, such law to cover all cases of the making of false statements to obtain property or credit in any form, whether such statements are made directly to the one from whom it is sought to obtain the property or credit, or indirectly, as to a mercantile agency, to be referred to by the merchant who sells goods. The bill brought forward in the California State Leg- islature may be quoted as an illustration. It reads as follows : AN ACT to punish the making or use of false statements to obtain property or credit. (Wherever a Penal Code or Consolidated Law is in force, the following should be in- serted as a section in its appropriate place. Where no such Code exists, the act may properly be enacted as a new act, entitled as above.) Be it enacted, etc. SECTION 1. Any person, (1) Who shall knowingly make or cause to be made, either directly or indirectly, or through any agency whatsoever, any false statement in writing, with intent that it shall be relied upon, re- specting the financial condition, or means or ability to pay, of him- self, or any other person, firm or corporation, in whom he is inter- ested, or for whom he is acting, for the purpose of procuring in any form whatsoever, either the delivery of personal property, the payment of cash, the making of a loan or credit, the extension of a credit, the discount of an account receivable, or the making, acceptance, discount, sale or endorsement of a bill of exchange, or promissory note, for the benefit of either himself or of such person, firm or corporation; or (2) Who, knowing that a false statement in writing has been made respecting the financial condition or means or ability to pay, of himself, or such person, firm or corporation in which he is interested, or for whom he is acting, procures, upon the faith thereof, for the benefit either of himself, or of such person, firm or corporation, either or any of the things of benefit mentioned in the first subdivision of this section; or 84 MERCANTILE CREDITS (3) Who, knowing that a statement in writing has been made, respecting the financial condition or means or ability to pay of himself or such person, firm or corporation, in which he is inter- ested, or for whom he is acting, represents on a later day, either orally or in writing, that such statement theretofore made, if then again made on said day, would be then true, when in fact, said statement if then made would be false, and procures upon the faith thereof, for the benefit either of himself or of such person, firm or corporation, either or any of the things of benefit mentioned in the first sub-division of this section: Shall be guilty of a felony, punishable by (insert amount of fine, term of imprisonment or both). Federal Decisions The Federal Government has also entered into a vig- orous campaign against those who are using the mails for sending false financial statements in order to obtain credit. A notable case of this kind was tried about a year ago in one of the Federal Courts in the state of New York. The charge was based upon financial statements of the defend- ant's concern signed by himself, and sent through the mails to a wholesale dry-goods firm and to the commercial agencies. The latter issued them to subscribers, and the subscribers in turn extended credit to the firm on the strength of these statements. A representative of the dry-goods firm exhibited envelopes in which he said the various financial statements of the defendant's firm had been received through the mails. Important testimony was given by an expert representing the department of jus- tice, who showed that an examination of the books of the defendant's firm revealed an average difference of $65,- ooo between the figures of the firm's books and the finan- cial statement of the firm's condition submitted to the cred- itors and commercial agencies. He reported that there was an apparent insolvency of $5,800. The attorney for the defense pleaded that never before had a case of the kind been tried in any court; that the FINANCIAL STATEMENTS 85 indictment was founded on a postal law of 1873, which had been passed to stop frauds such as gold brick and green goods schemes, fake medical advertisements, etc.; and that no one at the time of the drafting of the law expected that it would be used against a merchant doing a legitimate business, who might have mailed a few finan- cial statements which on analysis were found to be over- optimistic or exaggerated. He said that Section 215 of the Criminal Code of the United States has been looked upon by the legal fraternity all along as applying to fake mining schemes and get-rich-quick propositions, and that it would be a very dangerous matter to broaden the mean- ing of the law to include financial statements, which, if put to the test of expert analysis, might be found in a multi- tude of cases to be a shade more favorable than the actual conditions warranted, yet might be made by men uncon- scious of fraud, and entirely innocent of wilful intent to deceive. In charging the jury, the judge who presided at the trial, in interpreting Section 215, said that, if it were the intent of the defendant to defraud creditors or those about to become creditors of his firm by making false representa- tions, then it was the duty of the jury to bring in a verdict of "guilty"; that a false or misleading statement made through gross carelessness or lack of knowledge of figures to mislead others, in order to secure property belonging to others, is a false representation. The jury brought in a verdict of "guilty." In passing sentence of imprison- ment for one year and three months in the Federal pen- itentiary, the judge declared that he wanted it generally known among those who were inclined to do as the de- fendant had, that there is a law and a certainty of punish- ment necessary for the public good and as a deterrent to others. 86 MERCANTILE CREDITS Section 215 of the U. S. Criminal Code under which the defendant was convicted reads as follows : Use of Mails to Promote Frauds. The Criminal Code of the United States. Sec. 215. Whoever, having devised or intending to devise any scheme or article to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises, etc., shall for the purpose of executing such schemes or artifice, or attempting so to> do, place, or cause to be placed, any letter, postal card, package, writing, circular, pamphlet, or adver- tisement, whether addressed to any person residing within or out- side the United States, in any post-office, or station thereof, or street or other letter box of the United States, or authorized de- pository for mail matter, to be sent or delivered by the Post Office establishment of the United States, or shall take or receive any such therefrom, whether mailed within or without the United States, or shall knowingly cause to be delivered by mail according to the direction thereon, or at the place at which it is directed to be delivered by the person to whom it is addressed, any such letter, postal card, package, writing, circular, pamphlet, or advertisement, shall be fined not more than one thousand dollars, or imprisoned not more than five years, or both. CHAPTER V COMMERCIAL AGENCIES AND REPORTS BY E. R. PURDY Primitive Methods By way of preface to the subject of mercantile agen- cies, it may be well to review briefly the history of these agencies, and the conditions which existed previous to their establishment. There was a time when mercantile transactions were unknown, when every man if he could took what he wanted from his fellow-man under the simple law of plun- der. Then, as civilization advanced there came the era of barter, which, however, involved no granting of time for payment, no question of credit. Exchange was in kind, commodity for commodity, and each transaction was as simple, brief, and individual as the swapping of school- boy jack-knives. The Beginnings of Commerce With the development of the more civilized instincts of mankind, fostered by a growing recognition of the ad- vantages of peace, there came a great advancement in all industrial arts, followed by an immense production of everything required to meet the demands of necessity, or to satisfy the craving for luxury. These conditions led to the establishment of trade relations between nation and nation, until gradually the system of barter disappeared, and in its place came a broader and more enlightened commerce. 87 88 MERCANTILE CREDITS Necessity of Credit But even then, goods were, as a rule, delivered only for immediate cash, as is clearly indicated by medieval account books. However, as commercial relations became extended and complex, the necessity for credit was grad- ually forced upon those engaged in the larger enterprises; and while for centuries the credit methods employed were crude, yet by their use individuals and nations prospered and added greatly to the material wealth of the world. Complexity of Modern Credit Relations This condition continued with but little change for a long period; in fact, up to the time of the beginning of American development during the last century. At this time, the rapid growth of the United States and Canada, their great extent, the marvelous enterprise of the people, the resulting mercantile, agricultural, and mineral develop- ment, and many other related causes, all combined to pro- duce conditions which had never before existed nor been possible in the history of the world. In connection with all this, the great geographical separation of debtor and creditor, the distance between commercial centers, and the length of time required for transportation, ultimate de- livery of goods and remittances, imperatively demanded some system of investigation as a guide for extending credit. It is therefore not improper to say that the work of the mercantile agency in its present state of develop- ment and extension is a natural and logical evolution from a commercial necessity. Early Credit Conditions Previous to the late '405, no intelligent and general system of reporting mercantile credits had been attempted. COMMERCIAL AGENCIES AND REPORTS 89 There had been no scientific study of this most vital factor in our commercial progress; methods were crude; in- formation regarding customers was too often obtained by creditors from untrustworthy or prejudiced sources and in a haphazard way; finally, the time limits of payment were irregular and marked by an unwise over-indulgence to debtors with consequent disaster to creditors. All this pointed so clearly to the need for better credit methods that the establishment of the mercantile agency was a nat- ural sequence. Growth of Mercantile Agencies The credit methods employed in the early days of Bradstreet's would now be condemned. The ratings were at first merely published on loose sheets and distributed to subscribers. But in August, 1857, the first reference book published by a mercantile agency appeared. It was an annual, and consisted of only 56 pages, with ratings in certain stipulated lines in New York, Boston, Philadel- phia, Pittsburgh, Cincinnati, Chicago, and St. Louis. Later, semi-annuals were published in January and July; and later still, what were called second editions, in March and September, in which appeared such changes as could be inserted without rearranging the forms. In due time, to meet the growing demands of trade, regular quarterly volumes were issued, in January, April, July, and October, including all changes and all new names, up to the approx- imate date of issue. The rating books now list almost 2,000,000 names. Necessity for Credit Investigation Credit is first of all based upon the personality. A man's own character, abilities, and energies are the basis 90 MERCANTILE CREDITS for credit, just as they constitute his powers in the business of life itself. It has been well said that, u the intercourse of society its trade, its religion, its friendships, its quar- rels is one wide judicial investigation of character." In- vestigation of some sort is necessary for the establish- ment, maintenance, and protection of all that pertains to human interests whether social, religious, or mercantile. Just as society protects itself by perpetual and diligent inquiry regarding the character, habits, and associations of its every member, so the mercantile world recognizes the need of investigation as to the character and responsi- bility of its membership. And this function the mercantile agency undertakes to discharge. It aims to be the clearing house of credit; to be the conserver of solvency on the one hand, and the active enemy of the dishonest trader on the other. The chief advantage realized from the activity of the agency is that the information necessary for accurate judgment as to commercial credits is obtained through a number of varied and trustworthy sources sources which would be entirely inaccessible to the majority of private persons. Bases of Credit As before stated, character is the first factor to be con- sidered. Capital is desirable and even necessary, but without a solid basis of character laid by the business man himself, capital alone will not suffice. The individual's own statement, properly confirmed by the mercantile agency, must form the ground work of the credit report, and the value of this statement depends largely upon his personal character, just as his business success depends largely upon his personal ability. COMMERCIAL AGENCIES AND REPORTS 91 Influence of the Agencies on Commerce Capital, character and ability, all of them important requisites, would, however, be of little or no avail without the medium of the credit reporting system, which affords to the outside world the evidence it must have as to the actual existence of these qualifications. Wherever we find the credit agency flourishing there is also found prosperity and progress. On the other hand, wherever the credit agency is unknown or hampered by ill-advised legislation there is sure to be found an unregulated, feeble, and inter- mittent traffic. This fact was well illustrated when some years ago a western state enacted some hasty legislation which made it practically impossible for a reporting agency legally to conduct its work in that state. Bradstreet's omitted the state from its rating books, giving in its place an abstract of the laws which had made such action necessary, and advising its patrons that no reports could be supplied on mercantile subjects in that state. Dealers and manufac- turers, being thus deprived of the usual means of getting information as to the credit standing of the merchants of this state, greatly curtailed credits in that section, and in some instances refused the extension of further credit al- together, with the result that the legislature was urgently petitioned to repeal those particular laws. The petition was successful, as it was obvious that the effect of this legislation on the mercantile credit and prosperity of the state had not been carefully considered. Nature of the Reports The agency report of today is a summary of all the facts necessary for the information of the merchant, man- ufacturer, or banker who has to decide on the wisdom and 92 MERCANTILE CREDITS expediency of granting credit to the subject of the report. Full details are given; but with conciseness, with simplicity of language, and without any attempt at verbal embellish- ment; and the report is such as can be readily compre- hended by any reasonably intelligent business man. Methods of Collecting Information The modus operandi of the agency in gathering its data and constructing its report is about as follows : The reporter or correspondent according as the report is in the city where the agency has an office, or in the country approaches the subject for a statement of his financial affairs. It should be borne in mind, however, that the agency representative cannot compel the subject to submit a statement if he does not see fit to do so. On the other hand, very many modern business men have been long since convinced, by the agencies and by their own necessi- ties, of the desirability of submitting financial statements; and the number who establish their credit by this method represent a very large percentage of the total engaged in business. The credit man of today at once sets a mark against the customer who declines to make a statement to the agencies. If a merchant asks credit he owes it to the grantor of this credit to acquaint him with his ability to discharge the obligation at maturity; and the only logical way to do this thoroughly is through the agencies, which have the facilities for checking up the statement and test- ing its accuracy. The merchant is also asked by the agency representa- tive to state his former place of residence, as his previous record very frequently determines the degree of credence to which his financial statement is entitled. This antece- dent record will relate the experience and qualifications of the subject, his manner of paying bills, whether or not he COMMERCIAL AGENCIES AND REPORTS 93 failed or left any unsettled liabilities, his estimated worth at time of leaving, etc. Then trade opinions are secured, and authorities consulted who are qualified to pass upon such points as whether the merchant is commencing with reasonable capital for the venture ; whether there is a good opening at the time and location for the line engaged in, etc., etc. Form of Report To illustrate more clearly the construction of these reports, one of the simpler forms issued by Bradstreet's is given below: LACOMB, F. A. DRY GOODS MODEVILLE, PA. Francis A., age 67, married. Clearfield Co. March 21, 1913, he dictated to our traveling reporter the fol- lowing statement, which he signed: "Financial condition March 21, 1913, as per estimate: ASSETS: Merchandise at cost $ 50,000 Accounts receivable, actual value 7,000 Cash in bank 1,000 Cash on hand 400 Fixtures, actual value 5,000 Homestead and other real estate 80,000 Other assets, securities 1,000 TOTAL VALUE OF ASSETS $144,400 LIABILITIES: On open account for merchandise $ 6,000 Mortgage on homestead and other real estate 50,000 TOTAL AMOUNT OF INDEBTEDNESS $ 56,000 Insurance on merchandise, $35,000. Buildings are all insured. Never suffered a fire loss. The real estate given in this statement stands of record in the name of Francis A. Lacomb. (Signed) p. A. LACOMB." 94 MERCANTILE CREDITS He was formerly engaged as an oil producer and formed a part- nership with his son-in-law, C. A. Brown, and they started in the dry-goods business in September, 1906, the firm operating under style of C. A. Brown & Co. They continued until May 8, 1907, when the business was incorporated under style of the C. A. Brown Co. The latter corporation was organized under Pennsylvania laws, with an authorized capital of $150,000, charter dated April 18, 1907, and at the time they claimed to have a paid-up capital of $100,000. The corporation operated two stores, one in Modeville and one in Frankdale, Pa. In a statement submitted as of April 23, 1909, the corporation represented its total assets at $162,807, with liabili- ties, exclusive of capital stock, of $62,807. Under Brown's manage- ment, the business is reported to have run steadily behind and to have lost money. About January 1, 1910, F. A. Lacomb took over the business from the corporation, disposed of the stock in the Frankdale store and has since continued to conduct the Modeville store only. As one of the conditions connected with the transfer of the business to him, Mr. Lacomb is said to have assumed the obligations of the corporation. In order to provide for this indebtedness, authorities advise us that he has arranged with a local and out-of-town bank to furnish funds to the extent of about $45,000 and as security he has given a mortgage on his real estate for $50,000, as indicated by the Crawford County records of March 9, 1910, mortgage payable six months after date. We are advised that Mr. Lacomb has been steadily reducing the C. A. Brown Co.'s liabilities, until at the present time it is understood these debts amount to about $18,000. An authority who is familiar with his affairs estimates his farm, containing about 685 acres, at about $55,000, and his real estate in Modeville at $15,000, making the total estimated value of the real estate $70,006. Other informants who have known Mr. Lacomb for many years state that he is a man of integrity, and they have expressed their confidence in his ability to put the business on a prosperous basis. The gen- eral opinion among those consulted is that his net worth may be conservatively estimated as between $35,000 and $50,000 after making all reasonable allowances. TRADE OPINIONS: May, 1913. In an out-of-town market two authorities have been found who have credited the concern up to $1,000 each on seventy days, and payments have been prompt. A third house has credited as high as $2,000 and payments have been lately prompt, but previously slow. A fourth authority has credited to the extent of $500, last transaction two weeks ago, and pay- COMMERCIAL AGENCIES AND REPORTS 95 ments, at one time 30 days slow, have improved to prompt or only a few days slow. Three other dealers have credited in amounts of $75, $400, and $1,200 respectively, on 60 days, and payments to all have been prompt, nothing owing which is past due. At four other sources the account has been checked for $300 at one source, $700 at another, $1,000 at a third, and $1,500 at a fourth, and payments have been made either according to terms or fairly promptly. R C May 5, 1913. Of course, there are reports of much more elaborate and extended character on large wholesale houses, bank- ers, manufacturers, and industrial combinations, which contain exhaustive, analytical statements furnished by the concerns themselves, with appropriate comments on their prospects, degree of prosperity, character, and methods of management, and observance of their obligations, the whole forming a general summary of all the facts con- stituting their standing in the mercantile world. Necessity for Cooperation The reader has doubtless met credit men who have professed to see little good in mercantile agencies and their reports, while others, and these usually the most suc- cessful, say they would not know how to get along with- out them. Here we touch upon a very important point, because the results the credit man derives from agency service are largely dependent upon his attitude toward the agencies. If he recognizes that the agency is in reality but a branch of the credit department, and the workers therein but his colleagues, and gives them the keenest coopera- tion, confidence, patience, and good fellowship, the results to him will be rarely disappointing and the highest mutual success will generally be attained. Now, this is invariably the attitude of the credit man who says he could not get along without the agency. The largest firms and most successful houses with which I am familiar are liberal 96 MERCANTILE CREDITS users of agency service and reports, never curtailing their credit men in this respect. They regard the disbursement for agency service as nominal when they consider the volume of credit business they transact each year, and which the agency service aids them to protect. They realize that they cannot have at hand too much informa- tion on the people to whom they are selling; they see the importance of being entirely familiar with the business of their customers and the various conditions surrounding them ; they understand that it is not only a question of ex- tending or not extending credit, but also one of how much. Accuracy of Information The credit man's constant cooperation with the agency is of very great importance. If every credit man were to educate the salesman to state on the order blank in every case the proper official style of the firm on which informa- tion is desired, correctly spelt, instead of some nominal trade or awning style which may have been used by dif- ferent owners of the business for as much as ten years past, this one improvement alone would vastly increase the promptness of agency service; as much wasted time and effort would then be avoided, which could be used to ad- vantage elsewhere on the subscriber's behalf. Of equal importance is the street address of the cus- tomer in the larger towns, which salesmen should always be required to furnish. Lack of proper firm name and street address on the inquiry blank which the agency sends to its correspondents, especially in the larger towns, causes more good correspondents to resign their posts than any other known cause. The character of agency work re- quires a responsible, intelligent, representative man; and the services of such a man cannot be retained if he receives many inquiries which, in consequence of a defect in the COMMERCIAL AGENCIES AND REPORTS 97 firm style or street address (the last particular is some- times entirely missing), make it necessary for him to go through the town with a fine tooth comb in order to locate the subject of inquiry. He cannot afford to waste his time this way, and soon resigns. This is a considerable detri- ment not only to the agency itself, but to the subscriber, as good correspondents are not so plentiful and so readily engaged as might be supposed. Completeness of Information Moreover, if every credit man would fill in as far as possible answers to all the questions on the back of the inquiry ticket, it would further the efforts of the agency to supply quick as well as accurate service. It is absolutely essential that the agency and the credit man work together if prompt service is to follow, and yet I have known some instances where subscribers have withheld information when putting in an inquiry, which, if given to the agency at first as a clue or lead, would have saved much valuable time. However, it is only fair to state that most modern credit men are trying to help the agency and incidentally themselves in every way, though many of them lament the difficulty of educating the sales force to the importance of the details mentioned. Insufficiency of Private Investigation The reason why each credit department does not, as you might say, act as its own mercantile agency, is because it lacks the necessary facilities. Hence, the mercantile agency steps in and acts as agent for all dispensers of credit the country over, devoting all of its time and energy to this one feature of modern business. With its vast or- ganization over the whole world, its many offices, its rec- 98 MERCANTILE CREDITS ords, and its experience, it is able to gather and issue to its subscribers dependable reports at a nominal fee com- pared with what it would cost each credit department to secure these data itself. As a matter of fact, there are probably some portions of the antecedent record of the subject which neither the credit department nor any affili- ated credit bureaus could possibly secure. As an illustration, let us say that John Smith is a new- comer to a community; commences business forthwith, and says he came from some little hamlet in Alaska, or Hono- lulu, or Australia, or any other remote point on the globe. Could the credit department obtain this man's antecedent record? No; but the office of the agency reporting the previous place of residence of John Smith will have on file his business history, which will reflect his reputation, his manner of paying bills, court records covering such things as judgments for debts and petitions in bankruptcy, if any, and finally his reported financial worth at time of leaving. Importance of Antecedent Record This antecedent record is often more important than any other feature of the report, especially if it indicates traces of dishonesty, for it may be presumed that a man's antecedents will exercise some influence on his future rec- ord. The mercantile agency records bear this out. It is nearly always the case that the merchant who has been in business for a term of years and has maintained an honor- able position as to his dealings and the discharge of his obligations (this, by the way, does not necessarily imply invariable promptness), sustains this favorable record to the end of the chapter, no matter where he may go. It is always safe to extend reasonable credit to a man of this kind almost regardless of his capital, because he will be a. COMMERCIAL AGENCIES AND REPORTS 99 careful buyer, not likely to contract beyond his ability to pay, and will in all probability eventually bring his newest business to a successful issue, as in the past. The excep- tions to this general rule are so rare that they simply help to prove it. And if a man with a good record wanders from the straight and narrow path and causes a money loss to his creditor's firm, the credit man is in no measure to blame, nor is the mercantile agency, for neither can look down into a man's heart and foretell what he is going to do. If he has previously been recognized as a reputable man, we are justified in assuming that he will continue to deal honorably; and the agency records show that in the very large majority of cases this judgment will be correct. This works both ways, however; so it is well to remember that usually, where antecedent investigation shows a man's record to have been bad in matter of principle, he should be closely watched, and transactions with him well guarded, for this kind of man will generally repeat his previous record. It will be seen from this how important a factor is the antecedent information embraced in mer- cantile agency reports. Indeed, many credit men, to save time, endeavor to learn from the customer starting a new business, where he was formerly located, and convey this information to the agency when putting in their inquiry. This enables the agency to start a request for the man's antecedent record by first mail, in the meantime proceed- ing in the usual way to interview the man and secure his financial statement. Accuracy of Agency Reports It may be said at this point that failure statistics give encouraging corroboration of the substantial accuracy of the agency reports. For instance, the following statistics prepared by Bradstreet's show that there were some 14,- ioo MERCANTILE CREDITS 047 failures during 1911 in the United States and Canada, and of this number 13,187 (or 93 per cent) had very nom- inal or no credit ratings; only 766 of those who failed were rated in good credit, and only 94 in very good or highest credit. It has also been deduced from the same statistics that almost 80 per cent of failures can be traced to the short- comings of the merchant himself. The most frequent cause of failure is lack of capital in other words, lack of judgment shown in commencing business without sufficient backing; and next in line is incompetence, which includes poor judgment in buying merchandise or in extending credit, or in operating expenses, in pricing goods, figuring costs, etc. Inexperience and extravagance, both business and personal, also produce failures. All these main points the modern credit man has so well in mind that they almost automatically come up for consideration when deter- mining credit or investigating an account. The Agency Cannot be Infallible It is the constant effort of the old-established agencies to provide the credit man with the most thorough and re- liable reports humanly possible to secure. I say humanly possible because the agencies are not infallible, nor can they ever attain absolute perfection in their reports or ratings, for they have to depend upon human effort that is, the efforts of their thousands of correspondents in the towns and villages throughout the land. The most the credit man can demand of the agency is unquestionable good faith, and a system carefully calculated to bring the service up to as high a standard of efficiency as possible. If the agency reports were infallible, there would be no need of credit men, for then the agency could automati- cally take their places. But since the reports are not and COMMERCIAL AGENCIES AND REPORTS 101 cannot be absolutely free from faults, they should be taken together with other facts of which the subscriber or credit man may have personal knowledge. Rates of the Agencies During recent years the credit man has been asking more and more of the agencies; and willing response has been made to these demands, at least to such as were feasible. But these demands on the part of the credit man call for something in return on his part; namely, co- operation, as already explained, and in addition, a readi- ness to pay a proper fee for the service. The agency report of today bears but scant resemblance to the report of a decade or more ago, and is vastly more costly to procure; but the advance in the agency rates have been very inconsiderable. Personally, the writer feels that agency rates have always been too low. A disbursement of a hundred dollars or so a year for credit information by a firm which transacts annually a credit business ranging all the way from $100,000 up to several millions, is surely not exorbitant. Very often the sub- scription price for a dozen years may be involved in any one account or bill, and yet the service covers the credit accounts for the entire year. It would be well if sub- scribers could have a more direct and extensive knowledge of the difficulties the agencies daily meet with, in gathering their data. They would then be a little more indulgent and cooperative. CHAPTER VI CREDITS AND COLLECTIONS BY C. A. PARMELEE The Development of Business Science Most of the risks or hazards of commerce have been gradually eliminated, and modern insurance methods have made it possible to protect the merchant on sea and land. Improved means of transportation and quick communica- tion have resulted in greater stability of prices ; but, until within the past twenty years, business has never been re- duced to a science, and the greatest advancement has been made within the last decade. A few years ago, the majority of merchants were still working in a more or less haphazard manner. They bought as best they could, sold in like manner, established a profit rate they thought necessary or that competition would warrant, and did the best they could with expenses. Having done this, they trusted to luck and waited until the end of the year for the inventory to show what had been accomplished. But under present methods of systematizing, account- ing, and the segregation of various items of profit and expense, it has become possible for the merchant to know absolutely, monthly, weekly, or even daily, his exact finan- cial condition how much he has made or lost in each de- partment. Almost automatically a way is opened to remedy a weakness, stop a leak or increase a net profit. 1 02 CREDITS AND COLLECTIONS 103 Importance of the Credit Department Credit is one of the principal links in the great chain upon which modern business hangs, and the most im- portant and final accomplishment of the credit department is collecting the money. Credits and collections are just as important to a successful business as buying and sell- ing. The tens of thousands of great fortunes that have been built up by commerce and trade had their origin, in almost every case, in a business conducted on a credit basis. There are, of course, a few very marked exceptions; but they are almost entirely among retailers, such as the Woolworth Syndicate and many of our department stores, which are operated on a strictly cash basis in selling, but buy on credit, usually taking advantage of all cash discounts. Credit Risks The conduct of a mercantile business on a credit basis is not, or at least need not be, a hazardous undertaking. There will always be some loss from bad accounts in any credit business, large or small, but given proper organiza- tion and management, the rate of loss will be a mere frac- tion of a per cent. And furthermore, the probable loss can be forecast almost as accurately as the death rate can be figured from the actuary tables of our life insurance companies and that is so accurate as to warrant the investment of hundreds of millions of dollars. The rate of loss from bad accounts can be so closely estimated that there are credit insurance companies which, for a com- paratively small premium, will guarantee against any loss in excess of the normal rate. In speaking of the normal rate of loss I refer to the average rate which, as time and experience have shown, exists in various lines. 104 MERCANTILE CREDITS Duties of the Credit Man Right here, however, is where the fine work of the credit man comes in. He must work with the sales department, to build up sales and develop trade, and must not drive it away by drastic collection methods or undue caution; and yet he must be so able and so well informed that he will not lose an account or let it run so long that it becomes unprofitable. It is easy to reduce the losses if you ignore the necessity for business development. It is the duty of the credit department to act as a guardian over the many customers throughout the country. They should not be permitted to overbuy, and so contract obligations beyond their financial strength. If credit is easily obtained, and they do not feel the serious obliga- tion of paying accounts when due, there is, in nearly all cases, a tendency to overbuy and thus accumulate dead stock, and this results in loss of profits, a generally un- satisfactory condition of business, and too often in final failure. The credit man should also insist that the stock of merchandise of all debtors be adequately insured. This is a necessary protection for all parties; and a business that cannot afford to pay the premium on a fire insurance policy should not be allowed to continue. The custom of charging interest on overdue accounts is becoming quite general, is entirely just and to be encouraged. Duties'of the Collection Department The art of collecting can be successfully practiced only by those who have patience, good judgment, courage, and decision to act quickly in emergencies, and a willingness to use harsh methods when conditions demand it. It is the first duty of the collection department to col- CREDITS AND COLLECTIONS 105 lect accounts when due. It will be found that a fairly large percentage of debtors pay promptly and therefore require little attention; the remainder come under the various headings of slow, very slow, undesirable, and bad, and must be watched. All accounts should be watched at all times, but especially the slow accounts. When the reason for slow payment is discovered, the remedy can usually be found. It is very necessary to keep in close touch with debtors; and a personal visit of the credit man to the debtor, as often as once a year, is very desirable. This gives an opportunity to size up not only the man, but also his business, his methods, and the condition of his stock. Then again, a man is sometimes A-i this year, but by next year is on the down grade, and the account may, in a short time, change from good to bad. Watching an Account I recall an instance of a jeweler in one of our nearby cities, who had been an excellent customer for a number of years. He did a good business, and his account was very desirable. After a while, however, we noticed that he was getting a little behind. When he was reminded of his past-due account he replied giving a very plausible excuse, and asked for a considerable extension on most of the indebtedness. Owing to his previous record this was granted. A few months later he did not reply to corre- spondence, and investigation disclosed that he was drink- ing to excess, and gambling; but all this had been carried on so quietly that our regular salesman had not learned the facts. I then made a personal call, and spent the entire day with this man getting information. Conditions were so bad that his continued patronage was not wanted, and I was free to use harsh methods so far as necessary. io6 MERCANTILE CREDITS As a result, $500 was raised that day, some merchandise was returned, and a fairly satisfactory adjustment effected. Within 60 days he was forced to make an assignment, with assets of $2,500 and liabilities of $6,000. This is an example of how quickly a good account can, under adverse circumstances, become a bad one. It is equally important to watch weak or even bad accounts, for in this day of speculation and quick profits many a poor risk has suddenly become a desirable and profitable account. I have in mind a man in this city who today is worth undoubtedly $20,000,000, whom our firm only a few years ago, and for good reasons, held strictly to C. O. D. He was broad-minded enough, however, not to hold a grudge, and when he had money became a liberal buyer, running an account. System in the Collection Department On the subject of system in the collection department, I cannot do better than quote the following article* : "PLAN YOUR WORK THEN WORK YOUR PLAN." u The best results in collection come from working on a systematic plan, which begins with a request for pay- ment when an account becomes due and ends only when the money is collected, hammering away at regular intervals with form letters when they can be used effectively, but discriminating carefully in their use, and changing the forms frequently. "Work on collections begins with the monthly state- ments. All statements should be out not later than the 5th of each month; and, if it is possible, have them out on *By R. W. Van Valkenburgh, of the Western Electric Company of New York. CREDITS AND COLLECTIONS 107 the 3rd. When you get statements from the bookkeeper divide them into three classes : ist. Those having items dated only during the previous month. 2nd. Those having items dated in the second previous month. 3rd. Those having items in the third previous month or prior. "The first class may go without comment, as they are not due and will not be due this month. The second class should be copied, name, address, and amount, then sent out marked: 'Please remit.' The copy will be kept until the 2Oth, when you will write a form letter to those who have not paid. The third class you will associate with correspondence, either writing a letter to be sent with the statement, or noting the amount on correspondence and sending statement out without comment. During the last few days in the month, it is a good plan to write to nearly all of your overdue accounts; then when the state- ment comes through you can rush it out without a letter, and it will act on the customer as a reminder of the letter received a few days before. "Do not get into the habit of just asking for money call attention to indebtedness, first in a form letter, after that write such a letter as will appeal to the man you are writing to. In order to do this you must know your man. There is a considerable percentage of your customers to whom form letters should not be sent, and there is some question of their value after the first letter. I prefer to study each account, and write the letter that I think will bring the best result from the particular customer in hand, using model letters instead of form letters. By model letters, I mean letters that have been well thought out, io8 MERCANTILE CREDITS and from which I can extract a well-turned phrase to meet the case in hand. Certainly it is a mistake to let a cus- tomer know you are writing him form letters. u The second letter I have usually made to express my disappointment or surprise at not having received the remittance asked for in the previous letter, taking at all times the stand, in a firm, courteous manner, that, as the amount is due, I am entitled to a remittance or an ex- planation. "The third letter might call attention to the previous two, and notify that draft is being made through the bank with whom the customer does business. To provide this information, names of banks used by customers should be taken from incoming remittances and noted on the ledger. "It is not worth while to apologize to your customers when you want them to pay up for instance, asking them to pay because 'we are in need of funds/ or 'have large obligations to meet.' You really want them to pay be- cause the money is due; and if for any good reason they cannot pay, you should usually be willing to extend more time; but you are entitled to a reason; and most men will think more of you for saying what must be said in a straightforward business-like way, appealing, whenever possible, through your personal knowledge of them. In this connection let me say that it is just about as im- portant for the credit man to know the customer person- ally, as it is for the salesman to know him. There are a good many customers in every territory whose accounts will be made larger when the credit man can see and talk with them. "Insist that the books be kept posted up to date. You cannot pass credits nor make collections intelligently un- less you know how your accounts stand. If you cannot get action from other employees, go to your manager without CREDITS AND COLLECTIONS 109 hesitation and without delay; a man responsible for credits cannot afford to take chances on some one else's poor work. "Keep after the claim department all the time in the effort to keep accounts clean. "Labor diligently to gain the confidence of salesmen, but do not stand for any sales work that interferes with collecting on regular terms, except with the knowledge of the manager. If anyone gets better than regular terms you must be consulted, and it is your duty to pass on them. Do not allow salesmen to make note settlements without consulting you. Advise freely and often with the salesmen regarding their customers, and be liberal in extending credit, but make the distinction between liberality and recklessness ; and when a customer whose account amounts to $500 or more, ignores your correspondence, or you have reason to believe he is in trouble, it is time for you to get out and see him. You will at least impress him with the feeling that you not only want, but expect, fair treat- ment, and you consider it only fair that he answer your letters. At the same time, if a credit man approaches the average country merchant in the right spirit, he can do a lot toward cementing the customer's friendship to the house. "You should rarely lose a large account, because you should be watching them so closely and know them so well, that if there is danger you are the first to know it and therefore first on the ground. 'First come, first served.' Do not force anyone except as a last resort; and on an account of any considerable size, see the man before giving it to an attorney. You can almost always effect some kind of a settlement by getting in personal touch with the customer, and you do not antagonize him as you do when an attorney is called in. Try to look at no MERCANTILE CREDITS each problem as it comes up, in a big, broad-minded way. Be liberal, honest, and fair; make that your attitude, and you cannot help but be right a good part of the time." Legal Methods of Collection The credit man should have a fair amount of legal knowledge, so as not to be entirely dependent upon the services of an attorney. Such knowledge, and judgment as to just how and when to act, has saved many an account, especially in cases of attempted fraud. It is often advisable to bring suit and get judgment even though there is, for the moment, no chance of mak- ing collection. If the debtor has nothing and is unable to pay, get a note if you can do no better. If this is refused, and the debtor is not an old man, it will usually pay to bring suit and get judgment. The judgment can easily be kept alive for an indefinite number of years, and it is very probable that sooner or later the debtor will acquire property, and the account can be collected. The law allows interest on judgments until paid. I recall an instance in which an account of this kind was assigned to the local board of trade. They secured judgment and kept it alive; and many years after we had written the account off to profit and loss, and forgotten it, they found the debtor possessed of real estate and col- lected the entire amount with interest. On another oc- casion a hotel man deliberately planned to beat us out of his account by transferring his property to another per- son. Later on, one of our collectors chanced to overhear a remark, made by him in a public place, to the effect that he had a certain sum of money on deposit in one of the city banks. We acted upon this information, brought suit, and attached his bank account; but through some techni- cality he kept the money from us. We nevertheless se- CREDITS AND COLLECTIONS in cured a judgment, which we kept alive for years; and finally he found it so difficult operating in his wife's name, that he voluntarily came forward and paid up. Another debtor, in order to swindle his creditors, placed his property, worth about $25,000, in his wife's name. We with others brought suit, got judgment, and quietly waited. Later on, the man and his wife separated ; and the husband brought suit against his wife for the property, stating in court that it was his. This, of course, was our opportunity. Collecting by Instalments Excellent results are often obtained on slow or even bad accounts, by arranging for small and frequent pay- ments. Many a debtor cannot get together $50 or $100 at a time, but can raise a smaller amount, and by getting this down to a weekly basis, great progress can be made in a few months. Often a debtor will consider a note more binding than an open account, or will make more effort to meet it when due. The following form of instalment note is legal, and leaves the account in such shape that any default of a small payment makes the entire amount due and payable : $1096.03 Los Angeles, Cal., Jan. 27, 1913. For value received, we promise to pay to the order of Blank Company the sum of One Thousand Ninety-Six and 03/100 Dollars, payable in instalments as follows: On February 5th, 1913 $ 366.03 " March 5th, 1913 365.00 " April 5th, 1913 365.00 Total $1096.03 H2 MERCANTILE CREDITS Each instalment to bear interest at the rate of six per cent (6%) per annum from date hereof until paid. Should default be made in the payment of any one of the said instalments, or of any part thereof, or of the interest thereon, upon the day whereupon the same becomes due, then, and in any one of the aforesaid contin- gencies, the whole of the aforesaid principal sum, or any balance unpaid thereof, together with interest thereon, shall immediately become due and payable. The note shall be payable at the Bank of , San Francisco, California. Troublesome Retail Accounts In the retail business there are many excellent ac- counts with rich patrons, which are very difficult to handle. It is not uncommon for a very wealthy woman to make frequent and large purchases, and expect the account to run indefinitely, sometimes for months or a year. If an attempt is made to hurry the collection, it is resented, and the account taken elsewhere. This state of affairs is ex- ceedingly unfortunate, and the merchants who have al- lowed such conditions to grow and thrive are decidedly to blame. The conditions are, however, very difficult to correct, as no united action can be secured among retailers because of their fear of losing good customers. The Wealthy Customer I recall an instance of a millionaire customer, who had traded with us for years. She had been allowing her account to run until it was hardly profitable to carry it. The credit department then commenced to write collection letters, which at first had no effect; but after sending the second or third, a check in full payment was received, to- gether with a very indignant letter. Our customer de- clared that she had traded with the house for over twenty years, but that if this was to be our attitude she wanted the account closed, as she had no time to check up and CREDITS AND COLLECTIONS attend to these bills, and would not trade with a house that was not willing to allow her to pay at her pleasure. The usual conciliatory letter that is necessary under such circumstances was sent her in reply. An occasion like this always gives a good opportunity for a rather lengthy letter going into details, which can often, without giving offense, make quite clear the position in which the firm is placed, while at the same time it shows a willing- ness to co-operate with the customer so as to make the continued carrying of an open account mutually agreeable. In the instance referred to, the lady continued to be a regular customer. I have noticed that her account has never since run over 30 or 60 days, although several years have now elapsed. I maintain that all accounts not paid within a reasonable time should have personal attention, no matter how rich or influential the person may be, and this rule generally works out right. Liability of Stockholders In the case of a corporation becoming involved, and unable to pay its debts, the stockholders in some few states become personally responsible, in proportion to their holdings ; and in these states it is possible to collect either in part or in full from the individuals, though the corpora- tion is insolvent. Even in these states great care should be taken in selling to a corporation that is still in process of organization, as a stockholder is only responsible for debts incurred after he has acquired his stock, even though he may be an owner at time of delivery of merchandise, and derive the benefit from same. There was an occurrence of this kind a few years ago, when a large hotel corporation was being projected. The proposed stockholders had agreed to organize as soon as certain legal details were completed; a manager was H4 MERCANTILE CREDITS engaged; much of the money had been paid in; and the building was in course of construction. In order to obtain in time, certain supplies which had to be manufactured in the East, orders were placed by the manager in October, delivery to be made in January. The organization was not completed nor stock issued until December. All the forms, however, had been regularly complied with before arrival or delivery of the merchandise. In April, the corporation, through bad management, went into the hands of a receiver, and there was nothing left after the building material men were taken care of for unsecured creditors. Suit was brought by the Eastern firm against the stockholders, on their personal liability as stockholders. After a long, tedious time in court, the case was decided against the firm, for the reason that the stockholders had not acquired their stock at the time the order was placed, although they were bona fide stockholders when merchan- dise was delivered, and had accepted and used the same, and refused to relinquish title to the property. Staving Off Disaster Occasionally a good business man, with good oppor- tunities, will become involved; and through misfortune, or some cause for which he is not responsible, will be unable to meet his obligations. Then, unless he is helped finan- cially, and an extension granted, he faces sure ruin. In such cases a general meeting of creditors should be called, so as to prevent any one firm taking undue advantage. By this means a firm is often saved from ruin, and in a reason- able time is again on a profitable basis. Local boards of trade have done much good along these lines. They have also assisted in making satisfac- CREDITS AND COLLECTIONS 115 tory adjustments, and in the selling and handling of stocks of goods for the benefit of both debtor and creditor. Conditional Sales In many lines of merchandise it is possible to handle accounts in a way that is practically free from danger of loss, by selling on a lease, or conditional sale contract, whereby the title of the property does not pass to the pur- chaser until entirely paid for. This plan is being followed very extensively on all classes of merchandise except perishable goods, or such as are consumed in use, like groceries. The form of contract used is very simple ; and it is not necessary that it should be recorded. Failure to pay as agreed is sufficient cause for removal of goods. If, however, a fairly large payment has been made in ad- vance, the purchaser is sure to pay the balance if possible, when due. Merchandise held under such contract cannot be sold by the purchaser or removed, nor is it subject to attachment. Cooperation Among Credit Men Friendly relations should be encouraged between the credit departments of competing firms, for mutual assis- tance and the exchange of information on slow or doubt- ful accounts. The services of the commercial agencies also are always necessary and valuable. Collection Agencies Many collection agencies exist throughout the United States, a few of which are good, and sometimes able to collect bad accounts which have been given up by the firms holding them. Great care should be exercised in employ- ing such agencies, however, as far too many are irrespon- n6 MERCANTILE CREDITS sible and do not turn in the money collected. It is my opinion that a properly organized collection department can do about as good work on bad accounts as any out- side firm, although such accounts are disagreeable, and require a great deal of labor and time. But a collector will not be a success unless he thrives on work, and is willing to patiently labor, day after day, until he can bring results. Successful Strategy Strategy, new methods, and timely schemes, are neces- sary to bring results on many of the accounts that have become habitually slow. On one occasion a dealer in Santa Barbara had per- sistently maneuvered to avoid paying a $300 account that was over a year old. He had a fair standing, and we hesitated to bring suit, yet could not afford to sell him any more goods without a settlement. Knowing that he would take in considerable money during December, we wrote him that we had divided his account into ten dis- tinct parts, making a draft for each amount, and dating the drafts in such a way that one would be presented each day, beginning with the I5th of December. The amounts were small in the earlier drafts, and made larger as they came nearer to December 25th. We arranged with the Bank at Santa Barbara to wire us in case any draft was not paid promptly, and also engaged an attorney, telling him to be ready to file suit in case we notified him. All the details of the arrangements were explained to the debtor, and he knew that if he failed to pay as arranged, his place would be attached during his holiday business. The scheme worked well and the entire account was paid. Strange to say, he took no offense and has since given us business, but on a cash basis. CREDITS AND COLLECTIONS 117 Hard Work The way of the collector is always hard. There is no quick and easy way to collect all accounts, but persistent work will count; and the heart of the collector will fre- quently be cheered by some unexpected pleasure, such as the payment of an old or outlawed debt. CHAPTER VII AUDITS AND INVESTIGATIONS BY W. C. MUSHET, C P. A. In taking up the subject of accounting in relation to credits, I wish to speak of credit in a rather comprehensive way, and there is one central thought that I wish particu- larly to emphasize, and that is the importance and neces- sity of strict investigation in all matters relating to credits. In this investigation accountancy will frequently play an important part. Sources of ^Information Now, with regard to merchandising. What is it that a merchant wishes to know about accounting in relation to credits? He wants to know the financial standing of his customer. But he does not want to stop there; he also wants to know the history of his customer's business, and where can he get that information? Well, he goes to Bradstreet, and he goes to Dun, ask- ing for the commercial standing of this or that man; and he gets a report which purports to tell him what that man's assets are, and what his liabilities are, and what is his net worth. But where do Bradstreet and Dun get their infor- mation? First, they go to the prospective customer and ask him for a statement. They ask him to tell them about himself. 118 AUDITS AND INVESTIGATIONS 119 Mr. Isaacstein's Mistake I remember a story here that illustrates the point I want to make. One day, early in March, a man with a handful of papers went into a store on Main Street I don't know whose store, but we will say it was Mr. Isaac- stein's and he said, taking out his papers, "I would like to find out how much stock you have got." Mr. Isaac- stein suddenly became very busy so busy he could not stop to make a calculation but volunteered in a very large way, "Well, we have got about $10,000 worth of stock on the shelves." "Yes. And how many solvent creditors have you got? How much is owing to you that you consider good?" "About $5,000." "Well, how much do you owe?" "Don't owe anything." "Good," said the inquirer. "I'll see you later." So that afternoon he returned to the store, and taking out his papers, an- nounced, "I have come to collect your personal property tax." "Well," said Mr. Isaacstein, not remembering him, "I suppose you want to find out what property I have got." "Why, no," explained his caller; "I was here this morning, and you told me." And he assessed him accord- ingly. Mr. Isaacstein was angry, and said, "My friend, you did not treat me right. I thought that you were a Dun or Bradstreet man 1" Credit Misinformation You will note that it is not a legal crime to lie to Dun or Bradstreet. If it were, there would be no necessity for the act now before the California State Legislature to make it a crime for a man to make a false statement in writing to either of these agencies. Dun and Bradstreet do not rely entirely on the state- ment of the party himself, but make every effort to get 120 MERCANTILE CREDITS corroborative evidence. They go to the creditors of the man that they are investigating, and also to the bankers, but they do not always get the truth even from those people. I remember the case of a man in Arizona who was on the verge of failure and owed the bank in his town some six or seven thousand dollars. He wanted to trans- fer his account from that bank to one of the very large banks in a distant city, and the two bankers had some correspondence on the subject. The local banker, know- ing the true conditions, and wishing to u get from under," gave the debtor a very excellent reputation, and the ac- count was removed from Arizona to the distant city, to which news of the depositor's failure came some few weeks later. It is evident from this that sometimes even a banker, in order to save himself, will give an incorrect statement regarding a debtor. Board of Trade Reports Of course the agencies do the best they can. They get the information; but the information that they get neces- sarily must come chiefly from the debtor and from the references that he gives. For the betterment of this condition the Los Angeles Board of Trade maintains a reporting bureau, which gets a great deal of advantageous information for the credit man. Similar bureaus are maintained in many other cities. The plan works something like this : Mr. Jones of Los Angeles has applied to you for credit. You want to know how he stands, and you send an inquiry to the board of trade. The board of trade will list all such persons inquired about, and that list will be circulated through the trade, and the next day the information re- ceived will be tabulated. In this way the board finds out each day, or as often as called upon, how much a certain AUDITS AND INVESTIGATIONS 121 man owes at a certain time, and how much is past due; and also gets information as to the character of the payments. But this report, you see, deals only with the liabilities of the man. Next, they send out a request to the party for a statement; that is, they send him a form asking him to make his own statement about his affairs. i Scope of Statement Now, all these things deal with the present condition of the debtor's account. But that is not sufficient. It is necessary to know how that man stands today, but you want more than that. You want a history of his business. You want a certified statement from his books and records. But what are you going to do when there are no books? Unfortunately, many a small merchant does not keep books in any real sense. You will find in his store a couple of spindles, on one of which he puts the bills as they come in, while on the other he puts the bills as he pays them. He may also have a blotter in which he re- cords the sales he makes on credit. Sometimes you will find both a blotter and a cash record, but there will still be absolutely no record of his investment. What is to be done under such conditions? Proper Records Of course, we have the remedy for this condition in our own hands. In England, it is a statutory offense for a retailer not to keep a set of books; and a like condition can be brought about in this country. But at present, in a case where there are no books, all that you can do is to in- vestigate the past history of the concern, and insist that in the future some fundamental records shall be kept. You already require your customers to carry fire insurance. 122 MERCANTILE CREDITS Insist on their keeping proper records, just as you insist on their carrying fire insurance. Require them to keep simple records of account, not only for your benefit, but for the benefit of the owner of the business himself. Incomplete Statements But suppose that a proper set of books is kept, what is necessary? You want a certified statement from those books and records, and you want the whole truth. Not a part of the truth, but the whole truth. I remember an instance in point. A certain concern in my town was in dif- ficulties ; and a statement signed by a certified accountant was placed upon my desk, showing that the assets were $123,000 and the liabilities were $100,000. That looked as if there were a surplus of $23,000. The business had been running for only ten months, and it appeared that it had made $23,000 profit in that short period. But when I made a personal investigation, this is about what I found. The assets on the ledger were apparently $123,000, and the liabilities were $100,000. The expenses stood at about $60,000, making the gross gain $83,000. Yet this com- pany, instead of making a profit of $23,000, had actually made a loss of $27,000. But, as it would not help the sale of its stock to go before the purchasing public with a statement showing a $27,000 loss in operating in ten months, the officers of the company asked an accountant to tell them what they should do. The accountant went home that night, after inspecting the books, and dreamed that some timber lands owned by the company up in Ore- gon had increased in value from $50,000 to $100,000. Accordingly, he put a profit of $50,000 on one side of the ledger, to balance the loss of $27,000 which appeared on the other side, and the result of this was an apparent net profit of $23,000. A number of indictments followed this AUDITS AND INVESTIGATIONS 123 discovery, and two of the manipulators of that fraudulent corporation are now serving time. Yet the books were technically correct, and the book- keeper, a German, kept them magnificently, with faultless neatness and accuracy. But he was a mechanical book- keeper. After he had written the books up, he did not understand what they spelt, and the poor fellow invested $7,000 of his own money in that fraudulent concern, and lost it, simply because he could not read the handwriting on the wall, though he had written it with his own hand. Profit and Loss Statements I repeat to you, therefore : When you get a statement, get a statement of the whole truth. It is very easy to cover a multitude of sins by saying: Assets, $123,000; Liabili- ties, $100,000; Surplus, $23,000; but that is only half the truth. This is an asset and liability statement a capital statement and it does not say a word about profit and loss. You can take up any newspaper, you can take up any report of any institution in America, and all you get is a statement of assets and liabilities; that is, just one-half of the truth. But, if you had all the debits and all the credits a capital statement and also a profit and loss statement then you would know what was going on. In the in- stance just quoted, if, instead of merely giving an asset and liability statement, and showing a surplus of $23,000, there had also been a gain and loss statement, the $50,000 in assets which had been thrown into the accounts would have been disclosed, and people would have asked where that $50,000 came from. Then they would have discov- ered that it was not an operating profit. There was, in fact, an operating loss of $27,000; and even admitting, for the sake of argument, that the price of that Oregon property had actually increased $50,000, that increase 124 MERCANTILE CREDITS was a capital increase and not an increase from operation. There are two kinds of profit a profit from opera- tion, and a capital profit. And if a statement submitted shows the difference between these two kinds of profit, you will get the whole truth and not half of it. Responsibility of the Accountant In the case just cited, the accountant deliberately made a false report, and was as guilty as the officers of the com- pany who were indicted for fraud. There should be some means of holding an accountant responsible under such cir- cumstances. In England they manage things of this kind differently. The English Corporation Act requires that any company selling stock to the public shall have an audi- tor appointed by the stockholders not by the officers and manipulators of the corporation who makes a semi- annual examination. He then reports to the stockholders, and he must give them not only an asset and liability state- ment, but a gain and loss statement also. Now, that is what we should insist upon. A merchant wants to know, not only what a customer is worth today, but how much he has made or lost in his business during a definite period of time. A lawyer came to me some time ago for advice in re- gard to a client of his. This client had entered into part- nership with another man a year or two before, and each of them had invested $1,800, making $3,600 altogether, which constituted the assets of the business. His client, however, had put in $1,800 of actual money, while the other partner had put in his business at an estimated net worth of $1,800; that is, he claimed the assets were worth $1,800 net, over and above the liabilities. No statement of profit and loss was shown, and in the course of the year it was found that the real value of the business had only AUDITS AND INVESTIGATIONS 125 been $900 just half of what was stated. In other words, my friend's client had been swindled, and the original assets of the firm were only $2,700. The business was continued, but lost money right along. "We have just taken stock," said the partner who had invested the cash, "and find that the assets figure $3,000, and the liabilities $1,800, so that all we are worth is $1,200 as against $2,700 a year ago. In other words, we lost $1,500." Now, that is what the merchant wants to know. It is true that he is interested in knowing that the assets today are $3,000, and that the liabilities are $1,800, and that there is a real investment there of $1,200. He wants to know that; but he also wants to know that during the year the investment has dropped from $2,700 to $1,200, and that there has been a loss, if such is the case. He should know that, although the principal is still alive, it is in a pre- carious condition, and he will never find it out from an asset and liability statement. He must have the whole truth in order to make an intelligent decision, and that is why I am insisting upon the necessity of showing the losses and the gains, as well as the assets and liabilities. Optimism is Natural A man making a statement of his own affairs will nat- urally put his best foot forward. He will even deceive himself. He is optimistic. He will inflate, in his mind, the assets, and he will deflate the liabilities. You know Bob Burdette's story about the optimist and the pessimist. "The pessimist says, 'I wonder if there is any milk in that pitcher!' And the optimist says, 'Pass the cream !' " Busi- ness men are all optimists naturally, or should be. They are going to put their best foot forward. They are going to make things look as rosy as they can, and it is for the credit men to get right down to the true facts. 126 MERCANTILE CREDITS Inflated Assets Not very long since, I was going over the books of a large water company, and we put in a record of material. I had them take stock of the material, and compare it with their material account upon the ledger, and they discov- ered that the material by actual count was about $1,800 less than the material account upon the ledger. A few days afterward they had adjusted this difference. They did not alter the ledger account, but they fixed the ma- terial, which, from my point of view, means that there is an inflation of $1,800 in the material account. Depreciation of Assets In our investigations we must not only watch for in- flation of values, but must also watch to see that proper allowance has been made for depreciation. Sometimes the allowance is too small, and occasionally it is too large. I once knew a gentleman in the agricultural implement busi- ness who, when he took his inventory at the end of the year, wrote off 50 per cent of any merchandise that was on hand the year before. In other words, if it had not moved during the year, he considered that half its value had gone. If it had come in during the year, depreciation was reckoned on a lower scale; but if it had been on the inventory two years before, he depreciated it 100 per cent. He simply listed it. Now, that may be a little extreme; but you will often find, when you come to scrutinize a list of assets handed you, that the person responsible has gone to the other extreme, and has made no allowance whatever for depreciation. Accounts Receivable Then again, some people will carry accounts receivable on the books for years and years. They don't write them AUDITS AND INVESTIGATIONS 127 off because they look like an asset. Notes receivable are often treated in the same way. I remember such a case some years ago. There were two boards of trade in a certain city, and naturally they were antagonistic. The standing of a debtor had been submitted to one of these boards, which, after a little investigation, said to the man: u Oh, everything is all right, we will give you an extension of time; go on and attend to your business, and we will see that your creditors do not make you any trouble. Leave it to us." One of the creditors, however, brought that man into the other board of trade, with which I was connected, and we also went through his affairs, and our report was very different so different that his creditors said: "This man's condition is so serious that, in order to protect ourselves, we must take a transfer of his assets. He is not in a fit condition to run his business, and his busi- ness is not in a fit condition to be run by him ; he has lost too much money already." Now, where did the difference come in the viewpoint of those two boards? Right in notes receivable. When we came to scrutinize the seven or eight thousand dollars of notes receivable listed as assets, we found they were notes given by an individual member of the firm to the firm. The man was listing as assets his own notes ! Understanding the Liabilities As to liabilities, they are very apt to be understated. I could narrate to you from my own experience numbers of cases where companies have understated their liabili- ties. In one concern that we investigated, we had to make adjustments of the aggregate amount of $108,000, debit and credit, in order to put a true record on the books as of a certain date. And that meant that this concern, which had been paying dividends in the belief that it was solvent, 128 MERCANTILE CREDITS as a matter of fact, had not made any profit, but had been running at a loss and did not know it. Now, if the concern itself did not know it, how were its creditors to find it out without an investigation ? The Public Needs Protection If a merchant needs a credit man to look after his busi- ness for him, how much more does the public need a credit man to look after its business ? It is popularly supposed that the public likes to be humbugged. That may be true politically, but I do not think it is financially. It is a com- mon saying that a sucker is born every minute. That may be true in one sense. It is also said that the best bet is the public apathy. As a matter of fact, Get-rich-quick Wal- lingfords in this country get millions of dollars from the unsuspecting public every year. What we need is a law which will force all stock-sell- ing corporations to tell the whole truth, and let us have the operation account as well as the statement of assets and liabilities. The public wants to see that profit and loss statement. It is all right to have a statement of assets and liabilities; that is good as far as it goes ; but it is only one- half the truth; and if I must have but half, the half of the truth that I prefer to have before me is the profit and loss statement, which shows where the profits if there are any come from. When you find that out, you know where you are. < Building Associations Now, I want to tell you about home building associa- tions. There are many of them, and some are better than others, but they should all be investigated before you trust your money to them. Let me give you a typical statement: AUDITS AND INVESTIGATIONS Operation, one year: Legitimate profits $10,000 Rise in the value of real estate 70,000 Premiums on sale of stock 20,000 129 Total $100,000 Now, they had made an operating loss : Expenses $90,000 Dividends 10,000 Total $100,000 As you will note, the profits were made by raising the assets value. They threw the increase into the gain column. The stockholders got in on the ground floor, but the manipulators got in at the sub-basement! An accountant came to me today and said : u The com- pany I am investigating has been operating at a loss, but the directors have declared a dividend, and are carrying a surplus over into the next year. How can this be?" I explained to him the method: Buy a piece of property today for $100,000. Go home, go to sleep, have a dream. Tomorrow morning put it on the books at $200,000. Profits $100,000 ! What a fine investment! Of course, a rise in the price of stock follows; and when stock rises and the premium is paid on it, then take the premium for profit. You receive $200 for stock, par value $100, and you put the $100 on the books as a liability a capital lia- bility of the stock, while the premium is a profit thrown into the gain column. Then dividends ; and so on, and so on, until the crash comes, as it is bound to come sooner or later. And what then? They have been discounting future dividends. If the company is paying all the profits in dividends now, then when the stock is all sold and there are no more premiums and property ceases to rise in value, or is sold at an increased price which has already been taken into 1 30 MERCANTILE CREDITS consideration and declared as dividends, what is going to happen? First, the dividends will grow smaller; by and by the dividends will pass; and then there will be assess- ments. This is not a guess ; it is something that is happen- ing, not occasionally, but continually. Necessity for Surplus Now, when assessments come, there will be a fall in the price of that stock; and when the stock falls in price, there will be a panic among the stockholders; and when the panic comes, there will be a further fall in the price of stock; and so on. This is the penalty for such manipula- tion. To inflate values is unsound accounting, is unsound financiering, is unsound legally. To illustrate the danger of such inflation, I may men- tion the case of a man who paid $30,000 for an orange grove in Southern California just before the severe win- ter which destroyed the groves in that part of the state. Three months after he purchased the grove he was beg- ging someone to take it off his hands at $15,000. That winter meant to Southern California a loss of millions of dollars. Such calamities must be provided for; and to offset these is a good way to dispose of that rise in the value of property. And right here I want to quote a para- graph in regard to a court decision on the matter of pay- ing dividends in anticipation of profits. This is a New York case, in which the court said : "To calculate months in advance on the result of future transactions and on such calculations to declare dividends, was to base dividends on paper profits, hoped-for profits, future profits, and not upon the surplus or net profits required by law." The Proper Treatment of Unearned Increment A very wealthy corporation bought considerable land a number of years ago, and has held most of it since. That AUDITS AND INVESTIGATIONS 131 property stood on the books at a million dollars ; but at a conservative estimate it has risen in value during the last ten or fifteen years to, we will say, $2,000,000. The cor- poration still has the property, or a great deal of it. Now, in 1909 the Federal Government passed an income tax requiring the payment of i per cent upon all profits over and above $5,000. The Government does better for it- self now, for under the present law it takes the tax on the entire corporate profits; but in 1909 it was satisfied with less. Now, here was a company with land upon its books at a million dollars, which was worth $2,000,000, and this gave a million dollars of profits right there. For better illustration, take a single piece of the prop- erty that the corporation bought fifteen years ago. We will say it cost $1,000, and could be sold for $2,000 in 1909, and in 1910 for $2,200. The company had made a profit there of $1,200, but how much was the Government to get out of that? Should the Government take its i per cent on the total profit, or only on the increase from 1909 to 1910, which was but $200? Here it is obvious that the Government should only tax the increase after the law went into effect in 1909, when the property was already worth $2,000, until 1910, when it was worth and was sold for $2,200, a profit of $200. On this the Government was entitled to its i per cent. After the passing of the income tax law it became nec- essary to put the property on the books as of the new valu- ation; that is, $2,000, just twice the original cost. This gain of a thousand dollars, however, was not put in the Profit and Loss account, but was put, as an offsetting lia- bility, into a capital surplus account; and when the prop- erty was sold for $2,200, the profit of $200 was added to the $ 1,000 in the liability account, which, when taken out I 3 2 MERCANTILE CREDITS and put with the $200 in the gain column, made a total realized profit of $1,200. Dividends from Premiums I will now briefly discuss the subject of premiums on the sale of stock as a profit out of which to declare divi- dends. Section 309 of the Civil Code of the State of Cali- fornia says that dividends must not be paid except from surplus profits arising from the business of the corpora- tion. Most of the states have similar laws. If the busi- ness of the corporation is to sell its own stock and make a profit on it, then premiums can go into the gain column, but I do not think that any corporation will claim that its business is to deal in its own stock. I do know of one cor- poration, however, whose only business for six or seven years has been to sell its own stock; and it has declared dividends, not once but many times, absolutely without any justification. In all the years of its existence its legiti- mate profits have not amounted to $3,000, but it has traded notes which it took for its own stock to another concern, and has gone on accruing interest on those notes which it did not own, putting that accrued interest upon its books, calling it profits, and declaring dividends out of those profits. I attended a recent stockholders' meeting. They decided to lease a piece of property, and immedi- ately the value of that lease was put on the books as $50,- ooo, and dividends were declared on the strength of the profit thus disclosed. The district attorney will tell you that the improper declaration of dividends out of capital is only a misdemeanor, it is not a felony. That company is not declaring dividends now, and a poor woman came to me, and said, "What am I to do? I haven't very much money, and I put $1,000 into this thing, not for myself, but for a niece in Philadelphia, whose hus- AUDITS AND INVESTIGATIONS 133 band is bedridden, for it was expected to pay 10 per cent, or 12 per cent, and that would have meant $10 a month for my niece and her husband. I don't know how on earth they are going to get along without that $10." But the manipulators of that company are living in mansions that cost $100,000, and they ride in their automobiles. I know of another case where the victim, a refined woman, has been obliged to take in washing for a living on account of these vampires. I know of a case where a dying man put all he had, $10,000, into something that he thought was good, one-half to go to his son and the other half to his daughter, and now there is nothing. I know of still another case and all these cases have come under my personal observation where stock is being sold at $2 par value, and the book value is only 38 cents. I knew a real estate manipulator, with his property mortgaged to the hilt who was hard up, with not money enough to pay his taxes who formed a stock company, and went into the business of selling its shares. He holds control of the com- pany, and is now drawing over $10,000 a month, although its expenses are more than the income. All this money comes from suckers who buy the stock. Getting a Credit Standing Manipulators of this kind resort to an infinite variety of schemes to further their semi-fraudulent enterprises. A banker told me the other day of a man who came into his bank and said, "Mr. Blank, I have opened an account in your bank, and I want you to know it." "And," the banker continued, "every time that man came in afterwards with a deposit, he would make it a point to come to my desk, in order to show that he had an active account in the bank." After a while I found out what he was after, for one day he came to me and said, "Mr. Blank, there are I 3 4 MERCANTILE CREDITS inquiries about us on the outside, and I should like to use your bank's name as a reference." I said, "Well, I have no objections, but wouldn't it be just as well if you told me something about yourself and your concern ?" "Certainly. Do you know," he said, "that the proposition in which I am interested is going to be the biggest industry in the world?" And he explained just what it was, but the banker knew the actual facts, and told his depositor flatly that he was a gold brick artist, and a bunco steerer; and finally added, "You refer inquirers to us, and take partic- ular care to see that the correspondence comes to me per- sonally, and I'll tell them." But the depositor did not refer. He withdrew his account. His concern spends perhaps $15,000 a year of stockholders' money in adver- tising. Swindling Schemes Some of the schemes encountered in the course of an accountant's investigations are nothing more nor less than swindles. In one case in my own experience, the pro- moters of a land company wanted to get a good lot of stock for themselves without giving any real quid pro quo. The stock was selling at 20 cents a share. After studying over the situation, the promoters devised the following somewhat ingenious plan : They had an option on a valu- able piece of land. "Now," they said, "we will sell that option to the company f or $ 1 5 ,000 ; that is to say, $ 1 5 ,000 worth of stock." This, at 20 cents a share, mounted up to 75,000 shares. The plan was carried out. The com- pany bought the option, and the promoters got their 75,- ooo shares of stock, which, in consequence of the rise in value of land held by the company, is now worth consid- erably more than 20 cents a share. The company never exercised the option. Of course, that was the company's AUDITS AND INVESTIGATIONS 135 misfortune. It had paid stock actually worth $15,000 for this option which had never been exercised. In another case which came under my observation, the swindle was even more lightly disguised. The chemical formula for sugar is C 12 HL Ou. The formula for water is H 2 O. Now, a very shrewd young fellow saw the formula for sugar, and it occurred to him that it looked like carbon and water. So he devised a scheme to make sugar, not out of sugar cane or beets, but out of water and carbon. Ap- parently he was successful. I saw him make the sugar, or thought I did, and I have some of it now. It is a very fine, pulverized sugar. The bright young man had a very elaborate mechanism which transformed the water into steam, and passed this steam through fine tubes, where it was gasified. In another mechanism he was burning char- coal to get his carbon, and these things were mixed and supposedly combined by means of an electrical current. I do not know how he did it, but after a while the mix- ture came out fine powdered sugar. On the strength of that exhibit he sold a very great deal of stock. Of course, the whole thing was a humbug; and the last I heard of the bright young man the Pinkertons were looking for him. Now, in conclusion, everything that I have said may be summed up in this one piece of advice : Always insist upon the full truth when you are asked to give credit. Get the profit and loss statement as well as the statement of assets and liabilities, and see that they tell everything they should. CHAPTER VIII LIENS ON PERSONAL PROPERTY* BY N. P. CONREY Fundamental Property Rights The Constitution of the United States guarantees to all of us the fundamental right of security for life, liberty, and property. To be a free man is necessarily to be one who is capable of holding, owning, and controlling prop- erty things of value for personal use, of value to society, and therefore things which are articles of commerce. These things the free man may hold in his own right. To the extent of that ownership the law gives him an attri- bute of sovereignty. The state itself guarantees that it will not interfere with that right except where this is necessary for the public good. It is provided, therefore, that one's property shall not be taken away without due process of law; and that it shall not be taken away under any pretense, against the owner's will until after the ascertainment and payment to him of due compensation. So, a man and his property stand encircled and protected by the law. Sale and Transfer Now, that is good for a starting point, but no one lives to himself alone. Man is a social being. He seeks * It is impossible to give the varying lien laws of the different states in the present volume. The California law which is discussed here will give a fair idea of the general law of liens and will indicate what the credit man must look for when investigating the matter in other states. 136 LIENS ON PERSONAL PROPERTY 137 social relationships, or has them forced upon him. He then begins to have also legal relationships, and his prop- erty, too, begins to have legal relationships which bring him and it into touch with other members of society, and this leads to trade and transfer. Out of affection or philanthropy, you may give your property away; you may exchange it for other property or you may sell it for the medium of exchange, which we call money. There are rules of law and practice applicable to all such transfers; conveyance of land by deed or by delivery of possession; conveyance of personal property by delivery of possession and bill of sale; and so on. Liens Then there is another line of relationships which comes short of sale, transfer, or conveyance in the first instance; and these relationships are described by the word "lien." This word implies that the owner of the property continues to be the owner; but someone else, who is described as the holder of the lien, has acquired a claim upon that property not a claim of ownership, but a claim of right to hold that property as a pledge, or security for the performance of an obligation which has been personally contracted towards him, or which is im- posed because of some service rendered with relation to the property. The Civil Code In California we have a set of written laws which we call the Civil Code. We have also a Penal Code, a Code of Civil Procedure, a Political Code, and the general statutes of the state. But the Civil Code is the body of statute law in which the state sets forth especially the laws relating to property, legal contracts and obligations, 138 MERCANTILE CREDITS and so on. This Code is simply an expression in statu- tory form of the principles of the common law, modified by new declarations of the will of the state; it includes in statutory form those instances where the legislators of the state were not satisfied with the common law as it stood. Origin of the Common Law In your general reading you will often find a dis- tinction made between civil and common law, and per- haps some of my readers who are not students of law will follow me more easily if I explain first what is meant by "Common Law." The states of Europe are largely controlled by systems of law derived or copied from the Corpus Juris Civilis, or Code of Civil Law of the Roman Empire that great law-giving nation of the ancient world and many principles of the Roman civil law have directly or indirectly found lodgment in our own system. But apart from the Roman law which prevailed in Europe, there grew up in England a characteristic- Eng- lish law which was not the outgrowth of centuries of learning embodied in books and formally stated by jurists, but the practical outgrowth or development of the experience of the English people and of their courts and judges. In this way they built up gradually a system of law, or rather, a congeries of laws, a hodge-podge of laws, if you please. Nevertheless, when, in the course of time, men reduced it to a more formal system, it proved to be, as Blackstone has pointed out, a beautiful system of laws, expressive of the rights, duties, and obligations of men to each other and to society. The founders of the thirteen colonies brought with them the common law of the mother country, and their descendants carried it into the West and South, so that today nearly all the LIENS ON PERSONAL PROPERTY 139 states of the Union have, for the basis of their jurispru- dence, the English common law as it stood at the time of the War of Independence. When California was ad- mitted, in 1850, the question came up as to whether we should adopt the civil law which prevailed in Mexico to which California had formerly belonged or the Eng- lish common law. The commission appointed to study the question recommended that the common law of Eng- land, as followed in the Eastern states, should be the basis of our law. Later, when it became desirable to codify the laws of the state, the codes which I have named were formulated, among them being the Civil Code, which is expressive, in large degree, of the principles of the common law as they are found in the old records and decisions of the common law courts. The Object of Legislation It has been said that law is the perfection of reason. Of course, that was said by an admirer of the law; but the law, like every other human institution, has its de- fects. The object of the law is to promote justice by compelling men to perform their just obligations to each other and to the state; yet we frequently hear of the in- justice of laws. The legislature may adopt a law that is oppressive to some one, or that fails to bring about the expected good result; and it may be that the courts, in endeavoring to apply that law as they, after study, think they understand it, may fail of perfect results as regards the administration of justice; but we have nevertheless developed in this country a system of approximate jus- tice, a pretty good article of human justice, under which men may, except perhaps under the stress of public excite- ment or other unusual circumstances, live peaceably and transact business with each other. 140 MERCANTILE CREDITS The Law of Liens We come now to the definition of lien as expressed in the Code. "A lien is a charge imposed upon specific property, by which it is made security for the perform- ance of an act, and it is created either by contract of the parties, or by operation of law." In order that you may get the general meaning clearly, I have omitted a qualify- ing clause in that definition, which, in full, reads as follows: "A lien is a charge imposed, in some mode other than by a transfer in trust, upon specific property, by which it is made security for the performance of an act." Now, I think we have the idea of the lien. It is the legal right of the creditor to compel the property to answer for an obligation. As a general term the word lien applies equally to real property and to personal property. Priority of Liens According to Date There may be several liens upon the same thing. You have heard of a first mortgage, a second mortgage, and a third mortgage; and in the same way there may be several liens upon the same personal property, the same household goods, or the same stock of merchandise. The element of time is important in determining the order, value, or priority, of liens; and we have this rule, that (there being no reason to the contrary) liens on the same property have priority according to their dates. Bottomry Liens Now, there is an exception to this rule which we will dispose of in a few words, as it is of interest to a com- paratively small number of business men. This exception refers to cases of bottomry and respondentia liens, respect- ively obtained on ships and their cargoes, where the risk is of a maritime character. Bottomry is a contract by which LIENS ON PERSONAL PROPERTY 141 a ship or its freightage is hypothecated as a security for a loan, which is to be repaid only in case the ship sur- vives a particular risk, voyage, or period. In the case of two or more bottomry liens on the same subject, a later one would have the priority if created out of necessity. For instance, it may be that the cargo is about to go to the bottom of the sea, or its owner finds himself in some other difficulty in connection with the safety of the ship, or cargo, or with the successful result of the voyage. Now, the loan which enables the merchant to save his ship or cargo from these perils, or enables him to reach his market, will have preference over any other because of its peculiar relation to the thing taken as security, even though other liens had the priority in point of time. With the exception of these special instances, however, different liens on the same property have priority according to the time of their creation. Distinction between the Pledge and the Mortgage The matter of possession distinguishes two classes of liens: (i) where the owner remains in possession, and (2) where the owner goes out of possession. In the case of a pledge, the property is put in possession of the pledgee, the creditor, or a pledge holder. In the case of a mortgage, the property is retained in possession by the owner, but the creditor receives in some legal form, a paper lien a thing of the mind, of the law. It enables him to compel payment of the debt, however, just the same as if he held the property pledged. In conditional sales or transfers of property the vendor has something more than a lien; he actually retains the legal ownership, after the possession of the property passes into the hands of the debtor-purchaser, and he may, on the failure of the purchaser to keep his contract, recover actual possession. 142 MERCANTILE CREDITS Formalities of a Mortgage A mortgage can be created, renewed, or extended only by a written contract executed with the formalities required in the case of a grant of real property. That is to say, a mortgage must be acknowledged before a notary public in order to be recorded and to have all the rights that it should have. The mortgage of personal property requires further formalities, in the form of affidavits, as explained later. The Mortgagor is the Owner The mortgagor of property is the owner and remains in possession. He has simply made a contract imposing a lien on his property, but which does not result in any transfer of ownership except in case of foreclosure and sale. "Every transfer of an interest in property (other than in trust) made only as security for the performance of any other act, is to be deemed a mortgage, except when, in the case of personal property, it is accompanied by actual change of possession, in which case it is to be deemed a pledge." This definition again very clearly emphasizes the difference as to possession between a mortgage and a pledge. Legal Effect of a Mortgage A mortgage does not bind the mortgagor personally to perform the act for the performance of which it is security, unless there is an express covenant to that effect. A mortgage may be made by the owner of property as security for the payment of another man's debt. In that event, unless the mortgage specifically provides, or the mortgagor in some other way has specifically provided or made an express covenant that he will pay, he has simply handed over his property to be subject to the lien. LIENS ON PERSONAL PROPERTY 143 A power of sale may be conferred by a mortgage upon the mortgagee, or any other person, to be exercised after a breach of the obligation for which the mortgage is a security. Assignment of Claim The assignment of a claim secured by mortgage car- ries the security with it. For example, here is a note, secured by a mortgage upon land or personal property. The assignment of the note carries with it the security. The custom is, very properly, to assign the mortgage with the note, and to record the assignment. But the rule remains the same, that the mortgage is an incident to the debt, and whoever owns the debt has the right to the mortgage. The Law of Chattel Mortgages Now we come to mortgages on personal property. A section of the Civil Code of California, adopted in 1872, provided specifically a short list of articles of personal property on which chattel mortgages might be made, and you could not put a chattel mortgage on personal prop- erty, except as the Code provided. This list was gradu- ally extended. The needs of business called for more liberality; and it became the regular biennial custom to amend Section 2955 of the Civil Code, describing articles of personal property that might be mortgaged. These amendments began in 1875 and extended on, about every two years, until 1907. By this time the legislators had become conscious of the absurdity of a long list of this kind, and they therefore reversed their method, and by the amendment of 1909 made the general rule that such mortgages may be placed on all kinds of personal prop- erty, with three exceptions. The amendment of 1909 reads simply: "Mortgages may be made upon all grow- I 4 4 MERCANTILE CREDITS ing crops, including grapes and fruit, and upon any and all kinds of personal property, except the following: per- sonal property not capable of manual delivery; articles of wearing apparel and personal adornment; the stock in trade of a merchant." Executing a Chattel Mortgage We come now to the formal steps in executing a chattel mortgage, as to acknowledgment and affidavit. A mortgage of personal property is void as against credi- tors of the mortgagor, and subsequent purchasers and encumbrancers of the property in good faith and for value, unless it is accompanied by the affidavit of all the parties thereto, both debtor and creditor, that it is made in good faith and without any design to hinder, delay, or defraud creditors; there must be also an acknowledgment and certificate, as in case of grants of real property. It requires two kinds of certificates one of acknowledg- ment and one of oath. Now note again that there are several persons who may claim exemption; that is, who may claim not to be bound by the mortgage unless it is in this form. In the first place there are the creditors of the mortgagor; that is, any creditor other than the mort- gagee, who may be seeking to find the property of this mortgagor and bind it by some process of law to compel the payment of debts. Or, suppose the man who has made or attempted to make the mortgage, has made no such affidavit, and subsequently sells the property. The mortgage would be void as to any subsequent purchaser in good faith and for value, or as to any subsequent mortgagee. Thus great care must be exercised with re- gard to the form of the mortgage, and especially in re- quiring the affidavit of both parties, in addition to the duly certified acknowledgment. LIENS ON PERSONAL PROPERTY 145 Recording Chattel Mortgages A mortgage of personal property must be recorded in the office of the county recorder of the county in which the mortgagor resides, if the mortgagor be a resident of the state, and it must also be recorded in the county in which the property mortgaged is situated, or to which it may be removed. I remember a case a short time ago where the mortgaged property was in Los Angeles County, and the mortgagor resided in Riverside County. The claim was set up on behalf of some third person that, although this mortgage was in due form, and had been duly recorded in Los Angeles County, it had not been recorded in Riverside County where the mortgagor re- sided, and therefore the mortgage was not good, and a third party might buy the property and get rid of it. But in that case the mortgage prevailed, even though the technical requirements of the law had not been complied with. But this decision was owing to some special rela- tion of the parties which made it inequitable to enforce the general rule. Removal of Mortgaged Property Again, when personal property mortgaged is there- after by the mortgagor removed from the county in which it is situated, it is, except as between the parties to the mortgage, exempted from the operation thereof. The man who mortgages his personal property has not the right to move it out of the county without complying with certain rules; but if he does, the mortgage is no longer good except between the parties who made it, unless the mortgagee within thirty days after such removal causes it to be recorded in the county to which the property was removed, or else, within thirty days after such removal, I4 6 MERCANTILE CREDITS himself takes possession of the property. It is provided that, if the mortgagor voluntarily removes or permits the removal of the mortgaged property from the county in which it was situated when mortgaged, the mortgagee may take possession and dispose of the property as a pledge for payment of the debt, even though the debt is not due. Penalty for Unlawful Removal Under Section 538 of the Penal Code, mortgagors of personal property, excepting certain property used in transportation business, are forbidden, without the written consent of the mortgagee, to remove the mort- gaged property, or to cause or permit it to be removed, with intent to defraud the mortgagee, or his representa- tives and assigns, from the county where it was situated when mortgaged, and they are likewise forbidden to en- cumber such property, or cause it to be sold, transferred, or further encumbered. And the mortgagor for violation of this law is made guilty of larceny, and is punishable accordingly, unless at or before the time of doing any of the acts referred to, the mortgagor informs the person to whom he makes sale, transfer, or encumbrance, of the existence of the prior mortgage, and also informs the prior mortgagee in writing of the intended sale, transfer, or encumbrance, by giving the name and place of resi- dence of the person to whom the sale, transfer, or encum- brance is to be made. I find in the reports of the Supreme Court and Appel- late Courts of this state just one case where a man was convicted under that section. The conviction was affirmed, and I presume he has had to suffer imprisonment. His offense was the selling of a one-fifth interest in the furniture of a lodging house without notifying the pur- chaser of the existence of a chattel mortgage. LIENS ON PERSONAL PROPERTY 147 Validity of Contracts Made in Good Faith Mortgages of personal property, other than those permitted under Section 2955, and mortgages not made in conformity with the provisions of this article, or por- tion of the Code just discussed, are nevertheless valid between the parties, their heirs, legatees, and personal representatives, and persons who, before parting with value, have actual notice thereof. In other words, these provisions are for the protection of innocent parties, not for the protection of rogues who would, if permitted, repudiate their obligations because they had not been put in legal form. The Law of Pledges Now we will pass from mortgages to pledges. A pledge is a deposit of personal property by way of secur- ity for the performance of another act. The Code Com- missioners call attention in a note to this section of the Code, to something that I have already mentioned. They state that much difficulty has arisen in determining whether a certain transaction is a pledge or a chattel mortgage, the question generally being whether or not the title has passed. In this state, title never passes in case of property mortgaged or deposited as security; and whenever the possession of personal property is trans- ferred as security only, it is to be treated as a pledge. Even a chattel mortgage, when the possession of the property mortgaged is transferred, becomes a pledge. Possession is the criterion. Every contract by which the possession of personal property is transferred as security only, is deemed to be a pledge. The lien of a pledge is dependent on possession. Now notice that difference. A mortgage, or the lien of a mortgage, is not dependent on possession. Its security is obtained, not by taking the 148 MERCANTILE CREDITS thing, but by taking the paper which refers to it and describes it, and recording that paper in some place designated by the law for public notices. The lien of a pledge is dependent on possession, and no pledge is valid until the property pledged is delivered to the pledgee, or to a pledge holder. One who has a lien on property may pledge it to a third person to the extent of his lien. For example, A is a creditor of B; A has a lien upon B's property he may have his horse or his cow in his possession as a pledge. A needs money; he wants credit somewhere. He may pledge that horse, or that cow, to C to the extent of his lien, that is, to the extent of the debt already secured thereby. Re-pledging of Property "One who has allowed another to assume the appar- ent ownership of property for the purpose of making any transfer of it, cannot set up his own title to defeat a pledge of the property, made by the other, to a pledgee who received the property in good faith, in the ordinary course of business, and for value." (Civil Code, Section 2991.) This refers to another relation that may exist between persons in regard to property. You put your property in the hands of another person, allowing him to assume the apparent ownership of it; and you do that for the very purpose of enabling him to sell it; but instead of selling it, he pledges it. That is the situation already described, and the pledge is good provided the pledgee has acted in good faith. The Pledge Holder A pledger and pledgee may agree upon a third person with whom to deposit the property pledged, who, if he LIENS ON PERSONAL PROPERTY 149 accepts the deposit, is called the pledge holder. There are certain rules regarding the duties of a pledge holder, but these details may be omitted here. Misrepresenting Value of Pledge Where a debtor has obtained credit, or an extension of time, by a fraudulent misrepresentation of the value of the property pledged by or for him, the creditor may de- mand a further pledge to correspond with the value rep- resented, and, in default thereof, may recover his debt immediately, though it be not actually due. That, of course, is just. A man borrows money on 90 days, or has purchased goods on 90 days' time, and he has pledged something which he represented to be worth the amount of the debt, or 90 per cent of it, or whatever is required, and his word is taken without investigation; but it turns out the next week that he has pledged property that is practically worthless, or is worth only 5 per cent of the pledge; in other words, the creditor has been imposed on. What shall he do? He has given 90 days' credit. The law says that the implied obligation to wait 90 days is cancelled by reason of the fraud, and the creditor may act at once, and say, "You must make good your promise as to the value of this pledge; you must give me other security equal to the value that you represented in this case; and if you don't do that, I will proceed immediately by legal means to collect upon that debt, just as if the contract had read, 'I promise to pay on demand.' ' Sale of Pledged Property Some of you may like to know the precise rules cover- ing sales and pledges; and the shortest and most accurate way is simply to read the written law. "When per- formance of the act for which a pledge is given, is due, 1 5 o MERCANTILE CREDITS in whole or in part, the pledgee may collect what is due to him by a sale of the property pledged." But before pledged property can be sold and after the performance of the act for which it is security, is due, what must the pledgee do ? He must demand perform- ance from the debtor if the debtor can be found. What we call "snap judgment" is not permitted in law, even though the debtor is delinquent, and has failed to keep his promises. If, however, the pledgee has made his de- mand for performance, and still the debtor does not pay, the pledgee has complied with the requirements of the law as to demand, and may realize upon the pledge by selling it if he will. First, though, the pledgee must give actual notice to the pledger of the time and place at which the property pledged will be sold, at such reasonable time before the sale as will enable the pledger to attend. This is very important and necessary, because in sales of per- sonal property there is no subsequent right of redemption as there is in the case of a mortgage. Notice May be Waived Notice of sale may, however, be waived by a pledger at any time, but is not waived by a mere waiver of de- mand of performance. I have shown you how the pledgor is entitled to a demand of performance before a sale, and he is also entitled to a notice separate from the demand of performance, though they may both be made at the same time, or very close together. A debtor or pledgor may also waive a demand of performance as a condition precedent to a sale, by a positive refusal to per- form after performance is due. That is clear enough, I suppose. He has the right to demand notice before sale ; but if he says to the creditor, "I will not pay; I'm through with you ; I don't intend to pay," he has made a positive LIENS ON PERSONAL PROPERTY 151 refusal, and no formal demand of performance is neces- sary on the part of the creditor. Manner of Selling Pledged Property Now as to the manner of sale of pledged property. The sale by pledgee of pledged property must be made by public auction in the same manner, and with the same formalities, as provided in the Code for the sale of per- sonal property under execution. The pledgee cannot, however, sell any evidence of debt pledged to him, except where he holds the obligations of government, states, or corporations in pledge. Those he can sell; but in any other case, he simply may collect them when due. There are also legal provisions for the payment of the surplus, if any, to the pledger after satisfaction of the debt. In- stead of selling property pledged, under simple notice of sale, without going into court, the pledgee may go into court and sue on his claim and obtain a decree of sale, thereby foreclosing the right of redemption. After this the procedure is the same as in the case of a mortgage foreclosure sale. Special Lien of the Vendor "One who sells personal property has a special lien thereon, dependent on possession, for its price, if it is in his possession when the price becomes payable; and he may enforce his lien in like manner as if the property was pledged to him for the price." Labor Liens Now as to special liens on personal property. Sec- tion 305 1 of the Code provides a lien, dependent on pos- session, for compensation for services rendered by labor or skill employed on personal property. I called your 1 52 MERCANTILE CREDITS attention in the beginning to the fact that liens are granted in two ways : one by contract, and the other by operation of law. The mortgage and pledge liens that I have dis- cussed so far have been practically all liens by contract. I think that what I am about to quote will furnish an illus- tration of liens by operation of law. "Every person who, while lawfully in possession of an article of personal property, renders any service to the owner thereof, by labor or skill employed for the protection, improvement, safe keeping, or carriage thereof, has a special lien thereon, dependent on possession, for the compensation, if any, which is due to him from the owner for such service. A person who makes, alters, or repairs any article of personal property at the request of the owner, and has legal possession of the property, has a lien on the same for his reasonable charges for work done and ma- terials furnished, and may retain possession of the same until the charges are paid." In this case the liens are by operation of law. Not that there has been an agreement that the property shall remain there subject to the pledge, but simply from the relation formed between the parties on account of this work done. The pledgee must have possession, and is entitled to hold it until paid for his services. "Livery or boarding or feed stable proprietors, and persons pasturing horses or stock, have a lien, de- pendent on possession." And parties conducting a laundry business have also a lien, depending on possession. I sup- pose many an impecunious young fellow has found that out to his sorrow. Veterinary proprietors, and veterinary surgeons also, and others giving medical treatment to ani- mals, and keepers of garages, all have liens depending on possession. Special rules govern the sale of property where the lien is imposed by law, and such rules should receive careful scrutiny. LIENS ON PERSONAL PROPERTY 153 Bankers' Liens Here is the general provision with regard to bankers' liens : "A banker has a general lien, dependent upon pos- session, upon all property in his hands belonging to a customer, for the balance due to him from such customer in the course of their business." The relations between a banker and his customers are evidently very friendly, as I find but one decision in the entire legal history of Cali- fornia down to date, where Section 3054 is mentioned, and that was merely a mention of its existence. I suppose that the banks are able to enforce their liens without much application to the courts. But it is worth while to note the general provision. Warehouse Receipts Credit men occasionally have to do with warehouse receipts. Warehouse receipts are of two classes: first, transferable or negotiable; second, non-transferable or non-negotiable. Under the first of these classes the prop- erty is transferable by indorsement of the party to whose order such receipt was issued, and such indorsement is a valid transfer of the property represented by the receipt, and may be in blank or to the order of another. If a non-negotiable receipt is issued for any property, neither the person issuing it, nor any other person into whose care or control the property comes, must deliver any part thereof, except upon the written order of the person to whom the receipt was issued. Necessity of Expert Advice In the present chapter I have tried to cover at least in its main outlines the subject of liens on personal property. One could, however, spend months on the sub- ject if he attempted to examine all the situations that may MERCANTILE CREDITS arise, and the multitude of illustrations that do arise in actual experience. There are extensive text books de- voted entirely to liens on personal property. But this discussion is intended for the student of business, not of law; and one of the first things a business man needs to know is that, when a real difficulty arises outside of gen- eral business transactions, expert counsel from a compe- tent lawyer is the only safe thing. There is a maxim that a lawyer who attends to his own case has a fool for a client; and, if this is so, what might be said of a layman who attempts to act as his own lawyer. Conditional Sales We will conclude with the subject of conditional sales. It is a general principle, as I have tried to indicate, that ownership goes with possession, and a person in posses- sion of property is presumably the owner. He may, how- ever, hold that property in pledge, which condition gives him something in the nature of property rights. Analo- gous to this, it is sometimes found expedient in the con- duct of business to change possession of property by way of sale without passing the title from the vendor. This is called a conditional sale, and avoids the necessity of passing the title to the purchaser and taking in exchange a chattel mortgage with all its formalities and records. This is done in those cases where the purchaser wants to use a certain thing, and is not ready to pay for it and at the same time does not want to take the title and have a recorded chattel mortgage. In such cases the common law permits a contract of conditional sale. Statute laws in some states have tried to prohibit such sales; but in other states Massachusetts being a notable instance their usefulness has been recognized, and the legislature has merely attempted to regulate them by making rules LIENS ON PERSONAL PROPERTY 155 for the protection of the public, and, at the same time, for the protection of the vendor and vendee. One of these rules is that the person who wishes, after selling property under a conditional sale, to take the property back for non-payment, must make a formal demand and give thirty days' notice. The experience of merchants in Massachusetts has been that this method works very well, because usually satisfactory arrangements are made by the debtor within the thirty days. Rights of Possession Under ordinary conditions, a person in possession of personal property can claim to be the owner thereof is, in fact, the owner and transfer by him is accepted as passing the title. This is a statement of customary fact and not of law, for it is possible that the person thus assuming to act as owner may have stolen the property; or he may have borrowed or hired it for temporary use; or he may be the holder of it in pledge for a debt not yet due ; or, finally, he may be merely the purchaser under a contract of conditional sale. We will now consider the rights of third persons where the person in possession of property holds it under no better right than that of a contract of conditional sale. The law of California relating to this topic furnishes an illustration of the manner in which the common law prevailing in England, and generally in the states of our own country, has been adopted and applied as the law of this particular state. Cases on Conditional Sales The first actual conditional sales case in the Cali- fornia decisions seems to have been Putnam v. Lamphier, 36 Cal. 151 (1868). Here the court cites Parsons on 156 MERCANTILE CREDITS Contracts as follows: "Where the right to receive pay- ment before delivery is waived by the seller, and imme- diate possession is given to the purchaser, and yet by ex- press agreement the title is to remain in the seller until after payment of the price upon a fixed day, such payment is strictly a condition precedent, and until performance the right of property is not vested in the purchaser" ; and it was held by the court to be a general rule that even a bona fide purchaser from the conditional sale purchaser would not take title as against the original seller. In the case of Kohler v. Hayes, 4 1 Cal. 455 (1871), it appeared that the plaintiff had delivered a piano to one Dowling on an agreement that the same was to be sold to Bowling for a stated sum, to be paid at the rate of $40 per month, and that when the entire amount should be paid, a bill of sale would be given. Dowling, after pay- ing $100 on account, sold the piano to a third person who purchased in good faith without notice of the terms of the conditional sale. It was held that the title to the piano remained in Kohler, and that on the facts he would be entitled to recover possession in default of payment of the purchase price. In Hegler v. Eddy, 53 Cal. 597 (1879), certain household goods were delivered to Alice Cumminsky, to be paid for by instalments. She was to have the right to use the furniture so long as she should pay such instal- ments ; and, upon failure, the vendors might at once take possession of the property, and the moneys already paid were to be forfeited. Held: "This is not a sale but only a contract for the sale of the property, and the legal title to the property is not thereby transferred .or changed." The principles above stated have been approved from time to time down to the latest cases, one of which is Lundy Furniture Co. v. White, 128 Cal. 170, where an LIENS ON PERSONAL PROPERTY 157 instrument in the form of a lease, providing for payment of rents until the amount paid should equal the agreed value of the property (when a bill of sale was to be made), but expressly reserving title in the vendor with right to retake possession upon breach of its conditions, was held to be a conditional sale and not a lease. Fraudulent Contracts of Sale Sometimes agreements supposed to be of this kind have been so written that they were held not to be con- tracts of conditional sale and the title passed to the pur- chaser, and sometimes such agreements have been held invalid as an attempt to evade the laws concerning the recording of mortgages. For instance, in Palmer v. Howard, 72 Cal. 293 (1887). The agreement lacked two of the usual earmarks of a conditional sale: (i) No bill of sale was to be given on payment of the purchase price; and (2) if the purchaser failed to meet the pay- ments, the vendor might take and sell the property; but in so doing he must account for any surplus above the agreed price and expenses of the sale. Here the court said that it must be remembered that the policy of the law is against upholding secret liens and charges to the injury of innocent purchasers; and that mortgages of per- sonal property are permitted only in certain specified cases and under specified conditions, intended to give notice to the world of the character of the transaction and that when such conditions had not been complied with, the court would give effect to the transaction according to its true character, and not by the mere name given to it by the parties. Again, in other cases as where a harvester was sold and delivered to the purchaser under an agreement to give notes for the purchase money, and under the terms I 5 8 MERCANTILE CREDITS of an absolute sale passing title to the purchaser such absolute sale cannot afterwards be converted into a con- ditional sale, without any change of possession, by a mere agreement between the parties. CHAPTER IX LIENS ON REAL ESTATE* BY HON. LEE C. GATES Practical Importance of the Subject The present chapter is not a technical discussion of liens on real estate, but is intended for business men and students of practical business life. For twenty years and more the institution with which the writer is con- nected has been engaged in the study of liens, titles, and matters affecting the titles to real estate. All who are interested in real estate, either as purchasers or as en- cumbrancers, i. e., men who take mortgages and accept liens upon real estate, understand the importance of thorough investigation as to previous liens. Examina- tion of title for the purpose of investment in real estate, is undertaken mainly for two classes of people those who buy, and those who loan money upon real estate. Men who own property do not as a rule undertake to examine their titles until they are about to dispose of it, and the result is that many properties are sold for liens which, without the knowledge of the owner, have attached thereto. General Nature of Liens A lien is a claim that attaches to property, either by contract or by the operation of law. If you loan your *It is impossible to give the varying lien laws of the different states in the present volume. The California law which is discussed here will give a fair idea of the general law of liens and will indicate what the credit man must look for when investigating the matter in other states. 159 160 MERCANTILE CREDITS money on a piece of property, you have created a lien by contract. A tax lien, however, is created by law; a street assessment is also a lien created by law. These are in- voluntary liens, and many people do not know anything about them. We shall therefore, in our discussion of the general subject of liens, endeavor to ascertain what they are, where they exist, and to what extent and for what length of time they are binding on property. Taxes as Liens We shall discuss first the subject of taxes as liens which attach on all property. In the state of California, a few years ago, we adopted an amendment to the Con- stitution, providing that state taxes were to be levied on the public utility corporations of the state the power, gas, electric, telephone, railroad, and express corpora- tions and these public utility corporations were to pay us a certain percentage of their gross income. We also levy a tax on the capital stock and surplus of our banks. We levy these taxes directly upon the property of the corporations, and such taxes become a lien. The Franchise Tax Then, there is the franchise tax a tax levied upon the right to be a corporation. A corporation is a crea- ture of law, brought into existence by general statute, and we impose a franchise tax upon it. Many people doubt the wisdom of this tax, and there is much caviling, much abuse, and remonstrance against it; but it is imposed by our Constitution, and cannot be revoked except by an amendment thereto. This tax, therefore, is a lien on the property of every corporation. If a corporation under- takes to sell a certain piece of its property, any unpaid franchise tax is a lien upon that property a lien renewed LIENS ON REAL ESTATE 161 every year; and if it is not paid one year it does not out- law like a mortgage, but accumulates. The tax of last year, of this year, and of next year become liens, and continue so year after year. None of them outlaw, and none die. The statute of limitations never operates against a state, a city, or a municipality. An obligation to any one of these is perpetual; and a business man recognizes as a "preferred" lien the taxes standing against the property of either a corporation or an in- dividual. This condition is the reverse of the status of ordinary claims. The License Tax In California there is yet another tax found in few, if any, other states which is a lien on the property of a corporation; viz., the license tax. Some years ago, in order to raise revenue, a graduated tax falling due every year was laid on the capital stock of corporations. Unless this tax is paid within the time fixed by law, the penalty is not merely a lien on the real estate, but the existence of the defaulting corporation is destroyed. It forfeits its charter. It is no longer allowed to continue business. By its failure to pay the tax, it ceases to be a corporation. This license tax is something about which most people connected with corporations know little, unless they happen to be trained lawyers who have made a special study of the laws on this subject. Many think when they pay one of these taxes, usually the franchise tax, that they have paid both; and there are accordingly 30,000 cor- porations in this state which have forfeited their charters since the license tax law went into effect, and the license tax remains a lien against the property of these different corporations. Under the Constitution of California as it stood prior 162 MERCANTILE CREDITS to 1910, no statute could be passed by which a corpora- tion could be revived, so that a failure to pay the taxes in 1907, 1908, or 1909, left that corporation non-exist- ent. It could continue in business, for the law is, that affairs of a dissolved corporation pass into the hands of the directors who are in office at the time of forfeiture for liquidation, but there was no provision in the law by which it could be resurrected. To remedy this we had to adopt the constitutional amendment of 1910, providing that a corporation could be revived by the payment of its taxes and of all the penalties accrued against it. Now upon the payment of such taxes to the Secretary of State, and the issuance by him of a certificate to that effect, a corporation is reclothed with its powers. In other words, it can die, and then be resurrected by the payment of a tax. The license tax has brought annually into the treasury of California something like $800,000, but now we want to abolish it, principally because of its disastrous consequences. The Poll Tax There is another tax in California which, though not a property tax, becomes yet a lien on real estate owned by the man who fails to pay it. That is the poll tax of two dollars on every male citizen of the state. A peti- tion to abolish the poll tax is being circulated, but the movement is of doubtful wisdom. It is worth two dollars to be a citizen of the state of California; and moreover, the proceeds of this tax form a part of the fund that has been used to build up our public schools. Its abolition would mean the loss to our treasury of another $800,000. Your poll tax if not paid gets to be $3 and $4, be- coming a lien on the real estate of the man who owes it. LIENS ON REAL ESTATE 163 Many a time when property has been sold, the purchaser has found that the poll tax has not been paid, and that a lien attaches to the property and must be paid later. Sometimes property has been sold because of this unpaid poll tax. I have happened upon many cases where the poll tax with the costs made a considerable sum to be paid in order to release property. Selling Property for Taxes It will be understood that when you buy property on which the taxes have not been paid, there is a tax lien upon it an involuntary lien. You cannot escape it. Taxes are levied and they become a lien. You have to take care of them, or your property will be sold. Under the California law passed in 1897, all property in such cases is sold to the state. Up to that time it could be sold to any man who would pay the taxes on any par- ticular piece of property, in return for a certain propor- tion of that property, the successful bidder being the one content with the smallest amount. Sometimes it happened that a man would offer to pay the taxes on a piece of property on one of our streets, for the front inch of the property. Some other man would say, "I'll take a half inch," and another, "I'll take a quarter," bidding against each other, until it reached a point where there were no numbers left to register the bids. Well, the one offering to take the least would get it; and he would get a tax certificate, and later on, a tax deed, if it were not re- deemed. Of course, you can understand that there is no proper use an individual could make of a millionth of an inch of land even on Spring Street or Broadway, and this custom led to abuses. Now, therefore, the state becomes the purchaser of all property sold for taxes. It takes a certificate of purchase after one year; and after five years it gets a deed, and can sell the property. 164 MERCANTILE CREDITS Abuse of Private Tax Sales Under the old law there were men who made it a busi- ness to buy tax sales, attending regularly when the sales were held, and buying all they could. They then got tax deeds, and in time it became a question whether their title could be sustained by a suit, or whether they would accept a certain sum of money and let the property go. This grew into a very pernicious and disgraceful practice. There were "tax sharps," as we called them, who, after they got a deed costing $1.25, or $1.50, or $3, would ask $100 for a quit-claim deed to convey back the interest thus obtained, and so manage the matter that it was cheaper to pay than fight. So far was this carried that it became necessary to amend the law; and later, we passed an amendment by which the state bought all the property, and then we got rid of that practice forever. Tax Titles Tax titles, I may observe, have been throughout all history a very precarious class of titles. Very few tax titles have ever been held valid in the state of California, or in fact, in any other jurisdiction. You cannot buy a tax title with any degree of certainty that the owner will not be able to set aside your title and recover his property. Recently the courts have upheld some few tax titles ; but you can usually set aside a tax sale, though you may have to expend several times the amount of money that re- demption would have cost. Usually it costs less to buy off the owner of the tax title than it does to bring a suit and go through the various courts to a final decree. City and Special Taxes In California there are so many liens included under LIENS ON REAL ESTATE 165 the head of city taxes that I have not space to enumerate them. We have the street lien, the sidewalk lien, the sewer lien, the shade tree lien, the protection district lien, the school district lien and all these assessments must be taken care of and watched. When you go out into the country you find matters but little better. There are already sanitation tax districts, and recently a bill has been proposed, which, if passed, will levy a tax on the real estate in a certain district for the prevention of the flow of water into oil wells. Taxes and assessments are, in fact, almost limitless in number; and any property owner or business man must be very careful to ascertain what they all are, or he will find his property sold, and will have to pay a large amount of money, comparatively speaking, as the penalty for allow- ing it to be sold. Indeed, I might say things have reached the point in California where, if you desire to escape liens of taxes or assessments, you have to hire a lawyer, and a good one, or you will be mulcted. The Inheritance Tax Still another kind of tax is the inheritance tax. We are increasing the taxes on inheritances, though we are still a little behind other countries in that respect. The tax on the property of the man who dies is the only tax that no one ever pays; for certainly the man that dies does not pay it. A few years ago an indignant young fellow came to my office desiring me to prevent the levying of a tax in the state of Illinois on an inheritance which he had re- ceived from an aunt. The amount of money was $30,000, and he was outraged to think that the state of Illinois wanted to take something like $1,800 of it, leav- ing but $28,200 for him. He wanted me to bring a suit. i66 MERCANTILE CREDITS He said, "They have no right to take that money from me." "Why/' said I, "they didn't take it from you. Did you ever have it?" "No," he answered, "but my aunt gave it to me." "All right. Your aunt didn't give you all of it. She couldn't. The state of Illinois said she could only give you $28,200, and you are getting it. You don't pay that $1,800, for you never had it; and your aunt doesn't pay it, because she has passed away." The whole matter of inheritance is a matter of statute. Unless the statute said so, your children could not inherit one dollar. If there was no law on the sub- ject, and I died, my property would go to the state. There is no natural right to inherit. That being true, the state can tax property which passes from a decedent to the heirs in such sums as it sees fit. Large fortunes should be taxed heavily. If a man dies leaving several millions, the state ought to receive a very large share of it, because no one can make a million dollars; he only obtains it by virtue of the operation of the laws which have permitted him to do so. Judgments All tax liens are involuntary liens liens you must care for, or your property will be forfeited. Now I want to take up another lien, which partakes of the nature of an involuntary lien; that is, an attachment, including all such claims as come under the general head of "Judg- ments and Attachments." Under the California law a judgment obtained by one party against another in a suit becomes a lien on all the real estate then owned by the debtor, or acquired by him thereafter during the life of that lien. A judgment operates instantly on all the prop- erty in the county, and, if the debtor has property in another county, the man who obtains the judgment the LIENS ON REAL ESTATE 167 judgment creditor can send a transcript of that judg- ment into that county and have it levied there. But if a judgment is obtained before a justice of the peace, it does not become a lien on real estate until an abstract of the judgment is recorded in the recorder's office. A judgment rendered by a court of record, when docketed in the county clerk's office remains a lien on all the property for five years, and may be renewed at any time after five years upon suit brought for that purpose, or at any time before the five years have elapsed, by a mere motion. At the end of five years you may issue an execution of judgment and levy upon property, selecting any particular property you desire. The lien of the judgment becomes the lien of levy and execution, and, on the sale of the property by the sheriff, it merges into the certificate of sheriff's sale. Sheriff's Certificate of Sale Now, up to the time of the issue of such certificate the judgment is not a lien against a deed, though unre- corded. For instance, if Mr. Blank held from me a deed which he had not placed on record, and some one of my numerous creditors were to sue me, get judgment against me, and levy an execution on the property standing in my name, Mr. Blank could come in and put his deed on record; whereupon the judgment lien would be found inferior to his deed. But if he waited until the sheriff's certificate of sale had been made and issued, such certifi- cate would take precedence. The sheriff's certificate of sale remains a lien until the end of the year, during which time the owner may redeem his property, and after that time it merges into a deed, and title passes. Attachments Antecedent to the judgment is the attachment. A man 1 68 MERCANTILE CREDITS desiring to obtain a judgment against a debtor, may, under certain circumstances, attach a particular piece of property. Such attachment becomes a lien, which holds that property as against any other attachment or any other lien, mortgage, deed of trust, or otherwise, until the judgment is either rendered or denied. If the suit results in a judgment of non-suit, that is, if the plaintiff gets no judgment, this decision instantly dissolves the attachment; but if he gets a judgment against the man whose property he has attached, that judgment becomes a lien not only on the particular property attached, but also on all the property owned by the judgment debtor in that county. The Homestead Exemption Now that attachment is a lien. It is not, however, a lien as against an unrecorded deed of date prior to the attachment; neither is it a lien as against a homestead, which may be declared by the owner of the property even after an attachment has been levied. This is another peculiarity of our California law. The homestead ex- emption is not an involuntary proceeding. In many of the states, when one takes property, the homestead right attaches instantly; but in the state of California there is no homestead until the owner of the property, or the person who claims an interest in the property, makes his declaration of homestead and files it in the recorder's office. So that, if my property were attached tomorrow by some one of my numerous creditors, tired of listening to my excuses, I could defeat the attachment by levying a homestead lien upon my property, whereupon the attachment would go for naught. But if I waited until that creditor got a judgment, the homestead exemption would be of no value. LIENS ON REAL ESTATE 169 The Torrens Land Law Registry System The Torrens Land Law Registry System, which has been on the books in the state of California since 1897, is a system by which each owner may have his land certi- fied by the county recorder, as the registrar, who gives him a certificate. Now, under this system, the man who gets a judgment does not have a lien on all the debtor's property in the county, but only on those lands which he knows to be the debtor's property. He has to go to the recorder's office and select the lands. The Torrens Land Law Registry System has never been very effective in this state and an endeavor is now being made to amend and improve it. If the proposed amendment goes into effect, it will greatly modify the present conditions, of which the limited judgment lien is one feature. Benefits of the Mortgage Lien I come now to the mortgage lien the most familiar of all. There are few people who are entirely unac- quainted with mortgages. It is a very poor man indeed, and a very thriftless man too, who has never been able to borrow money on a mortgage. The whole advance of commercial civilization has been on borrowed money, and while we have come to look on a man who loans us money on our real estate as an enemy, there is, in my opinion, no more misleading and mischievous idea. The laws which give to the creditor the protection of this security enable him to loan his money to the individual who can furnish that security, the two men working hand in hand. I might say that our banking fraternity the men en- gaged in receiving the idle moneys of the country and turning them into the channels of trade are performing a very valuable service for the people of the communities in which they live. 1 70 MERCANTILE CREDITS Trust Deeds A trust deed given to secure borrowed money is not technically a lien on the land it covers ; it is a conveyance of the title to secure the loan. It is, however, really only a form of mortgage though not so called and is very frequently employed. There is a provision in our statutes which says that a conveyance of title as security for a debt, whatever its form, is in effect a mortgage, so that if you take a deed from me as security for a debt of $500, that deed, while it appears to pass title on its face, is, in fact, only a mortgage; and if you want to get the property, you must go into the courts and foreclose it as though you held a mortgage. Now, under our theory of law in California a mort- gage is only a lien. It does not pass the title. In some other states the mortgage passes the title a mortgage is simply a conveyance of the title; and the mortgagor can compel the mortgagee to transfer it back to him when he pays the debt. The lien theory of mortgages, however, is that on which we proceed in California ; and, therefore, a deed taken to secure a debt does not really convey the title. Now observe the possible result of this: If Mr. Blank takes a deed from me to secure a loan of $500, the* law says I still have the title although he has the deed, for he has in effect only a mortgage; but if he sells the prop- erty to some third person who does not know anything about it, and who buys it in ignorance of the fact that I still have the title, the law very properly says that this innocent purchaser from Mr. Blank gets the title. In other words, Mr. Blank is able to give the other man something that he never possessed. This is necessary for the protection of the innocent purchaser, for no man would be able to buy property without security except under such protection. LIENS ON REAL ESTATE 171 Deed Not Effective Until Delivered Delivery of property by a deed of title does not pass until the deed has been delivered. It is a common thing for a husband to make out a deed to certain property in favor of his wife, and to put that deed into a safe waiting for one of them to die, intending, in the event of death, to put it on record. Now, if that deed is delivered either to the grantee or to a third person, with instructions to that third person to deliver it to the other upon the death of the grantor, the title will pass when the second de- livery is made. That is a delivery in escrow. But some- times a man makes out his deed, puts it in his safe, and leaves it there, or sometimes the husband and wife make out two deeds and put them in the safe, agreeing that the title shall pass to the survivor and in such cases there is no delivery. If, under these circumstances, the wife should die, and the husband should put her deed on record (destroying his own deed), that deed is absolutely void. If he gets it on record, and no one knows about the de- struction of the other deed, or if he can apparently prove that that deed had been delivered to him, he may hold the property; and yet, if any of the heirs could prove the facts to be as I have stated, they could set aside the deed. In other words, no deed is effective until it is de- livered. If I made a note for $500 to Mr. Blank, and left it in my desk, and never delivered it to him, he would not have my note, and could not collect on it; just so with a deed. Even if written instructions were placed in the safety depository directing the deed to be delivered on the death of the grantor, the delivery would not be good. The deed must be delivered, either to the grantee, or to some third person. The only safe way, if a man wants to turn over his property to his wife on his death so as to save administration papers, is to make out a deed, take it 1 72 MERCANTILE CREDITS to his bank, put it in an envelope, and write on the face thereof: "This envelope contains a deed of certain prop- erty therein designated. You will hold this deed until my death. You will then deliver the same to my wife." Then, when that deed is delivered, the title will pass. Law of Mortgage Liens A mortgage becomes a lien from the time it is filed for record in the recorder's office; and it is a lien as to anybody who knows of its existence, even though it is not filed of record. In other words, you have constructive notice of the mortgage by the filing in the recorder's office; but if you know that mortgage is in existence, you have actual notice and are bound by it, regardless of whether it is filed or not. Legal Expiration of Mortgage Liens A mortgage lien attaches the moment it is filed for record in the recorder's office, and it continues until the time of its expiration, and for four years afterward. That is, a mortgage does not outlaw until four years after the date of its maturity as fixed by the court. The note, of course, is the principal obligation. The mortgage is merely an incident a security for the obligation. There is yet another interesting feature. Many times when a note has passed beyond maturity, the lender and the bor- rower are willing that the mortgage security shall be re- newed without making out new papers. They can do it by entering into an agreement to postpone the payment of that mortgage to a future time. But can they carry it beyond the time when the original papers would outlaw? They can, provided there is no other mortgage or lien after the mortgage which they are thus renewing. But if there is a second mortgage on the property, the old LIENS ON REAL ESTATE 173 mortgage cannot be renewed for a longer period than it would run without renewal. In other words, you cannot renew it beyond the four years after maturity. If you make it longer than that, the second mortgage becomes a first lien, and the first mortgage becomes a second lien. Lien of the Deficiency Judgment When a suit is brought to foreclose a mortgage, and the property has been sold for less than the mortgage debt, there comes into being the deficiency judgment. This is a judgment entered and docketed, but which does not become a lien until after the sale has been made, and the deficiency ascertained and put on the docket in the clerk's office. It then becomes a lien on what? It is not a lien on the property which has been sold by the sheriff, unless the owner redeems it, when it will instantly attach as a lien. To exemplify, if Mr. Blank had foreclosed a mortgage against me, and after that I came in and re- deemed the property which had been sold to him, by pay- ing him the purchase price and one per cent interest on it, the deficiency judgment which he had against me would instantly become a lien on the property in my hands. But if I should sell to some one else an equity in the property, and that person redeems, the deficiency judgment does not become a lien. So where there is a deficiency judgment, the judgment debtor rarely redeems if he consults an attorney. Rights of Second Mortgage There is another curious feature of the law, which resulted some years ago in the loss of a lien by a very capable lawyer, who had neglected to look up the law in the matter. A man had a second mortgage, and in a suit which was brought by the first mortgagor to foreclose, 174 MERCANTILE CREDITS he went into court and asked that the court foreclose his mortgage also, which he had a right to do by cross com- plaint. This was done. When the property was sold it brought a little less than the face of the first mortgage. The second mortgagee then offered to redeem, but accord- ing to the law he could not redeem because he had no lien on the property. He had foreclosed his mortgage and it was no longer a lien. He lost out because he had done the wrong thing in foreclosing. If he had gone into the suit and asked that any surplus after the sale of the prop- erty under the first mortgage be paid upon his own mort- gage, he would have had a right to redeem, because he would still have had a mortgage; but having passed his mortgage into a decree of foreclosure, it was no longer a lien on that particular property, and he could not redeem. In California a mortgage when foreclosed takes title when the sheriff's deed has been issued; and we have ex- tended the time of redemption from six months to a year. Law of Trust Deeds Now let us go back to trust deeds, which, as I said, are not liens, but take the place of liens. At nearly every session of the legislature there is an agitation about re- pealing trust deeds. When you make a trust deed you pass the title to the trustee usually a third person, although I can make a trust deed to Mr. Blank covering my property, for a debt owing to him, and he then be- comes both the debtor and the trustee. Our law has sanctioned this procedure, but as a rule a deed of trust is made by A to B for the benefit of C. A borrows of C, say, $2,000. He makes a deed to B of the property which is to be the security for the payment of that debt, and he gives to B the power, in case he himself shall fail to pay the money, to sell that property upon a compara- LIENS ON REAL ESTATE 175 tively short notice and in a comparatively expeditious way, and pay the debt. In other words, deeds of trust, as now drawn, usually provide that if the debtor fails to pay, or makes default in the payments required under the deed of trust, the trustee may publish a notice for si* weeks in some newspaper. When the property is sold at the end of that time, the title passes immediately to the purchaser, without any right of redemption on the part of the maker. That is too harsh, you say, too dangerous; you can sell a man out in too short a time. But you cannot sell him out unless he fails to pay his debt, or defaults in his payment. If he makes his payments, the trustee has no power whatever. Advantages of Trust Deeds Now I will show you how the trust deed works in the upbuilding of a new country. For example, there are thousands of tracts of land now being opened around the city of Los Angeles, and the owners of those tracts divide them into lots, and build houses on the various lots. They sell each house and lot to an individual, who is usually a man of limited means. We will say that such a house and lot is worth $2,500. The owners of the tract will be able to borrow from a bank possibly $1,500 on that house and lot. They give a mortgage to the bank for that amount, and that is a first lien. The owners will then sell to the individual purchaser, and allow him to pay perhaps $250 down, taking a deed of trust from him for the remainder of the purchase price, which is to be paid back on instal- ments. These payments are arranged so that the pur- chaser can make them out of his limited means without too much difficulty; and hundreds and thousands of homes are being paid for in that way. Now, would the owner of the property be able to do 176 MERCANTILE CREDITS this in any other way? Could he take a second mortgage, allowing the purchaser to pay it back in instalments? In that case, if the purchaser were to default in making his payments, the owner of the property, the seller, would lose heavily. He must have such an instrument that he can quickly take the property back in case the individual fails to make his payments, otherwise he could not afford to sell on such terms. If he had to take a second mort- gage to secure his claim on the property, and the man defaulted, what would he do ? He would have to hire a lawyer, he would have to go into court and bring a suit, and then wait three or four months. He would then have to sell the property after it had been advertised for three weeks, and then wait a year before he got possession, be- cause the purchaser would be in possession, and you can- not take property away from the legal owner under a full year. If we were without the security afforded by the trust deed for the owner who sells his property on small payments, it would be eighteen months before he could get his title back in case of default; and if the purchaser had to give a second mortgage, he would have to put up $500 or $1,000 for it, and under these hard terms, thou- sands of poor men would be unable to begin payment for a home. Now that is a part of the deed of trust theory. A deed of trust passes the title ; but there is an expeditious method by which the owner can recover his property after a default has occurred and the purchaser has failed to make his payments. Once in a while the owner of a debt will be harsh, and he will declare a default within a few days after the debt becomes due; but in the large majority of instances the owner is willing to allow a man 30 days in which to make his payments, and trust deeds are so written in a good many instances as to give the purchaser fifteen days of grace. LIENS ON REAL ESTATE 177 The Vendor's Lien There is another lien which is very little known, and often misunderstood. This is the vendor's lien on real estate. If I sell a piece of land, and do not take all the purchase price, I have a vendor's lien on that property in case I take no other security; but if I take other security, I have no lien. This vendor's lien is involuntary, but is little used in California. That is perhaps a fortunate circumstance, because it is so indefinite that no one can know exactly what his rights are under such a lien. The Mechanic's Lien We have not yet mentioned the mechanic's lien. The State Constitution provides that mechanics, material-men, etc., shall have a lien for the material furnished and for labor that has been performed. Some people think that we ought to have a mechanic's lien law that would give to the laboring man and the material-man the first lien on the property which is created by them, over and above a mortgage or deed of trust which secured the loan, and which antedated the beginning of the building. They say that it is the habit of mortgagors and trustees to slip in a mortgage just the night before the building is begun, and thus get a lien ahead of the mechanic's lien. It is, of course, a well-known principle of law that a mortgage or a deed of trust will take precedence over a mechanic's lien if it is filed before the building is begun, or before the material is on the ground. This is necessary, because nearly all building operations are undertaken on bor- rowed money, and the money which pays for the material and the labor is therefore, in most instances, borrowed money; and a large part of our building operations would cease entirely if we could not borrow the money with which to carry them on. 178 MERCANTILE CREDITS The Mechanic's Lien Law The mechanic's lien law has passed through many vicissitudes. The Constitution provides that mechanics and material-men shall have a lien. It also says that the legislature shall provide by suitable legislation for the enforcement of these liens, and the Supreme Court has held that no law existed for the enforcement of such liens until the legislature took proper action, and, although the Constitution declared that the mechanic had a lien, he actually had no lien. Laws have been passed for the enforcement of this lien, but the legislature at nearly every session is confronted with a number of bills for the amendment of these laws; and there is a bill under dis- cussion now. The owner can file his contract; but the material-men, the contractor, the laborer, and the arti- sans, may have their liens on the property; and if, under this bill, they can show that the owner has been in fraudu- lent collusion with the contractor, the mechanic's lien may be greater than the contract price. You have to bring suit within ninety days, and that suit when brought is to be tried in the manner in which the courts have tried these cases. You can consolidate all of them, and try them all in one suit I am not very familiar with the actual working of the mechanic's lien law, because my practice has not carried me into the courts in that respect; but, speaking generally, it is, in my opinion, a very valuable law. This, together with the trust deed law, has enabled us to build up the southern part of California, because the men who furnish the material and perform the labor feel that they have a lien on the property on which they are to expend that labor and material, and that they will be paid even though the owner shall refuse to pay them. CHAPTER X FRAUDS BY W. J. FORD Fraud Not Always Legally Punishable The subject of frauds engages the attention of the district attorney's office more, perhaps, than any other class of offenses against the community. Nevertheless, the number of prosecutions is limited, for the reason that there is a large class of frauds for which the law affords no criminal remedy, and in many cases where the law does afford such remedy the prosecution is so restricted by the rules of evidence as to render conviction very difficult. In cases where people have obtained money under false pre- tenses the most common form of fraud and the one most difficult to deal with we have really very few prosecu- tions. The Several Varieties of Fraud Fraud, as a generic term, includes all acts. of omission and concealment injurious to some person which consti- tute a breach of the trust or confidence justly reposed by that person in the one guilty of the fraud, or acts by which an undue and unconscionable advantage is taken of another. Actual and positive fraud consists in cir- cumventing, cheating, or deceiving a person to his injury, by any cunning, deception, or artifice. The term "legal fraud" has been used to characterize the false represen- tations, more or less innocent, which are reckoned suffi- 179 180 MERCANTILE CREDITS cient ground for rescinding a contract through a civil suit. A "constructive" fraud is held to be an act which, re- gardless of the motive of the perpetrator, the law de- clares to be fraudulent in itself. Such law is justified by the fact that certain acts carry in themselves irresistible evidence of fraud, or are liable to lead to frauds which can better be guarded against by declaring all cases that come within the operation of a particular statute, frauds in themselves or constructive frauds. Contract to Sell Property For example, a contract with a real estate agent for the sale of a piece of property must be put in writing before the agent can collect his commission. If an agent sells a piece of property for another without such con- tract, the law will not permit that agent to collect his commission, even though the agent is attempting to get what really and morally belongs to him. The law does not regard a verbal contract as valid in such cases; for it violates the statute of frauds. The reason for this ruling is that a man may come in and voluntarily offer his assistance in a transaction, though neither of the principals has really employed him in any capacity and neither of them desires his assistance. If it were not for the statute of frauds such a man could, to use a slang expression, "butt in" on a transaction unin- vited, and then attempt to collect commission. But it is not this class of frauds we are now to discuss. The subject of the prevention of fraud covers a wide field, and only a few special cases can be taken up here. Frauds Punishable by Statute There are many frauds which, according to the statutes, may be punished criminally. Such is that of FRAUDS 181 marrying under false pretenses, or obtaining money or property by impersonating another in a private or official capacity. Conveyances made with the intent to deceive or defraud, as for example, to deceive, hinder, or delay creditors, are punishable. We have statutes against sell- ing land twice, by which legal penalties are provided for anyone who enters into a contract to sell a piece of prop- erty to A, and who before that contract has been abro- gated, contracts to sell it to B or C. We have statutes forbidding married persons to represent themselves as competent to sell real estate without the concurrence of the wife or husband in cases where such concurrence is legally required. There are also statutes against false statements concerning the prices received for consign- ments of goods, commission merchants being required to make true statements to their principals as regards such property. Also, the statutes prohibit the removal of mortgaged personal property from the county where the mortgage is recorded, and mortgaged property may not be further encumbered without notifying the owner of the prior mortgage, and also notifying the second mortgagee that there is already a first mortgage. These are only some of the more familiar laws against frauds. All the special statutes against fraud exist in addition to the general statute forbidding the obtaining of money under false pretenses. It would seem that the laws concerning frauds, and making them punishable through criminal prosecution, are broad enough to cover every species; and yet they actually cover only a small proportion of the frauds that are a matter of daily occurrence. The Confidence Man In addition to the criminal offenses specifically desig- 182 MERCANTILE CREDITS nated as frauds, we have the various devices used by con- fidence men and bunco steerers for obtaining possession of the property of others, which are usually prosecuted and charged as larceny. Some of these schemes are familiar to you. There is the old-fashioned one of selling a gold brick, or green goods, while a more modern trick is that of parting the "sucker" from his money by means of a "fake" lottery or other gambling schemes. Often such a victim is ashamed to appeal to the police until it is too late to secure a clue to the whereabouts of the rascals. Another device as old as telegraphy and horse racing is for the swindlers to make acquaintance with some stranger and inform him that they know where there is a pool room in operation ; that they have a friend who has tapped a telegraph wire or is an operator, and who can delay the transmission to the pool room of the messages showing the winning horse until they have had time to go in and put up a good substantial bet on the real winning horse; and that by means of this device they can defraud the pool room. The "sucker" finds out that they have defrauded him instead before they get through. Of course the ordinary business man, if he is wise, will never come into contact with just such tricksters as these; and I mention them merely to give a general idea of the fraudulent schemes most common, and of the efforts of the law to guard against them in specific instances. Obtaining Money by False Pretenses Let us turn now to the classes of frauds with which business men are particularly concerned. When you meet a prospective customer you naturally inquire into his character. You want to know something of his general honesty, of his ability to carry on the business in which he FRAUDS 183 is engaged, of the class of customers he sells to and of his promptness in paying his own debts and in collecting moneys owing to him. In other words, you want to find out if he is a good business man and, in addition to that, you want to ascertain what assets and liabilities he has. These are some of the inquiries which must be made to determine matters concerning credit. In case of mistake there is practically no redress, although the law does pro- vide some remedy, both criminal and civil, for those from whom money has been obtained under false pretenses. Proof of Fraud In cases of false representation there are several points which must be established beyond all reasonable doubt, and it is these points that the credit man should always look into ; though, of course, he cannot under all circumstances guard himself against an untruthful man. As a rule, a man who has some standing and who wishes to obtain credit from a mercantile or banking institution, is one in whom the credit man has confidence. But if he lies as to certain facts, the creditor may proceed against him by criminal process. It is important, therefore, to understand just the elements which constitute the crime of obtaining money under false pretenses. First of all, there is the representation or pretense which the applicant for credit makes, which must be a representation as to an existing fact, or as to some fact that has existed in the past. Representations as to what is likely to occur in the future are not punishable by law. The law does not require any man to be a prophet as to the future, and he cannot be prosecuted because his judg- ment proves bad as to what the future may bring forth. If I tell you that during the last month I have sold one thousand dollars' worth of goods, I have made a 184 MERCANTILE CREDITS representation as to a fact that has existed during the past month. If I tell you further that I have in my grocery store so many cans of different kinds of fruit, so many boxes of goods, etc., and give you an inventory, or an approximate inventory, of my stock, then I am making a representation as to an existing fact; and if these state- ments are false, and you extend credit to me on the strength of them, I come within the law against obtaining money under false pretenses. Opinion Cannot be Construed as Misrepresentation But such representation must be a representation as to a fact, and not an opinion. If I represent to you that in my store I have certain fixtures, it may be that you are so situated that you cannot go to the store and look at them, and so you rely on my representation; and if I have mis- represented what I have in my store, I have made a mis- representation as to fact. But if, on the other hand, I tell you that the goods and fixtures which I have in my store are worth $3,000, when, as a matter of fact, in the mar- ket they may be worth only $1,500, I am not misrepre- senting a matter of fact but merely stating an opinion. Take another example that will illustrate the point a little better. If I tell you I own a lot and that it is worth $2,500, when the lot can really be bought for $1,600 or $1,800, I am making a misrepresentation as to opinion. In my opinion it may be that the lot is really worth $2,500, but it may be also true that you can get just as good a lot for $1,600. The representation which I have made is a matter of opinion for which I cannot be prose- cuted, except under rare circumstances. If I represent to you, however, that I am the owner of the lot when, as a matter of fact, I am not, or if I represent to you that the lot is free and clear when, as a matter of fact, I have FRAUDS 185 a mortgage on the lot, I am making a misrepresentation as to a fact and can be prosecuted. It sometimes happens, however, that a representa- tion as to a matter of opinion is so grossly incorrect that the Court will declare it a misrepresentation as to fact, particularly in matters involving opinions as to values. For instance, a lot in some little suburb, or some new town that exists only on paper, may actually be worth about $75. Some stranger may be informed that that lot is worth $10,000 or $20,000. The courts have sometimes held that under such circumstances the person who made the representation could not have honestly entertained the opinion that it was worth two or three hundred times its actual value, and have held that such a misrepresentation as to value is a misrepresentation as to opinion, and that the purchaser is entitled to protection against misrepre- sentations of such character. The business man must, however, for the most part look out for himself in such matters and be careful to ob- serve whether a misrepresentation deals with facts or with opinions and whether it represents facts as they now exist, or have existed in the past, not as they may be in the imagination of the promoter or the persons engaged in business, and not as they may exist in the future. Statement Must be Known to be False by Maker The person who makes a false representation must know that it is false or he cannot be held liable. A person who innocently makes a misrepresentation is guilty of no crime, even though his misrepresentation may result in a loss to others. He must either know that it is untrue, or he must represent something as true of his own knowl- edge, when, as a matter of fact, he does not know any- thing about it. Either of these conditions will make him 186 MERCANTILE CREDITS liable under the law. When a man knows his statement is false it can usually be proved by showing that he was familiar with the subject, and in a position to know if he wanted to. As a rule, the law presumes that men are sane, and that, if they are in a position where they ought to know, they do know. Intent to Defraud A misrepresentation must be made with intent to de- fraud. If it is made to somebody who is merely inquiring into your business affairs, and who, as you think, has no business to inquire into them, and you make your misrep- resentation to him only with the intention of misleading him, you are not guilty of any crime, because the mis- representation must be made with the intent to defraud. Creditor Must Rely on Misrepresentation There still remains something before the crime of false representation can be established. The person from whom the money was obtained must have believed the representations. If I come to you and tell you that I am the owner of the lot next door, and you know that some one else owns it, you must not extend credit to me think- ing you can prosecute me criminally, or that you have a criminal hold on me. You know better; you know I do not own it; and the law does not allow you to hold any- thing over my head. You must believe and rely on the representation that is made to you. Now, by relying on a representation that is made to you, I do not mean that it is necessary that you should abstain from making any investigation into what has been told you. That would be a foolish requirement, because you might be deceived in making your investigations. You might have relied in part on your investigations, and FRAUDS 187 in part on what was said to you. If you relied in any part upon what was said to you, and if you are primarily induced by what was said to you, and these other investi- gations which you made merely verified such statements, and caused you to rely upon them, then you have not lost your remedy you can still prosecute for obtaining money under false pretenses ; but remember always that you must rely on what is represented to you before you can prose- cute criminally. You must not close your eyes to those things which you know to be untrue. If you have business dealings with a man whom you find to be a liar, no matter what his assets are, no matter what clubs you hold over his head, you had better drop such a customer at once. I am sure that those who have had experience in credit work will corroborate me in this. That, however, is a phase of the subject that is outside the field with which we are dealing. I only mention it inci- dentally in discussing the question of your reliance on what the other person has told you when you extend money or credit to him. Silence is Not False Representation Now, there is another class of cases in which the person deceives himself, or, while he thinks he is acting upon representations or pretenses that are made by the other party to the transaction, does not really do so be- cause the other party merely remains silent. Of course, where it is the duty of one to disclose a fact, and he fails to do it, it constitutes fraud or deceit on his part; but the law leaves those cases to the civil courts, and frequently you have not even a remedy in civil law because of the old rule caveat emptor "let the buyer beware." For instance, if you had a horse in your possession, and I looked at the horse and admired it and asked how much 188 MERCANTILE CREDITS you wanted for it, and you said $100 and I paid you for the horse and went away with it, I would have no remedy, even if it developed that the horse had many faults, for you made no representations to me whatever. It was my business to make an investigation to inquire from you, or examine the horse. The law does not attempt in all cases to guard against ignorance or carelessness. It only attempts to guard against those things which you cannot guard against yourself; that is, to guard against the un- truthfulness and the misrepresentations of others. It protects you when you use that care and caution which you should use, and the man who would buy a horse without proper -precautions in the manner described, could not proceed in any way against the person from whom he bought the horse. Corroborative Evidence Necessary There is another thing that I want to discuss before we leave the subject of obtaining money under false pre- tenses, and that is the evidence by which a false pretense is proved. If a man has done the fraudulent things to which I have called your attention, he is guilty of obtain- ing money under false pretenses. But the other day in court I went down to hold a preliminary examination in a case where a man had been accused of doing these things. The prosecuting witness testified absolutely to every fact necessary to constitute that crime; and if the prosecuting witness was telling the truth, as I believe he was, there was no doubt that that crime was committed, but I had to dismiss the case at once. Why? Because when I asked him who was present, he had to answer, "No one." Then I asked, "Did you have any written memorandum con- cerning this transaction?" "No," he replied, "I didn't have anything in writing saying that the defendant had FRAUDS 189 made these representations." I said, "What other cir- cumstances are there that will corroborate your state- ment?" "I don't know of any other," was the answer. He was accompanied by an attorney who should have known better. I asked him, "What do you rely on to corroborate this man's statement?" He replied, "We are here to show that the other man is a liar." I said, "You can't do it. You have to corroborate your client's state- ments before you can make a claim of false representa- tion." So I had to dismiss the case, although the man accused may have been guilty of a crime. Before you can prosecute a man for making false pre- tenses, you must either have two witnesses to the trans- action; which may be yourself and some one else; or, you must have some representation in writing to corroborate your statement which is known in law as a false token or else some other circumstance tending to prove that the misrepresentation was actually made. Written Evidence As an instance of written evidence, I go to a money lender and borrow some money on a personal mortgage, or give a mortgage on personal property. I represent to him that I am the sole owner of that property, and that it is free and unencumbered. Usually money lenders put this phrase in their chattel mortgages: "The mortgagor hereby declares that he is the sole owner of the above described personal property, and that it is free and clear of all encumbrances." Right there you have a memor- andum corroborating what the mortgagor has said to the mortgagee; and if the representation proves untrue, the mortgagee can prosecute even though no special witnesses were present, because he has the mortgagor's own state- ment and the memorandum corroborating his statement to prove that the false pretense was made. 190 MERCANTILE CREDITS Corroborating Circumstances False pretenses may sometimes be proved by cor- roborating circumstances, but this method of proof is not frequent, because the man who commits the crime of obtaining money under false pretenses does not, as a rule, do any other corroborative act; he does not allow any other circumstance to be created which will corroborate His victim's testimony, if the victim sees fit to prosecute. It sometimes happens, though, that a man follows a cer- tain course of criminal conduct which enables the prose- cutor to introduce corroborating circumstances of suffi- cient weight to convict him. Value of Financial Statements As to the credit man, however, the best thing to do when a man applies to him for credit, is to have him make in writing a statement of what his assets and liabilities are. The important point is not the value of the assets, because that is a matter of opinion which ultimately you will have to determine for yourself, but the statement of fact as to what he actually owns and what he actually owes. What a man owes another is a question of fact; and if I owe you $100, my opinion as to whether it is more or less than $100 will not change the fact that it is $100. The nature of the customer's actual assets, and whether or not they are encumbered, are also questions of fact; and if you get both these statements, you have something that you can use. Banks usually require such a statement from those desiring to borrow money, unless the customer happens to be one with whom they are so well acquainted that they feel it unnecessary to be on their guard. There is another reason for requiring written state- ments, besides the fact that they will be legal evidence. FRAUDS 191 The man who is making a false statement will not put it in writing if he can help it; and if you request him to do so, he will temper it down to the facts, and will not attempt to exaggerate his assets so much and thus you will get at the truth. Business men do not want lawsuits; but they do want good, safe, reliable business. Business that is not safe and reliable, may compel the creditor to resort to the prosecuting attorney's office, or to the employment of private attorneys a kind of business not often profitable. Of course, a business man should know the law, and should know what to do if he has made a mistake in judgment, and what legal method he can employ to guard against the crook and the dishonest man; but he does not want to get into a lawsuit if there is any proper way by which it can be avoided. The Defrauded Person Not Always Blameless Captain Fredericks, District Attorney of Los Angeles, recently prepared some notes on the subject of frauds which I think contain very sound advice for the business man, and are therefore quoted here in part. "It is very rare indeed that a man is deceived by an- other, and parts with property, without having a criminal or a civil remedy, unless he, himself, has been endeavor- ing to get too much the best of the bargain. For instance, no man would pay one hundred dollars for a horse with- out asking the seller all sorts of questions which, if an- swered untruthfully, would be the basis of a criminal or civil action, unless he, the purchaser, believed he was get- ting so much the best of the bargain that he feared to endanger the trade by too much bargaining. In such a case if he gets the worst of the bargain, he is punished by reason of his own avarice and selfishness, and deserves what he gets." I 9 2 MERCANTILE CREDITS Self -Deception "Men in business must learn the difference between deceiving themselves and permitting others to deceive them. It is a fact that a man can deceive himself more easily than he can deceive any one else. Many of the cases involving fraud and deceit which get into the civil and criminal courts arise from the fact that the man who has suffered has deceived himself, or has not taken that care or made that inquiry which the law and ordinary prudence require. "There has been no thought more frequently and thoroughly impressed on my mind in the years I have had intimate knowledge with the sordid side of life than the thought expressed so aptly by Pope, 'All is infected that the infected spy, As all looks yellow to the jaundiced eye.' meaning that we often deceive ourselves into seeing what we are looking for, even though it may not exist/' This is just what we must bear in mind in securing business. We must not deceive ourselves into believing that a man is a good customer when he is not. Prudent and Imprudent Investment "To illustrate the safe and the unsafe method of pro- cedure in financial matters, I will describe two different methods of investing in an enterprise which is intrinsically good but undeveloped. "First. The reckless financier will put money and effort into an enterprise although he knows there is no hope of success unless others afterwards buy stock, or put in money, and that, if for any reason this should fail to take place, all that was originally invested would be lost. "Second. The safe financier agrees to invest his FRAUDS 193 money only when sufficient capital has been subscribed to fully finance the undertaking, including all possible acci- dents and incidents. He considers the entire course to be traveled, and all the expenses necessary to be incurred probably with the aid of experts, and after determining just what capital will be necessary to make all payments and cover all contingencies, he sets that amount as the mark which must be raised before he parts with any of his money. "Now suppose both these imaginary undertakings fail, and the money invested is lost. Who is to blame for the fact that the first and the second men put their money into the undertakings and lost it? The first man, to begin with, simply gambled on the probability of future hap- penings, or did not make sufficient investigation to know upon what contingency success depended. Probably no one deceived him. He did not give any one a chance to deceive him. He thought he saw a chance for large re- wards, and deceived himself. He is the one who requires the services of a guardian. "In the second instance, however, the investor has eliminated chances to a large extent; and when the enter- prise fails, he is in a position to hold some one civilly or criminally liable criminally liable if he has relied upon a false statement made to him in his investigation prior to investment, and civilly liable in any other case. "The first investor comes to the authorities in mad haste, and endeavors to use the criminal law in order to extort his money from some one who would rather pay than be prosecuted. I do not think that he does this always viciously, but as a rule thoughtlessly. He merely wants to get his money back, and is very much disap- pointed when the district attorney will not prosecute under the circumstances. I 9 4 MERCANTILE CREDITS "The second investor has not deceived himself, and if his enterprise fails, he has some one upon whom he can rely, or upon whom he did rely, rather; and when he comes to the district attorney he has a case." And that is the class in which you should always en- deavor to be. If, for any reason, you, or the firm or cor- poration with which you are connected, has been deceived or cheated, let it be not a case of self-deception, not a case of carelessness on your part, but a case where you had to rely and did rely on representations which were know- ingly, not thoughtlessly, made to you by the person with whom you were dealing. Then in that case a prosecution can be instituted in the criminal courts, and, if there are any assets at all, you can prosecute successfully a civil action for the recovery of your money. It is the duty of the district attorney to prosecute criminals, but it is not his duty to run a collection agency. Most men who have committed crime, if they themselves lack the funds, have friends or relatives who are willing to come to the rescue, and put up money to stop a prosecu- tion if the district attorney's office can be used in that way. But remember that this is not the duty of the district at- torney; and the ordinary district attorney objects to being used as a collection agency, and will refuse to be so used. When you attempt to compromise a crime, to dismiss a case once instituted, on recovery of your money, you are either compounding a felony or a misdemeanor, or you are guilty of extortion. A man who tries to use the dis- trict attorney's office even to collect a just debt is guilty of extortion, and he cannot, when charged with extortion, set up as a defense that the money he was trying to collect was really owing to him. This is something that is not realized by those who attempt to use the district attor- ney's office in this way, but it is the case nevertheless. FRAUDS 195 Summary You 'must use every effort to protect yourself from fraud; investigate with care, and then use your own best judgment. You should understand the law in order to know when a man who has violated it may be prosecuted, so as to deter him and others from committing like crimes in the future. When you have been cheated or defrauded to the violation of the criminal law, you ought to prose- cute relentlessly, even if your prosecution results in some temporary financial loss to yourself. If credit men in general will do this will let the criminally inclined know that money is no object to them when those with whom they are dealing have violated the law of fraud the prac- tice of obtaining money or goods under false pretenses will cease very soon, and the district attorney's office will no longer be needed as a collection agency. CHAPTER XI AMICABLE ADJUSTMENT WITH INSOLVENT DEBTORS BY F. C. DELANO Advantages of Amicable Adjustment The "Amicable Adjustment" is the peaceable, friendly adjustment between debtor and creditors by which the best results for both are obtained, and this without litiga- tion, for litigation is legal warfare, and war is expense ! Its superiority to all other methods is shown, first, in the reduced cost of handling estates; next, in the shorter time involved in settling with the creditors ; and last, but not least, in the larger amounts paid to the creditors. Of these three matters we will speak later. California Boards of Trade In the matter of amicable adjustments the West has taken a leading part. For many years the wholesale merchants of California have been adjusting their losses and liquidating the estates of insolvent debtors through the medium of adjustment bureaus, the principal ones be- ing the Board of Trade of San Francisco and the Los Angeles Wholesalers Board of Trade. The Board of Trade of San Francisco was organized in 1877, and has a present membership of 218, handling an annual volume of business amounting to more than $700,000. The Los Angeles Wholesalers Board of Trade has a membership ADJUSTMENT WITH DEBTORS 197 of 135, with receipts and disbursements in 1912 of more than $500,000. These two organizations are mentioned as prominent examples of the growth of the adjustment idea ; and the fact of their continued existence and the steady, un- solicited increase in their membership would seem to be sufficient evidence that the majority of the wholesale mer- chants of these two cities have realized, and are profiting by, the advantages of the adjustment bureau. Increase of Adjustment Bureaus Adjustment bureaus everywhere are growing in num- bers and in strength. The larger business centers west of the Rocky Mountains, such as Salt Lake City, Denver, Spokane and even small towns like San Diego have adjustment bureaus in successful operation, handling practically 75 per cent of all the business failures. The larger Eastern cities, also, are realizing the importance of co-operation, and are organizing for the purpose of settling cases of insolvency out of court by liquidation or otherwise; though it is safe to say that less than 25 per cent of their failures are settled through the adjustment bureau. Credit Associations In the East the various lines of trade have their own associations, taking over and handling adjustments in their own lines of business. Such are the Manufacturing Jewelers Board of Trade of Providence; the Shoe and Leather Board of Trade of Boston; the National Clothiers Association of New York; and the National Jewelers Board of Trade, with headquarters in New York and local secretaries in all the large cities. But the greatest co-operative association of this kind in the busi- I 9 8 MERCANTILE CREDITS ness world is the National Association of Credit Men, organized about eighteen years ago, and now having a membership of over 16,000, with more than 80 affiliated local branches, and with 45 bureaus for the exchange of credit information and for the adjustment of insolvent estates. Economy of Adjustments Now, what is the meaning of all this? It is simply a part of the forward movement, world-wide in extent, to stop economic waste. Great combinations of capital with the latest and most improved machinery, utilizing all the forces of nature, are striving for the maximum of pro- duction with the minimum of cost; but it has been left to the credit men of the extreme West to teach the whole- sale merchants of the entire nation the art of conserving their credits their debtor's assets and of saving to their own commercial houses the greater portion of that waste which has heretofore been eaten up by courts of equity, attorneys' fees, and other useless expenses. All this is accomplished by the amicable adjustment with failed debtors. Adjustment Procedure When a debtor fails, you are advised of the fact by the mercantile agencies, by your salesman, or by some other creditor; or perhaps your first notification is when the telephone rings, and you are asked to attend a meet- ing at the "Board of Trade." Such a meeting, however, does not always mean a failure; for sometimes, when a debtor is given an extension of time and helped along a little by his creditors, he pays them in full and continues to be a good customer, often discounting his bills. On the other hand, it frequently happens that an ADJUSTMENT WITH DEBTORS 199 individual who fails to recognize any moral obligation to his fellow creditors, will levy an attachment on a debtor's place of business, place a deputy sheriff in charge, close the store, and not only injure the debtor's trade, but run up a bill of expense that is part of the great waste he should be seeking to avoid. Sometimes, also, a debtor, poorly advised by some attorney who has a higher re- gard for fees than for the welfare of his client, evades his creditors and procures a coat of whitewash in the bank- ruptcy court. ] Consulting with Creditors When a man's place of business is attached, or when he is in financial distress, his wisest course is to consult his heaviest creditors. If they are unable to help him over his immediate difficulties, a meeting of creditors should be called at once. Sometimes a meeting is called by a creditor who has heard something of the debtor's troubles, financial or otherwise; sometimes by one who knows nothing of the debtor's difficulties except that he has been unable to collect his own account. These meet- ings are held at various places, sometimes at the office of the debtor's attorney, occasionally at the debtor's place of business, but generally at the office of some creditor, or at the office of the adjustment bureau. When a debtor calls a meeting of his creditors, it is almost certain that he has reached the end of his rope, and wishes to place his affairs in their hands, allowing them to adjust them as best they can, and hoping that they will be satisfied to give him a release. Sometimes the debtor demands this release as a consideration for his making an assignment, or a transfer of his assets; some- times he overlooks this request, and it is granted to him voluntarily by his creditors; and sometimes, yielding to 200 MERCANTILE CREDITS the demand of certain creditors a demand not often made debtors will make an assignment or a transfer of their entire assets, and give their personal note for the deficiency. These notes are usually payable on demand, or at some specified time, without the slightest idea of how or when they can meet these promises. The Debtor's Attorney If a meeting is called by the debtor's attorney, there are several things to be considered. The attorney has generally gone over the debtor's affairs very carefully, and being fully advised as to his client's condition, will now ask that he be granted an extension of time in which to meet his obligations; or will suggest a composition settlement at so much on the dollar, ranging anywhere from 25 to 50 per cent; or will state that the debtor can- not continue the business, and is willing to transfer every- thing to the creditors, providing they will release him from all obligations. In this last case he generally insists on the further provision that the debtor be allowed to re- tain such of his personal or real property as may be exempt from execution or subject to homestead rights. Unscrupulous Debtors and Attorneys I am here speaking only of reputable attorneys. But sometimes we have to deal with a crooked debtor or a more crooked attorney more crooked because he is more experienced and more able and in such a case the credi- tors will often accept the proposition outlined by the attorney, even though it may be very unsatisfactory to them. They do this because they know, or at least they fear, that the attorney has carefully planned to prevent their obtaining any more under bankruptcy than the debtor is offering through this settlement. ADJUSTMENT WITH DEBTORS 201 But the best laid plans of crooks and their attorneys may sometimes fail. For instance, we had a case in a neighboring town some two years ago which had all the appearance of being a carefully planned fraud. We will say that the party's name was Brown. The business had been conducted in the name of "A. Brown" for a great many years; and it was generally understood that U A. Brown" meant Adam Brown; but as a matter of fact, it meant Anna Brown. In addition to the business, Mrs. Anna Brown owned considerable real estate, good prop- erty, and was responsible in every way. The business, however, got into a shaky condition and Mrs. Anna Brown, with the aid of a certain attorney of Los Angeles, conceived the idea of incorporating it. She transferred her stock of merchandise for the full amount of the capi- tal stock of the corporation, and then, in addition, took a note for $25,000 for the "good-will" of the business, and afterward transferred her stock to Adam Brown, who had no property. Had the concern gone into bank- ruptcy six months afterwards, Mrs. Brown would have been the largest creditor; but the real facts were by acci- dent discovered sooner, and, instead of collecting from the bankrupt concern, Mrs. Brown was compelled to give a trust deed on about $20,000 of real estate to meet its liabilities. This broke up the combination. The Creditors' Meeting Nearly all the adjustment bureaus now maintain credit departments where may be found reports on hun- dreds or thousands of debtors who are slow pay, or who are not in the habit of discounting. From these reports, if the debtor's name is included, a fairly accurate list of the various wholesale houses that he is owing may be obtained. If no such report is available, and if the 202 MERCANTILE CREDITS creditor asking for the meeting has no list of creditors, he will secure a partial list by telephone and invite all the local creditors known to him to attend a meeting. If it is possible, the debtor will also be requested to attend. Methods of Settlement Generally speaking, only four methods of settlement are possible: extension of time, with or without security; composition settlement; assignment, with or without re- lease; and bankruptcy, voluntary or involuntary. Information Required It is necessary, of course, before settling with a debtor, that his creditors should obtain as full and com- plete information regarding his affairs as possible. The first question they will ask is, "How much do you owe?" Next, they will want to know the amount of assets in de- tail, the value of fixtures, whether the fixtures are owned or leased, clear or mortgaged, or being purchased on con- ditional sales contract; and finally the amount of cash on hand or in the bank. You will invariably find the cash on hand to be the only asset that will not shrink in value before you get through just the real hard cash in the cash drawer or in the bank. And even the cash in bank will not be worth one hundred cents on the dollar if the bank holds a note that is due (and most bank notes are due in a crisis like this), for the law gives this creditor, the bank, the right to seize the debtor's money on deposit and apply it on his note. Then the creditors will ask for the amount of the book accounts that are good, the value of wagons, horses, and other live stock, the amount of insurance carried, the amount of business the debtor has been doing for the ADJUSTMENT WITH DEBTORS 203 past month or year, the margin of profit he is making, and so on. Then they will want to know the ratio be- tween his gross profit and his expense, and from these figures they will judge the probability of his paying in full if allowed to continue in business. The Business Doctor The debtor may need the services of an expert in some particular line a man who would now be called a "business doctor" or an "efficiency expert." I know one man who well deserves this title, for he can detect the wastes and leaks in the ordinary retail business with such accuracy that he can reorganize the entire system, and, if conditions are normal, put the business upon a sound basis so that soon it will show a steady and healthy profit. There are many men in need of the services of a good business doctor, and the latter, if he is allowed to prescribe in the early stages of trouble, will treat his patient with pills that are nicely sugar coated; but if the patient delays too long, his medicine is likely to be very bitter, and he may in the end furnish another job for the commercial undertaker. I can probably best illustrate this point by the case of a certain grocer who got into trouble. We will call him John Blank. A meeting of creditors was called, and the debtor requested an extension. This was refused at the time by the creditors, but an assignment was taken and the business was continued with a competent man in charge. The debtor had been in business six years, hav- ing lost during that time some $12,000. He had aver- aged nearly $200 per month loss. Starting with $6,000 in cash of his own money, he had become embarrassed, and then an uncle had advanced him as much more. Now it was all gone. In ten or twelve weeks, however, the 204 MERCANTILE CREDITS new manager stopped some of the losses, changed the system, and made some $995 profit. The creditors then settled with the debtor at 75 cents on the dollar. The debtor had learned how to stop the waste in his own busi- ness, and he still continues with apparent success. Details of Adjustment When the creditors have finished their examination of the debtor, they will excuse him from the room, while they discuss his affairs in private; and if the debtor is not suspected of fraud, they will consent to his making a transfer of the assets, and will relieve him of his obliga- tions. They then appoint a chairman of the meeting, and generally delegate to a committee of the larger creditors full power to negotiate with the debtor for the assign- ment, or for an extension, or for a composition settlement whichever is deemed best. If it is to be an assignment, the papers are generally signed at once, and a representative of the creditors ac- customed to such work is sent to take possession of the store and all other assets, to take an inventory, to collect the accounts, see that the place is kept insured, and in every other way protect the business as if it were his own. Then the report of the adjuster, or man in charge of the business, is presented to the creditors' committee, and the assignee, receiving his instructions from the committee, proceeds to conduct the business, or to settle it, or to close it up, or to move the business into a warehouse, or to dispose of it in such other way as directed by the creditors' committee. The creditors' committee is generally composed of the three largest creditors those who will suffer most if there is any loss; therefore, the smaller creditors, know- ing these conditions, can generally feel that their interests ADJUSTMENT WITH DEBTORS 205 are well protected, because the larger creditors will surely look out for their own. Continuing the Business If the creditors' committee decides to continue the business as a going concern, it will be necessary to pur- chase goods and do all the other things required to run the business. If goods are to be purchased in the name of the assignee, the buying should be confined to those houses which are already interested, but only on the con- dition that the prices, delivery, and quality of the goods are equal to those which may be obtained elsewhere. This should be watched very carefully, for I have often known creditors to raise the price of their wares as soon as they felt that the assignee was compelled to purchase his goods from them. Selling the Business If the business is to be sold as a going concern, or is to be closed immediately and sold after inventory, the sale may be conducted in several different ways; some- times even by the professional auctioneer, although we have never had very much success with this. Sometimes the assignee holds a public sale or we might term it a private auction to which he invites all professional buyers and others who may be in any way interested, or are likely to buy. Public notice is generally given through the classified advertising in the daily newspapers under the head of "Business Chances" or "Auction." Some- times these sales are handled exclusively over the tele- phone, or by the adjuster in charge, the different offers or bids made by the buyers being submitted by the assignee to the creditors' committee for its approval. Generally the assignee demands cash payment on the 206 MERCANTILE CREDITS sale of the assets, but occasionally he will be instructed by the committee to accept the note of the buyer. This is rarely done, however, for the reason that the creditors have already been without the use of the money repre- sented by their interest in this estate for a long time ; and they are usually eager to have the assets converted into cash. Of course they are entitled to this; but it is often hard to find a buyer who is able or willing to give as much as the committee believes the merchandise is worth, and it may be necessary to give him some time in which to raise the full amount of the purchase price. When- ever this is done, the purchaser should give security, or a guaranty of some kind, to the creditors. Preliminaries of Adjustment The adjuster in charge of the case, first sends to the assignee a full list of the creditors ; then he takes a com- plete inventory, and cleans up the stock and the entire store. He gives the assignee a list of all the accounts receivable, making such collections as are possible while in charge of the store, and assures all small or local credi- tors that the assignment is for the mutual benefit of all the creditors, trying to persuade them not to attach by advising them that such an act would increase the expense and materially lessen their recoveries for bankruptcy will most likely follow if any creditor attempts to force a settlement of his claim in any manner by which he obtains a preference at the expense of the others. Creditors Must Cooperate We had a case only last week where a man who was in debt about $1,600, with assets of about $1,800, made an assignment for the benefit of creditors. Two small creditors, having claims aggregating less than $100, ADJUSTMENT WITH DEBTORS 207 attached. They were frank to say that they believed that the other creditors would allow them to be paid in full, and tried to bluff it out; but it did not work that way. The creditors held a meeting, called the debtor in, and showed him the injustice of paying two small creditors in full and leaving the larger ones to take what was left. Then they persuaded him to prepare a voluntary petition in bankruptcy. This petition would have been put through, had not the creditors who had attached seen their mis- take and consented to the assignment. Shrinkage of Accounts Receivable And now a word about the book accounts which I have mentioned. Our records, extending over a number of years, show that the accounts receivable of the average retail dealer are not worth 60 cents on the dollar. I be- lieve our records for the past year show that we collected only 56 cents and a fraction. The ordinary retail dealer sometimes carries old and worthless accounts as live assets. I know of a case where a certain corporation had been selling to Mexican laborers and Indians on credit. In a recent attempt to collect these accounts, we found that many of the debtors had drifted away; quite a num- ber had been dead for some time; and one or two were in the penitentiary; and yet all those accounts were car- ried as live assets. The president of the corporation was fooling himself as much as he was his creditors. Many a retailer does not know the full name or ad- dress of a large number of his regular customers. He relies on his delivery clerk, who, after the failure, is too busy hunting for another job to assist the adjuster, or, as often happens, is immediately employed by a competitor, who hopes to secure all this new trade, and of course will give no assistance to the assignee. 208 MERCANTILE CREDITS Discounting the Debtor's Statements If the debtor is asking for an extension, the creditors should invariably take an inventory and thoroughly inves- tigate the situation before granting or refusing the exten- sion. When a debtor asks for an extension he will tell you he has a certain amount of merchandise and fixtures, and that he has so many thousand dollars 5 worth of bills receivable that are good in fact, he has everything but money and he will make almost any kind of a promise if only the creditors will allow him to continue. I have heard debtors who had only a small retail business make promises that many a wholesale business would hesitate to make. But if, on the other hand, the debtor wishes to settle with his creditors for 50 cents on the dollar, or any other amount, everything assumes a darker hue. The merchan- dise is shop worn, out of style; the stock is broken; the accounts are old and uncollectible ; the fixtures are mort- gaged or on lease contract. In fact, it would seem that the creditors must have forgotten all about this man, otherwise he never would have been allowed to continue. Now, when an inventory is taken it will generally show that the man who has asked for the extension, has inflated the amount, or at least the value and condition, of all his assets; while the other man has depreciated them, knowing that a much better settlement can be ob- tained if the assets are small. If a disinterested party makes an investigation, his report will show the condi- tions in their true light; and it is on this report, rather than upon the debtor's statement, that the creditors should base their action. Procedure when Extension is Granted When the creditors think the debtor is entitled to an ADJUSTMENT WITH DEBTORS 209 extension, some sort of an agreement should be entered into which will not only bind the debtor to perform cer- tain duties, but will also prevent the creditors themselves from taking advantage of each other or of the debtor, so long as he makes the promised payments. We have found it more effective, and I may say simpler, where an extension is granted, to allow the debtor to give his note for the amount of the indebtedness. The person to whom the note is made payable then obtains the assignment to himself of the claims of all the creditors. This so changes the situation that the debtor has but one creditor the man to whom he has given his note for $5,000 or $10,000, or whatever the amount may be; and the credi- tors, having assigned their claims to the holder of this note, are no longer able to molest the debtor, as they have no claims against him. Protecting the Creditors The one creditor holding the note who is, in fact, a trustee for all the creditors should be in a position at any time to demand the payment of his note if the debtor becomes delinquent in his payments, or if anything hap- pens to the debtor which in any way imperils the interests of the creditors. The form of jiote used in such cases provides that the note shall immediately become due and payable if any of the instalments or interest thereon be not paid when due; or upon any attachment or other pro- cess of court, or any other action or proceedings against the maker of the note ; or any notice of intention to sell, or of any sale of the stock in bulk. These provisions are very necessary to protect the interests of the creditors. Protecting the Debtor At the time this settlement is agreed on, it is scarcely 210 MERCANTILE CREDITS possible that the creditors, or even the debtor himself, will be able to state accurately the exact amount of his indebtedness; we find it convenient, therefore, and often of considerable advantage to draw the note for more than the amount the debtor thinks he owes; but, for the pro- tection of the debtor, we give him a contract or agreement providing that the holder of the note, who is also the assignee of the claims of all the creditors, shall credit upon this note the difference between the amount of claims actually assigned and the face of the note. This is a protection to the creditors themselves, and to their assignee, and is fair to the debtor. Providing for Contingencies The older credit men will at once recognize the wis- dom of providing for the various contingencies I have mentioned. If a debtor is inclined to be tricky, or is poorly advised, or of his own volition shall decide that the best thing to do is to save what he can from the wreck, then, if the ordinary note has been taken instead of one with these provisions, the debtor can make a few weekly or monthly payments to the holder of the note, and immediately thereafter sell out, or file a notice of in- tention to sell, and dispose of his business. He might be able to sell for cash, with which he could purchase real estate, file a homestead, buy building and loan stock, or in any one of a dozen different ways succeed in placing the proceeds of the business beyond the reach of his creditors. Investigate Before Settlement The foregoing applies to extensions. If the debtor asks for a settlement at 50 cents on the dollar, or at any other percentage of his liabilities, he should be compelled tl ADJUSTMENT WITH DEBTORS 211 to pay more than could be realized through bankruptcy, for the advantages to him are so great that even though he cannot raise the full amount of his settlement in cash, he should make up the difference later. But the debtor's proposition to settle should not be hastily accepted. Attempted deception is common under such circumstances. Sometimes fraud can be proved, but we have seen too many cases where we felt morally certain that the debtor had carefully planned for this settlement months in ad- vance, and yet, not having the proof of our convictions, nor any way of obtaining such evidence, have been com- pelled to accept a settlement which we knew was a rank injustice. We have hundreds of cases coming into our office every year, and no two are exactly alike. I have in mind one particular settlement where the debtor was believed to have gradually withdrawn funds from the business, placing them in the care of a relative or friend in Sacra- mento, or some distant town. These funds were with- drawn so gradually that the business did not appear to suffer. When the time came he borrowed this amount, the accumulation of his savings, from his friend in Sacra- mento, giving him a note, and then he paid one certain creditor, preferring him. Soon after, it was found that he was insolvent, and he made a settlement with his credi- tors at 40 cents on the dollar. He had no difficulty in preparing the evidence to corroborate his statements as to the amounts he had borrowed; but I am convinced now beyond a shadow of a doubt that the money borrowed was his own money. Nevertheless, so carefully had he arranged matters that it would have been very difficult, if not impossible, to prove in bankruptcy proceedings that a fraud had been committed. Therefore, on the evidence, the creditors' committee believed they were justified in 212 MERCANTILE CREDITS recommending this man's offer of settlement for accept- ance. Six months afterward, he came into my office and said he was in a position to finance any small dealer who needed ready cash to settle with his creditors; in other words, he was now a financier I Consent of Creditors One of the most important and most difficult tasks of the assignee or the creditors' committee is to obtain the consent of the creditors to the plan of settlement. This is done in various ways. The creditors are notified that a meeting has been held, and they are advised as to whatever action has been decided on. The amount of assets and liabilities are stated, as well as the causes leading up to the failure or whatever it may be. Original agreements are circulated for the signatures of the credi- tors, with a letter of explanation, or, if it is impracticable to circulate original agreements, then the facts and figures are given in a letter, with the recommendations of the committee, which asks for written authority to sign the name of the creditor to the original agreement. Creditors Must Wait for Their Money Now, whether the case be that of an assignment, an extension, or a composition settlement, the creditors want their money as soon as they can get it, and some of them become very impatient because the distribution is not made forthwith. This may be done if the assignee, or the person through whom the settlement is conducted, is absolutely sure that all creditors have consented to the settlement, or have agreed to the assignment. But the assignee cannot be positive; and it frequently happens some two or three months after a settlement has been made, or an extension granted, or the assets have been ADJUSTMENT WITH DEBTORS 213 sold under an assignment, that some unheard-of creditor appears. He may be a local creditor who has neglected his collections, or he may be an Eastern creditor who, depending upon his salesman's reports, has not yet re- ceived a report on this particular customer. Thus, for the protection of the debtor, as well as for his own pro- tection and that of the committee, the assignee should hold the entire proceeds of the assignment at least four months after the date of the transfer, because this trans- fer might become invalid and be set aside if within that time the debtor should file a voluntary petition in bank- ruptcy, or if certain creditors, having a personal spite or grudge against the debtor, should insist on payment in full. This often happens when the debtor fails just after receiving his first shipment from one or more firms, or when distant creditors and sometimes local ones as well instead of investigating the situation carefully for them- selves, file their claims with their own attorney. He, un- fortunately, often sees but one thing, namely, the fees which he, the attorney, is to make out of this particular collection. Now, this attorney may believe that he can play the "dog in the manger" act, and will hold up a settlement unless he receives payment in full for his client. Sometimes he carries this too far, and the other creditors deliberately file an involuntary petition in bankruptcy to compel this "dog in the manger" to prorate with the others, even though they know it is costing them many dollars. Again, if the assignee distributes the money at once, and an unfriendly trustee in bankruptcy is elected, he may demand an accounting from the assignee, who has re- tained nothing; and this will be very embarrassing, for you can well imagine the difficulty of collecting the money paid to far-distant creditors. This is why all funds in 214 MERCANTILE CREDITS assignment cases are held for four months, to protect the assignee as well as the debtor. Distribution of Dividends In cases of assignment the first dividend should be distributed immediately after the four months have ex- pired, and other dividends should follow as rapidly as funds accumulate sufficient to make a dividend worth while. In cases of extension, dividends should be dis- tributed as often as payments are made by debtor, unless such payments are so small as to make the dividend in- significant; but a dividend should always be declared, if all creditors have agreed to the settlement, as soon as there is sufficient for a 10 per cent payment. Difficulty with Foreign Creditors In composition settlements, the local creditors, who are familiar with the situation, generally sign the agree- ment without much delay, but foreign creditors those who are some distance away from the scene of action view the situation so differently that they always cause more or less trouble. About two-thirds of the foreign creditors will consent to the settlement if it is recom- mended by the local creditors. The other third will fail to answer letters, or will state that their claims have been forwarded to attorneys, or that they want a greater per- centage paid on their claims, or that they want a prefer- ence. Their wants are so many, and their indifference to your letters so great, that an immediate settlement or an immediate distribution is often impossible; and then comes trouble from those who have already consented. They argue that, having consented to the settlement, they should receive their pro rata at once overlooking the fact that a settlement is rarely possible unless all creditors give their consent to the same action. ADJUSTMENT WITH DEBTORS '215 Recently we had in process of settlement an estate where the principal creditors the three creditors who formed the creditors' committee, having among them- selves about $12,000 of liabilities had accepted and strongly recommended a settlement at 50 cents on the dollar; but this settlement could only be brought about by taking secured notes payable at $400 a month, the security being a ranch, a residence property, and apart- ment houses. All the creditors but one consented. This man was in Chicago, and letters and telegrams were sent to him repeatedly without effect. Finally, in response to a more urgent telegram than usual, he wired back that he would take 50 cents on the dollar provided Chicago exchange were placed in his hands before the i9th instant. This gave us five days to collect ! Attachments Sometimes Necessary I have undertaken to tell you the advantages of a friendly settlement over attachment or bankruptcy, but very often attachments are necessary to bring about a friendly settlement. Sometimes the sheriff is placed in charge of a man's business to protect him from some in- dividual creditor, or to protect some creditor as against other creditors for we find that creditors fear each other fully as much as they do the debtor. Attachments are necessary at times when some creditor has become impatient, and has demanded and received a chattel mort- gage as security on some past-due indebtedness, thus obtaining a preference; or when a debtor has disap- peared; or when, after a place has been destroyed by fire, the debtor for some reason declines to turn his insurance over to the creditors. But such attachments should be for the benefit of all creditors. Sometimes a debtor is recklessly extravagant, and 2i6 MERCANTILE CREDITS appears to be dissipating his own assets. Sometimes he has transferred a portion of his assets, or is suspected of having committed some act that would be a fraud upon his creditors. Then an attachment must be made to create an act of bankruptcy, for in such cases bankruptcy is necessary unless the debtor, after having been attached, willingly consents to a peaceable settlement without fur- ther litigation. Bankruptcy is necessary also when the debtor has conveyed his assets with intent to hinder, de- lay, or defraud any creditor, or, as just stated, when he has given a chattel mortgage for the purpose of preferring some one creditor over the others; or when some creditor having been poorly advised by his attorney, has attached the greater portion of the debtor's assets, believing that his attachment will hold good in spite of bankruptcy, and that he will receive his pay in full. Debtor Should be Released In nearly all cases of assignment, the debtor believes that he is being fully released from all his obligations ; and where the failure is an honest failure, and there is no im- mediate prospect of the debtor's recovering his financial stability, this release should be given to him by his creditors. I have known of very few cases where, an assignment having been made and no release given to the debtor, the latter voluntarily came in afterwards to pay off the bal- ance of the indebtedness. The only case I now recall is that of two brothers, Italians, who had been unsuccess- fully conducting a cigar stand. They made an assignment for the benefit of creditors, without asking for a release. There was a deficiency, as there generally is in such cases ; and one day, about six months later, the younger brother came into the office and wanted to know how the settle- ADJUSTMENT WITH DEBTORS 217 ment came out. When advised of the amount that was still owing, he produced the cash and paid off the entire balance. And how do you suppose he obtained this cash? He was working in a ditch, digging sewers at $1.75 a day. This is the one exception to the general rule, in my per- sonal experience. Comparative Costs of Settlement and Bankruptcy The advantages of the friendly settlement as to the matter of cost may best be realized by comparison. For example, take a case in bankruptcy where the total assets of the estate will amount to about $20,000, more or less, and, after the most careful administration by a competent trustee, he has for distribution, we will say, $10,000 in actual cash. We will assume that there are one hundred creditors. The expenses of administering this estate by the trustee, or through the bankruptcy court, would range from $700 which is the lowest possible amount that we can imagine up to $1,600 or even $2,000, while an assignee would not, or should not, receive more than $750, and the probabilities are that his fees would be much less than that amount, the maximum being $920 and the minimum $320. The difference is perceptible, to say the least. As regards bankruptcy, the annual report of the San Francisco Board of Trade shows that in the year 1912 the distribution under bankruptcy to the creditors in all cases handled by them was 21 9/10 per cent as against 55 3/1 o per cent in case of assignment. The reports of the Los Angeles Wholesalers Board of Trade for 1911 show 37 4/10 per cent dividends under bankruptcy as against 57 8/10 per cent under assignments, and in the year 1912 the ratio is about the same. And further, the Attorney General's report for 1912 shows the average 2 i8 MERCANTILE CREDITS expense of administration to be 29 7/10 per cent of the assets realized, while in California alone the expense was 33 per cent. Saving of Time Now, as to the saving of time that can be made through this friendly settlement. I would like to cite a special case that came to my notice not long ago where a friendly settlement was made with a certain debtor about forty or fifty miles away, who proposed to pay his credi- tors as fast as the cash came over the counter, or as his collections were made. He even offered, if the creditors preferred, to turn over all his daily receipts to a friend, and let the friend remit to the creditors. But the reputa- tion of this particular debtor was not of the best, and the creditors therefore hesitated about trusting his friend, for, although the latter was responsible and of unques- tionable integrity, he was nevertheless a friend of the debtor, which was enough to condemn him. The credi- tors therefore told the friend, who acted as mediator in this settlement, that they would sell their claims at a dis- count of 10 per cent. This proposition was accepted, and the creditors received their money in weekly instalments. While they did not receive 100 cents on the dollar, it is very doubtful whether they would have received any greater amount through debtor's own manipulation of his funds, and certainly not as much in bankruptcy. With- out the medium of some adjustment bureau, and in the absence of some one who could devote the necessary time to handling a matter of this kind, some creditor would probably have attached this debtor, and this would have resulted in bankruptcy, or else that one creditor would have secured a full settlement of his claim, while the others would have been left out in the cold. ADJUSTMENT WITH DEBTORS 219 Extensions Generally Successful As to the results that are obtained through settlement outside the courts, it may be safe to say that nearly all composition settlements will produce greater dividends than bankruptcy, the exceptions being where the debtor is dishonest. In case of extension the creditors will in most cases receive 100 cents on the dollar. My observa- tion has been that about two-thirds of the extensions are successful; and in such cases the creditors receive their pay in full and the debtor is able to continue ; but in about one-third of these cases the debtor is so crippled by the payments that he makes or attempts to make, that before he has completed them he is compelled to liquidate either through an assignment or through bankruptcy. But even though he cannot carry his payments to completion, the creditors in most cases have received a greater amount than they could have recovered had they attached, or had the debtor filed a voluntary petition in the beginning. Advantages of Settlement for the Debtor I have been trying to show you some of the advan- tages of the friendly settlement, but only from the stand- point of the creditor. The debtor, however, is protected and benefited by this mode of settlement fully as much as the creditor. If there were no adjustment bureaus or friendly adjustments, nearly every unsuccessful merchant would be attached or thrown into bankruptcy, as I under- stand is still the case in the East; and by some of his creditors, at least, he would be branded as a crook, sim- ply because they had lost money in their dealings with him. We find that this point of view is very often taken. At a meeting of creditors, some disgruntled individual, who has perhaps neglected to exercise the ordinary pre- MERCANTILE CREDITS cautions, will say, "Well, the man's a crook; let's get after him and prosecute him for fraud." But it does not neces- sarily follow, because a man owes you a debt and is pre- vented by incompetency or by some of your competitors from paying you the full amount of your claim, that he is dishonest. His intentions may be as honorable as yours. His business may not be as prosperous as some, but it is furnishing him with a livelihood; he buys many of your goods and pays for them after a fashion. He may be slow at times, it is true, but there is no prospect of loss until something out of the usual happens, and, even when this something happens, the debtor may obtain an exten- sion; he may pay out in full; and he may continue to buy many thousands of dollars' worth of supplies from you; moreover, having learned his lesson, he may discount his bills. There are many such cases; for the debtor, during his period of extension, is generally compelled to buy for cash, and, if he wins out, he has learned that the item of discount amounts to a considerable sum of money; and then, too, he has acquired the habit of discounting. If a man is insolvent and makes an equitable settlement with his creditors, he generally makes good; and the creditors who lost 25 or 30 per cent, or even a greater amount, in their former settlement with him, now consider him a safer credit risk than before, for by this settlement with his creditors he has wiped out a considerable portion of his debts without diminishing his assets. They now know his exact condition, whereas before they merely thought they did. The man has paid his debt in full so far as he is able ; in fact, he has paid his creditors generally a great deal more than they would have received in bankruptcy; and he has avoided the stigma generally considered to be attached to the bankrupt. ADJUSTMENT WITH DEBTORS 221 Adjustment Means Cooperation Californians will all remember the failure of the melon growers industry in the early days, and how by co- operation they were able, through the Melon Growers Association, to raise melons and ship them with profit instead of having only red ink returns. You may have heard also of the Orange and Lemon Growers Associa- tions. Now, what these various associations are to those particular industries, the Adjustment Bureau is to the credit man. The Adjustment Bureau is simply coopera- tion among creditors or credit men. The Los Angeles Wholesalers Board of Trade is only the machinery by which the wishes of creditors are carried out. Coopera- tion among creditors is our work, and should be the work of every merchant. If you remember this, you will more nearly realize what the National Association of Credit Men is trying to accomplish by having adjustment bureaus connected with its local branches in all the large cities. Cooperation Pays Generally speaking, bankruptcy cases cost about 10 to 20 per cent of your claims. If you have a claim against a bankrupt of some thousands of dollars, and you receive, we will say, 30 cents on the dollar, in bankruptcy, it is safe to conclude that in the majority of cases you would have received 40 to 45 per cent had the claims been administered by some assignee, some creditor appointed for the parties, a creditors' committee, or an adjustment bureau. We had a case some years ago where in bankruptcy we could not hope to realize more than 60 cents on the dollar, and this particular debtor was extremely anxious to go into bankruptcy. Some of his larger creditors labored with him for three days or more, trying to get him 222 MERCANTILE CREDITS to accept an extension rather than go into bankruptcy. At last they succeeded, and, putting an efficiency manager in charge, with the debtor working under his direction on a salary, they continued doing business; and paid 100 cents on the dollar. When the debtor had completed his payments, he made a statement to the mercantile agencies which showed that he had some $6,000 greater surplus than the surplus he showed on paper when he made the assignment. This is one instance. There are others that have worked out differently, but many cases can be made to pay out the same way. CHAPTER XII BANKRUPTCY BY W. T. CRAIG History of the Bankruptcy Law Among modern nations, the English have the most perfect system of bankruptcy law, and our system is borrowed largely from theirs. The English system dates from the time of Henry VIII. In those days the mer- chant sent out his ships, simply praying that they might reach their destination and return safely. If either or both of these things failed to happen, he was very likely unable to meet his obligations to his creditors and be- came a bankrupt. His creditors, however, did not have much consideration for him on account of his misfortunes. The laws did not provide that he should have the right to petition himself into bankruptcy and be relieved of his debts; they simply provided that, under those circum- stances, his creditors might throw him into bankruptcy and divide what he had. He had to pay the balance as best he could, and, if he did not pay it, he went to jail. That conception of bankruptcy continued down to a comparatively recent time. Only during the last century has the modern idea arisen that the bankruptcy law is as much for the benefit of the debtor as the creditor. Its purpose is not only to distribute the bankrupt's assets pro rata among the creditors, but to take from a man the load of debt which makes him a drone, and allow him again to enter society, and possibly retrieve his fortunes. 223 224 MERCANTILE CREDITS Moral Obligations of Bankrupts The idea that bankruptcy relieves a man of his debts is, unfortunately, an idea commonly entertained even by bankrupts themselves. It does not; but, like the statute of limitations, it relieves him of the possibility of a credi- tor's collecting the debt, although we do not regard a man who will not pay a debt because it is outlawed, as a man of high moral character. The moral obligation to pay debts exists just the same after a man has been discharged in bankruptcy as before ; and I am glad to say that many a man does pay his debts, even after he has been so dis- charged. Such a man is thereafter established in the community as entitled to credit above men of equal finan- cial standing; for the question of integrity is perhaps more worthy of consideration by a credit man than the question of financial standing. The increasing weight given to integrity in credit considerations is significant. Bankruptcy Law Definitely Established There is always a certain agitation for the repeal of the national bankruptcy act; and not long ago there was a debate between two universities in which the question of the evening was: "Resolved, that the bankruptcy law should be repealed." But I do not believe it is a very vital question any more. I will not assert that whatever is, is right; but it is safe to say that when a great majority of men definitely agree upon one thing, the dissenters are wrong; and practically every civilized nation in the world, except China, has a bankruptcy statute. In 1900 Japan passed a bankruptcy law which provides that a man must pay his debts, and, if he does not, his creditors may take all that the family has; and, if that is not enough, then the law provides that he shall not be allowed to vote any more. BANKRUPTCY 225 Voluntary and Involuntary Bankruptcy Bankruptcy is of two kinds, voluntary and involun- tary. Voluntary bankruptcy is open to any one. A debtor, whether he owes one dollar or a million dollars, may file a petition in the United States District Court to be declared a bankrupt; and he will be accommodated. All classes of corporations except four may go into volun- tary bankruptcy. The four are banking, insurance, rail- way, and municipal corporations; they may neither go into bankruptcy voluntarily, nor be forced into it. All other corporations may come under the bankrupt law by either method. The four classes of corporations that I have named may not be thrown into bankruptcy for good reasons. The banking corporations are usually governed by bank- ing laws which do not permit bankruptcy. The state law governs the state bank, and the national law governs the national bank. It would, of course, be obviously improper to throw a municipal corporation into bank- ruptcy; and the railways are of such interstate importance that it would not be expedient to allow them to be thrown into bankruptcy. The same reasoning applies to insurance corporations. Before you can throw a person into involuntary bank- ruptcy many conditions must be met, and a credit man in giving credit either to a corporation or to an individual, must take into account the fact that if the debt is not paid, he may have considerable difficulty in getting that corporation or person into bankruptcy so that he may get his share of the assets. For instance, no wage earner, and no person engaged chiefly in the tillage of the soil, can be thrown into bankruptcy at all. A wage earner is defined as a person who works for wages, salary, or hire for a compensation of not more than $1,500 a year. A 226 MERCANTILE CREDITS man, therefore, who earns a salary of $150 a month, would not be considered a wage earner. A person en- gaged chiefly in the tillage of the soil is, of course, a farmer. Preliminaries to Bankruptcy Proceedings Before any one can be thrown into bankruptcy, it must be alleged and proved that he has debts to the amount of at least $1,000, so that a person who owes less than $ 1,000 cannot be forced into bankruptcy, though he may be a voluntary bankrupt. And before a person may be thrown into bankruptcy, he must be insolvent. Now, the definition of insolvency, under the bank- ruptcy statute, is peculiar, and has great significance to credit men. A person is insolvent within the meaning of the bankruptcy law when the aggregate of his property, exclusive of any property that he has conveyed, trans- ferred, concealed, or removed, or permitted to be con- cealed or removed, with intent to hinder, delay, or de- fraud his creditors, is not, at a fair valuation, sufficient in amount to pay his debts. This is an innocent looking definition, but it frequently deters the credit man from getting his debtor into bank- ruptcy. A person whose entire property, at a fair valua- tion, exceeds his debts, cannot be thrown into bankruptcy. In the state of California, a man may have a homestead worth $5,000, which is exempt; he may have household furniture, which is also exempt, and there are many other exemptions. He is entitled to have all of this exempt property valued as a part of his assets if he defends a petition in bankruptcy. He may owe $2,000 or $3,000, and it may equal his entire merchandise or business assets ; but you cannot throw nim into bankruptcy, because this indebtedness is offset by the value of his home, his furni- BANKRUPTCY 227 ture, and other exempt property. This is something that credit men must always consider before granting credit. Furthermore, the debtor must be a resident of the judicial district in which the bankruptcy petition is filed, for the greater part of six months, which means more than three months. "Acts of Bankruptcy" Let us suppose that all these conditions exist. It is then further necessary that the debtor have committed what is called in the statute as "an act of bankruptcy." He must have done certain things, in addition to being actually insolvent. I know men who are absolutely bank- rupt; they owe debts of large amounts; and yet they can- not be thrown into bankruptcy, because they have not done one of those things called "an act of bankruptcy" by the statute. Those acts of bankruptcy are five in number and are as follows : First. Having conveyed, transferred, concealed, or removed, or permitted to be concealed or removed, any part of his property with intent to hinder, delay, or de- fraud his creditors or any of them. Second. Having transferred, while insolvent, any portion of his property to one or more of his creditors with intent to prefer such creditors over his other creditors. Third. Having suffered or permitted, while insol- vent, any creditor to obtain a preference through legal proceedings, and not having, at least five days before a sale or final disposition of any property affected by such preference, vacated or discharged such preference. Fourth. Having made a general assignment for the benefit of his creditors, or, being insolvent, having ap- plied for a receiver or trustee for his property, or where, 228 MERCANTILE CREDITS because of insolvency, a receiver or trustee has been put in charge of his property under the laws of a state, of a territory, or of the United States. Fifth. Has admitted in writing his inability to pay his debts and his willingness to be adjudged a bankrupt on that ground. In short, a bankrupt must have transferred some of his property to a favored creditor, or concealed it, or have been sued and a judgment obtained against him, and his property be about to be sold under execution; or he must have made an assignment for the benefit of his credi- tors, or admitted in writing his inability to pay his debts, and given his written consent to be adjudged a bankrupt on that ground. If he has not done one of these things, no one can throw him into bankruptcy. To meet this condition, it is frequently necessary to create an act of bankruptcy. For this purpose certain creditors will sometimes bring suit, obtain a judgment, and levy an execution, and then other creditors use the condi- tion so created as ground for throwing the debtor into bankruptcy. You can see that, if the bankrupt is attempt- ing to pay favored creditors, or endeavoring to keep out of bankruptcy in order that certain of his acts may not be inquired into, he is going to be very careful that one of those "acts of bankruptcy" cannot be successfully alleged against him. The Bankruptcy Law The national bankruptcy law, I believe, is going to be a part of the commercial organization of the nation. The present statute will probably be amended to suit changing conditions, as has been repeatedly the case in England, and the statute is likely to be more and more considered in commercial transactions, because the giving of credit is BANKRUPTCY 229 going to be placed upon a more scientific basis. The Na- tional Association of Credit Men is seeking to accomplish this object. It is opposed to the repeal of the statute, which it considers a necessary adjunct to the perfecting of the science of credit. Delays in Bankruptcy Proceedings The prejudice against the bankruptcy law that is, the earlier laws was caused by the enormous expense and delay attendant upon the execution of the law, and it must be admitted that under the law of 1867, which was repealed in 1878, the expenses and delays were certainly inexcusable. But no such conditions exist under the present statute ; and, if there is any reason to believe that in any given case things are mismanaged, it is the fault of the credit men, because the credit men now rule. Expense of Bankruptcy Proceedings Nor is the expense of bankruptcy great. The fees provided by the statute are very small. Take, for in- stance, the trustee the man who is elected by the credi- tors to take over the assets of the bankrupt and to con- vert them into money and distribute them. Upon him rests the administration of the entire estate; and, no mat- ter what he may have done, or what time he may have given to its administration, his fees are fixed by the law it- self; and you will admit that they are very small indeed: 6 per cent on the first $500; 4 per cent from that to $1,500; 2 per cent from $1,500 to $10,000, and I per cent on all above $10,000. Where the business of a bankrupt is conducted by the trustee, these fees may be doubled. Now, because this compensation is so small, there is very little opposition to the election of a trustee in the bankruptcy courts. It is only in very large cases that 230 MERCANTILE CREDITS any one wants the office at all. The contest for the elec- tion of trustee, if there is any contest in an ordinary case, does not originate in the fact that some one wants to be trustee to get the fees, but in the fact that there are various classes of creditors who desire to control the estate. There may be a receiver in the case ; and the law pro- vides that the receiver's fees must not exceed those allowed to the trustee. In addition to that, the referee is paid i per cent on whatever dividends are paid, and twenty-five cents for each claim filed; and there is a filing fee of $30, $15 of which goes to the referee in bank- ruptcy, $10 to the clerk, and $5 to the trustee. There is, in addition, an attorney's fee allowed to the petitioning creditors, to the receiver, to the trustee, and to the bank- rupt. These fees, however, are so small that the ordi- nary bankruptcy estate is not attractive to the attorney. Advantages of Voluntary Assignment It is true, as explained in a previous discussion, that the expense attendant upon a voluntary assignment for the benefit of creditors is less than the expense of a bank- ruptcy proceeding. There are many reasons for this. It is not that the fees are less, but the creditors under a voluntary assignment may do many things that cannot be done under bankruptcy. For instance, they may take their own time about winding up the estate ; they may conduct the business as they see fit; they may wait and dispose of the goods in a favorable market. Another reason is that bankrupt sales are notoriously sales at a discount, and therefore it may be expected that assets that are sold in bankruptcy will produce less than those sold under an assignment. As a matter of fact, a man who makes an assignment for the benefit of credi- BANKRUPTCY 231 tors will usually omit his family claims and will try to do what he can to save himself from the stain of bankruptcy; whereas, if he goes into bankruptcy, every claim that exists against him is inevitably filed in the bankruptcy court But there are some cases where the credit man should insist on bankruptcy. If the man is dishonest, the credi- tors should not give him a release under an assignment for the benefit of creditors. It is wrong to the honest man to give a dishonest man a receipt in full, and allow him to go and benefit by his dishonesty. It is right under such circumstances that he should be put into the bankruptcy courts; and, moreover, the bankruptcy courts are fre- quently the only place where you can prove his dishonesty. Examinations in Bankruptcy The bankruptcy court is perhaps the only court in which it is permitted to examine a wife against her hus- band, or a husband against his wife. In state courts you cannot summon a wife to testify against her husband, or a husband to testify against his wife, any more than you can subpoena an attorney at law to testify against his own client as to communications between them. But it is not so in bankruptcy. Also in bankruptcy any man may be called before the court to testify in relation to the affairs of the bankrupt, and particularly in relation to his property, and hearsay evidence is admissible. This gives an excellent oppor- tunity for "fishing excursions." If a man on the street has said that he heard that Tom Jones said that John Brown had smuggled away some goods, you can call Jones and ask him if he said that, and if he says, "Yes," you ask him, "Who told you?" "Well, it was Smith." Then you may call the other fellow and bring them all in, and 232 MERCANTILE CREDITS after a while you run the rumor to cover, and discover either that it is a mere rumor or that it amounts to some- thing, in which latter case you have some clue that may lead to the discovery of the hidden goods. Grasping Creditors There are other reasons why bankruptcy is sometimes necessary. Perhaps an honest man cannot otherwise ob- tain the release to which he is entitled. I have known many cases where the creditors as a whole did not wish to throw the debtor into bankruptcy, but some one creditor believed that, by refusing to agree to an amicable adjust- ment, he would force the other creditors to pay him one hundred cents on the dollar, to get him out of the way. He figures that his claim is small, while the aggregate of the other creditors' claims is large; and to put the debtor into bankruptcy would mean a loss to them of more than his whole claim; and so he will not come into the settle- ment. We meet with such people every day. Of course, if such men find out that you will not be coerced into pay- ing them out, they will not cause much trouble. But some- times the creditors, in their eagerness to save from bank- ruptcy some man who does not deserve that punishment, or to save themselves the serious loss which a failure en- tails, mistakenly pay such a claim just to get it settled, and the successful bluffer tells another, "I held them up; they paid me in full," and the result is that a regular crop of those fellows comes along. Composition Now, bankruptcy will compel each person to take what is offered. You know we have such a thing as com- position in bankruptcy. A man who goes into bankruptcy does not necessarily have all his property sold out. He BANKRUPTCY 233 may go into bankruptcy and propose an honest composi- tion, and, if the majority in number and amount of credi- tors petition the court to allow it, the court will decree that he is entitled to it. Whatever the settlement may be, the balance of the creditors are bound by it; and so the honest man gets his due. Adjustment Bureaus The credit man has found that the bankruptcy statute is almost a necessity to him. He must either have bank- ruptcy or an association where voluntary assignments can be taken care of. In Los Angeles and on the Pacific Coast generally, the boards of trade are very well organized, and most insolvent debtors make assignments for the benefit of creditors through adjustment bureaus; but in the Eastern states these boards of trade did not formerly exist. The National Association of Credit Men is organ- izing adjustment bureaus in all our great cities, but in the East it is uphill work and the adjustment bureaus are not as strong there as they are here. In some of the large Eastern cities nearly every one who fails finally gets into the bankruptcy courts. Electing the Trustee The most important thing about a bankruptcy estate is to see that the proper trustee is elected. I remember the case of a Chicago man who was denouncing the bank- ruptcy statute, and when we asked him why, told us about a claim of his for $2,000 against a man in Sioux City, which he had placed in the hands of lawyers there. He could not get any satisfaction out of his lawyers, and finally went himself from Chicago, and when he reached Sioux City found that the lawyers who represented him also represented about $20,000 of claims belonging to 234 MERCANTILE CREDITS the bankrupt's mother, father, sisters, and brothers. His own claim, added to these, had helped to elect the trustee, who was a brother of one of the attorneys. The Chicago man investigated the whole matter per- sonally and came to the conclusion that all those family claims should have been thrown out. Because this was not done he was denouncing the whole bankruptcy law, but the trouble was with the trustee. Now, if the credi- tors, or the credit men, would see to it that their claims were properly voted in bankruptcy for a proper trustee, the bankruptcy statute would not, I think, be in such dis- favor. The Referee Perhaps it may be well to explain the difference be- tween the referee and the trustee. The referee in bank- ruptcy is practically the court. The bankruptcy statute used two phrases "the judge," and "the court." The word "judge" is used a few times in the statute, but gen- erally the word "court" is used. Now, as a practical proposition, the court is the referee. The judge is the United States district judge, who, in bankruptcy proceed- ings in this district, does nothing except adjudicate and refer the matter to a referee and act as an Appellate Court. The judge, immediately upon the adjudication, refers it by order of reference to a "Referee," who then becomes the court, and all proceedings in the bankruptcy case take place before the referee, acting as a judge. The Trustee Represents the Creditors The trustee is the party elected by the creditors them- selves to take charge of the property of the bankrupt, and the court has nothing to do with this election. That is why credit men are responsible for maladministration in bankruptcy matters where it does occur. BANKRUPTCY 235 The referee calls a meeting after a bankruptcy adju- dication, and sends notice to every creditor that at a cer- tain time and place there will be elected a trustee. The creditors come together accordingly, and nominate Mr. Jones or Mr. Smith for trustee. The court has nothing to do with it except to approve their choice. The trustee qualifies by filing a bond, and he becomes thereby invested with the title to all property of the bankrupt throughout the United States of America. Responsibility of the Creditor Credit men often simply file their claims in the bank- ruptcy courts, and then forget all about them until they receive a check for a dividend; and when it is a small dividend, they denounce the bankruptcy law. They ought to realize that they must give some of their time to the administration of the statute. Formerly they gave a great deal of time to the collection of their bad accounts; for it was a case of first come, first served. The man who levied the first attachment on a debtor's business was paid in full, and the man who came along last got nothing. In those days the credit man led a strenuous life. Nowadays he gives more time to the granting of credit and less to the collection of debts, because he knows that in case of bankruptcy he will get his share of what there is. But he must realize that there is a certain personal responsibility resting on him for the proper administration of the bank- ruptcy law. Preferences Everything in the administration of the estate de- pends upon the trustee. He has every right and every obligation that the bankrupt has; and he also has rights that the bankrupt has not. For instance, a voluntary pay- 236 MERCANTILE CREDITS ment by a bankrupt to a favored creditor may be per- fectly good as between the bankrupt and that creditor; but, under certain circumstances, it is absolutely unfair to the other creditors, and the trustee has to consider not only the rights of the bankrupt, but the rights of creditors, and must recover any unlawful preferential payments. To recover unlawful preferences it is necessary to throw the debtor into bankruptcy. The ratable distribu- tion of the assets among the creditors is, in fact, one of the prime objects of the law. Now, you cannot recover every preference that has been given, but only payments that have been made within four months of the bank- ruptcy, and then only under certain conditions. The per- son receiving the payment must have had reasonable cause to believe that the debtor was insolvent at the time he made the payment. That is not hard to prove, because a person cannot shut his eyes when he receives a payment and simply say, "I won't investigate, for I don't want to know anything about the man's condition." Nearly all credit men get caught at one time or another in that way. They think, "Well, if I don't make any investiga- tion of this thing, they cannot say I had any reasonable cause to believe the man was insolvent." It has been said that it would constitute reasonable ground for belief that a usually well dressed fellow were insolvent if he were met in shabby attire. If after this you should receive a payment from him, it might be held an unlawful preference on the ground that you had rea- sonable cause to believe the man was insolvent. In other words, it is your duty, when anything occurs to cause you to take notice, to investigate and find the complete facts. I recall the case of a wholesale merchant to whom an- other wholesale merchant was in debt. One day he went down to the debtor's place and found no one there but BANKRUPTCY 237 the clerk. The store contained some potatoes, a pair of scales, the ordinary office furniture, and so on. The creditor asked the clerk where the proprietor was, and the answer came, "He's been gone about three days, and I'm wondering where I'm going to get my pay for my work here." "Well, when do you expect him back?" "I don't know." "Are you selling as usual?" "Yes." "How much will you take for that scale?" "I think it's worth $10." "All right." The creditor bought nearly everything in the store and moved it across the street to his own store. When the other creditors came to investigate they found an empty store and they threw the debtor into bank- ruptcy. The trustee then demanded the return of the hundred and fifty dollars' worth of stuff that the whole- sale merchant had taken out, and the creditor who had bought the stuff came up to court and said, "Mr. So-and- so might have been a millionaire, for all I knew. I hadn't any knowledge or notice that he was insolvent. I simply went down and bought that stuff and credited it on my bill." "But," the court said, "you're a produce man; you are not selling scales, counters, and desks, are you?" "No." "Then what did you buy those things for? You bought them because you wanted your bill paid?" "Yes." "Why did you want the bill paid so badly as that?" "Well, I didn't know when that fellow was com- ing back." "Exactly. Well, he didn't come back," said the Court. "And so you will have to give the goods back." The worst part of it was, that in the meantime the creditor had sold the stuff to a second-hand man for about $40; and when he offered the trustee the $40, the trustee said, "No, I want the value that you took it at; the amount you paid for it." "Well, it wasn't worth that." "Then 238 MERCANTILE CREDITS why were you buying it?" He answered, "I won't pay the valuation." But the trustee sued him and he had to pay it. Now, that is an illustration of the fact that anything unfavorable you may hear about a man's financial condi- tion puts you upon notice that that man may be insolvent. If, in your credit business, you find that a man has bill collectors after him ; if you go into his store and see three or four other merchants around there after money; then you have reasonable cause to believe that man is insol- vent, and, if you take money from him to the prejudice of his other customers and he is insolvent, you will have to account for it, because, if investigation would have shown insolvency, you are supposed to have made the investigation. Preferred Claims Of course, there are certain debts that are properly preferred. Not every payment constitutes a preference for which you can throw a debtor into bankruptcy. All labor is given priority to the extent of $300 if earned within three months before the filing of the petition, and there are other things entitled to priority, such as taxes, costs of preserving the estate, costs of administration, filing fees, and claims for debts all of which are given priority under the laws of the state. Liens made more than four months prior to the filing of the petition, liens given for a present valuable consideration, and payments made without the parties having any reasonable cause to believe that the second party was insolvent at the time, are also entitled to preference. In other words, not every payment made within four months is void. For instance, where there is a present consideration, as when a man delivers goods and receives his payment for them, such BANKRUPTCY 239 payment does not constitute a preference. Or, if a credi- tor has a claim against a bankrupt, and receives a pay- ment, and after receiving that payment, although he may know that the man is insolvent, gives him further credit to the extent of the payment received, the courts will allow that payment to stand. Such a transaction, if in good faith, does not injure the other creditors. Discharge in Bankruptcy I come finally to the question of discharge in bank- ruptcy. Courts favor discharges in bankruptcy for the same reason that they favor a ratable distribution of assets. If you are in court seeking to set aside a prefer- ence, seeking to recover something that a creditor has obtained within four months, or seeking to throw a man into bankruptcy, and the court sees that what you are seeking is equitable and that, if it is denied, some one is going to be injured, you are two-thirds through with your case. My own personal experience has been of this nature, and when I go into court I know that I have the advantage of the man opposed to me, because I repre- sent creditors entitled to redress, and the law favors the ratable distribution of assets. On the other hand, the law also favors the discharge of a bankrupt, and it is almost impossible in this jurisdic- tion to have this discharge denied. It must be an abso- lutely sure case. There must almost be proof sufficient to convict in a criminal action in order to justify the court in denying a discharge in bankruptcy. I have had some of these cases but not many. Knowing the reluctance of the court to deny such discharges, I have been compelled in a great number of cases to advise creditors not to op- pose the discharge, because it would be decided against them. 2 4 o MERCANTILE CREDITS Grounds for Denying Discharge The statute, however, provides many grounds for denying the discharge. For instance, it may be denied if the bankrupt has committed an offense punishable by im- prisonment as provided by the Act; that is, if he has, be- fore or after his discharge, knowingly and fraudulently concealed from the trustee any property belonging to the estate in bankruptcy, or has made false oath or account in relation to any proceeding in bankruptcy. You see this is very restricted. Either the bankrupt must have concealed his property, or some of it, or he must have lied somewhere along in the bankruptcy pro- ceeding; otherwise you cannot prove that he has com- mitted an act punishable by imprisonment. Now, this does not mean that a prosecution must follow, or that the evidence must be sufficient to bring about his conviction by a jury; but you must prove with reasonable certainty that he has committed perjury or concealed his property. Destroying Records But there are other reasons for denying a man a dis- charge in bankruptcy that credit men should, perhaps, pay more attention to. A discharge may be denied when the bankrupt, with intent to conceal his financial condition, has destroyed, concealed, or failed to keep, books of account or records from which such condition might be ascertained. This is not so unusual as might be supposed. In one case, the day before he went into bankruptcy, an insolvent debtor destroyed all the books and papers from which his financial condition might be ascertained, except his ledger. That was a very unfortunate thing for him to do. He claimed that he did it honestly; that he did not know it was forbidden by the statute; that he did not think those records were of any importance because they were BANKRUPTCY 241 only his sales slips, check books, and old checks, which were ancient history; and that the ledger showed his true financial condition. But, unfortunately for him, his credi- tors considered those records very necessary to show what had become of a great many thousands of dollars of his assets. False Statements A discharge may also be denied when it can be shown that the bankrupt has obtained money or property on credit from any person upon a materially false statement in writing made to such person or his representative for the purpose of obtaining such credit. This is the "false statement in writing" provision; and the time will come when no credit man will give credit without a statement in writing, any more than a bank would give you a loan today without such a statement. When that time comes, there will be fewer discharges in bankruptcy. The state of California has just passed the "False Statement in Writing Bill" for which the Credit Men's Association has so long been fighting. This provides that any false state- ment in writing hereafter made by any person in Cali- fornia for the purpose of obtaining credit, given either to the commercial agencies or to the credit man, makes the person guilty of misdemeanor. This is of great ad- vantage to the credit man, for the man who makes a false statement hereafter will not only be subject to punishment under the state law, but will be unable to obtain his dis- charge in bankruptcy. Any false statement in writing made to any creditor may be taken advantage of by any other creditor in objecting to the discharge. Concealment of Property Discharge may also be denied if, at any time subse- quent to the first day of the four months immediately pre- 242 MERCANTILE CREDITS ceding the filing of the petition, the bankrupt has trans- ferred, removed, destroyed, or concealed, or permitted to be removed, destroyed, or concealed, any of his prop- erty, with intent to hinder, delay or defraud his creditors. Discharge Within Six Years Discharge may be denied if the debtor has been granted a discharge in bankruptcy in voluntary proceed- ings within six years. In other words, a man may not obtain two discharges within six years, provided the first bankruptcy was voluntary. It is therefore important for the creditors always to have a man file a voluntary peti- tion when they can get him to do so, because it will check future activities. Contempt of Court The final ground for denying a discharge is the refusal of the bankrupt in the course of the proceedings in bank- ruptcy to obey any lawful order of, or to answer any material questions approved by, the court. In California that does not mean as much as it does in the East. It is a very frequent order of Eastern courts that a bankrupt shall produce property that he has not accounted for. Liability of Stockholders There is one thing that credit men should remember: The discharge of a corporation does not discharge the stockholders from any liability imposed upon them by the statutes. Every credit man in California, when he gives credit to a corporation, not only considers the finan- cial responsibility of the corporation, but he also con- siders the financial responsibility of the stockholders of that corporation, because, in this state, every stockholder of a corporation is liable for that proportion of its debts BANKRUPTCY 243 which his stock bears to the whole amount of the sub- scribed capital stock of the corporation. If, therefore, the corporation is of insufficient financial responsibility, and the stockholders are well known to be perfectly respon- sible financially, the credit man will immediately grant a credit based on the responsibility of the stockholders, and, as I said a moment ago, the discharge of the corporation has no effect whatever upon that liability of the stock- holders of the corporation. Fraudulent Debts Not Discharged Certain debts are not discharged at all in bankruptcy; and that is where financial statements become of so much value. A credit or property obtained by false represen- tations or under false pretenses, creates a debt that can- not be discharged in bankruptcy. Sometimes I have won- dered that the credit men do not get together on this written statement proposition and absolutely demand it. It is impossible for one individual wholesale house to demand a statement in writing before giving credit to its customers, for such a house would not have any business. If only one bank in Los Angeles demanded a written statement, and all the others gave credit without it, the bank demanding the statement would certainly lose some customers, and a wholesale house following a similar course would lose still more. It must be a general agree- ment and arrangement among all of the houses to require written statements. Now, if a false written statement is given to a house and credit is granted upon that state- ment, the debt remains forever. A man cannot be dis- charged from that obligation. Although his general dis- charge may be granted, yet that particular debt remains a debt, and, if at any time in the future the discharged bankrupt acquires property, the debt may be collected. 244 MERCANTILE CREDITS Reclamation Proceedings Another proceeding that is not used as much as it should be in California, although it is used frequently in the East, is what is known as a reclamation proceeding. If a man makes a false written statement to you, or even an oral statement that is false in any respect, and thereby obtains from you goods, those goods may be reclaimed if they can be found in his possession at the time of his failure. Not long ago a wholesale house in Los Angeles sent its salesman to Salt Lake City, and the salesman went into an establishment there supposedly worth from $75,000 to $100,000, and, after obtaining an order for two carloads of goods worth about $3,500, said to the customer, "Before shipping this, I would like to have a financial statement" The customer replied: "I have just given a financial statement to Dun and Bradstreet, and if you will examine that statement I think it will be suffi- cient." The Los Angeles house accordingly got a state- ment from either Bradstreet or Dun before shipping the goods, and that statement showed that the Salt Lake house had a net worth of about $75,000. The goods were therefore shipped; but within a week after their arrival in Salt Lake City the purchasing concern had gone bank- rupt. The Los Angeles house immediately wired a firm of attorneys in Salt Lake City, asking whether the goods were still in the possession of the bankrupt. The lawyers reported that the goods were still in the house, and imme- diately reclamation proceedings were commenced in Salt Lake City on the ground that the goods had been ob- tained under false representations as to the financial worth of the concern, and the Los Angeles concern got them back. BANKRUPTCY 245 Future of the Bankruptcy Law I have tried somewhat briefly to give you a general idea of bankruptcy proceedings. I know that the bank- ruptcy statute is one that will remain on the books, one that credit men will have to consider more and more in the granting of credit in the future, and one that will be necessary for them to study and to understand thoroughly, because no man should grant a credit without reference to that statute. CHAPTER XIII INSURANCE IN COMMERCIAL AFFAIRS BY WARREN C. KENNEDY Insurance in its different forms is steadily becoming a greater factor in the business world, as is evidenced by its enormous growth in volume and the widening field for its varied activities. It is therefore one of the important collateral duties of the credit man to obtain a proper understanding of the principles of commercial insurance. Kinds of Insurance The three great divisions of insurance are life, fire, and marine; but besides these there are scores of other forms of greater or less importance, including personal accident; health; employer's liability; public liability; steam boiler explosion, fly wheel, elevator; team liability; damage to crops by hail or fire; plate glass breakage, sprinkler leakage; defective titles; earthquake; cyclone; riot and strike damage by violence; burglary; securities in transit; luggage in transit; live stock; automobile loss from fire, theft, or in transportation; owner's liability for injury caused to person or property; loss of rent by fire or defaulting tenents; loss of leases by fire; loss of profits by fire; physicians' liability; credit indemnity. Closely related to the miscellaneous insurance lines are the departments of insurance companies dealing with bonds fidelity, contractors, bail, in legal proceedings, etc. 246 INSURANCE IN COMMERCIAL AFFAIRS 247 Injudicious Insurance As with other things necessary and useful to mankind, insurance is often misunderstood, overdone, or insuffi- ciently done. Sometimes it is placed with an irrespon- sible company or where a risk does not exist, and some- times a real hazard is left unprotected. Some of us in- sure too much and injudiciously, others not enough to protect their business from failure or their widows and orphans from poverty. Importance of Preventive Measures Insurance does not create or save wealth, it merely distributes the losses of the few upon the many. In other words, all insurance losses are in the end borne by the public. The guiding principle which should always be in evidence with any hazard, whether insurable or not in- surable, is prevention, intelligently administered : fire pre- vention, accident prevention, prevention of many perils of the sea, of accidents to employees, of casualties, of credit losses, boiler explosions, loss of land from defective titles, losses from dishonest employees. Secure competent offi- cers for your ships, careful foremen for your laborers, safe machinery for your workmen, intelligent credit men for your business, competent engineers for your boilers, reliable experts for your land titles, and men of good character for positions of trust. Life Insurance for Firms Life insurance in commercial affairs is life underwrit- ing that a man purchases to protect his business in the event of his death. This is sometimes called partnership or corporation insurance, and in an increasing number of concerns one or more partners or corporation officials are insured for the protection of the establishment. The 248 MERCANTILE CREDITS death of an important member of a business house is often a great loss, and sometimes a calamity, and this risk should receive the same consideration that any other busi- ness misfortune is entitled to, in its relative degree. If the important member of a firm is in bad health, no insurance can be had. If in good health and under sixty years of age, life insurance will often protect a valuable business, and, in turn and proportionally, the interest of the deceased partner's family therein. Business insur- ance will enable a surviving partner to pay cash to the deceased partner's family for its interest in the busi- ness, and this arrangement is sometimes contracted for in articles of partnership. The advantage here in many cases is mutual, the surviving partner being able to pur- chase the deceased partner's interest instead of having the latter's family dependent on dividends from the business without ability to assist in its responsibilities; while the family receives under this arrangement the equivalent in cash of its interest in the business, and is therefore free from dictation from the surviving partner with whom it may not be in sympathy. Business insurance policies sometimes run to very large amounts. Some individuals are now carrying from $1,000,000 to $4,000,000 of life insurance to protect their large interests. History of Life Insurance Life insurance is an outgrowth of the friendly socie- ties of three centuries ago, and these societies in turn followed certain trade and religious guilds which have had existence in European and Asiatic civilization for thousands of years. The frequent need of assistance to bury the dead prob- ably gave origin to a system of organized aid in families or localities ; and this has developed into a large plan for INSURANCE IN COMMERCIAL AFFAIRS 249 mutual contributions from the many, and thereby built up the enormous trust funds now held by life insurance com- panies with policies aggregating in the United States over twenty-six billion dollars. In 1698 the Mercers Company in London undertook to furnish annuities for the widows of clergymen; but the Amicable Society of London, founded in 1706, was the first general life assurance institution ever established. However, little was accomplished before the organiza- tion of the Equitable Life Assurance Society in 1762. This old company is still operating in London; has assets of $25,000,000, and transacts its business without payment of commission to agents. This practice permits of a small percentage of expense, but limits the usefulness of the institution to a comparatively small field as compared with the commission paying companies, for, as we all know, it is human nature for the majority of men not to insure unless actively solicited to do so. In the United States the first Freemason's Lodge was established in Boston in 1733 ; and later organized benev- olence led to a clergymen's insurance society in 1759. Numerous other enterprises of a similar nature were started before a successful and permanent life underwrit- ing company was launched. The great Mutual Life In- surance Company was established in 1842, and its success led to the formation of several important competing com- panies. Massachusetts established the first insurance de- partment in 1855, and in Elizur Wright, insurance com- missioner, found a master mind whose ability and writ- ings wrought sound principles and a scientific system out of the loose practices which had been prevalent. The laws regarding life insurance have been repeatedly revised in the interests of the policy holders so that these now have, under all circumstances, an equity in premiums paid. 250 MERCANTILE CREDITS Assessment Societies An important feature in American life insurance has been the great growth of assessment societies. Their success has been mostly with men ignorant of insurance, and attracted solely by the low cost. Unfortunately, many of these societies have been in unskilled or un- scrupulous hands, resulting in a large percentage of failures, with many families left unprotected when most in need. Probably the most successful association of this character was that which recently discontinued the taking of more risks on an assessment basis, and adopted the methods of the "old line" companies for all its new busi- ness because of the uncertainties of the assessment plan. For business or corporation insurance, assessment societies do not appear to be available. Amount of Life Insurance in the United States In 1909, life policies and certificates in the United States numbered 36,500,000, amounting to $25,175,797,- 538, while in all the rest of the world life policies in force amounted to only $8,742,509,421, showing that the United States has in force three-quarters of the life in- surance of the world. History of Marine Insurance This is the oldest and most complex form of insur- ance, and is doubtless the least understood by the ordinary purchaser. A kind of indemnity for marine losses in the form of loans was practiced by the ancient Greeks and was fully described by Demosthenes about 350 B. C. Money was advanced on a ship or cargo to be repaid with large interest if the voyage prospered, but not to be repaid at all if the ship were lost. Eight centuries later, A. D. 533, the Roman Emperor, Justinian, enacted laws regulating the rate of interest to be paid on such loans. INSURANCE IN COMMERCIAL AFFAIRS 251 Marine insurance was probably practiced in France in 1182, having evidently been adopted from a practice established in Italy. In England it was in active use in 1555, over a century before fire insurance was established; and in Queen Elizabeth's time the British Parliament de- clared it to have existed from time immemorial. Modern English and American marine insurance law is largely based on the rules and principles laid down by William Murray (Lord Mansfield), presiding justice in the Court of Kings Bench from 1756 to 1788. The con- summate ability of this masterly jurist has caused him to be regarded as the founder of modern commercial law, of which insurance law is only an important part. Nature of Marine Insurance Marine insurance is a contract by which the under- writer agrees for a premium to protect the assured against loss arising from certain perils or sea risks to which a ship or merchandise may be exposed during a specific voyage or period of time. Losses are divided into three general classes: (1) Claims for total losses. (2) Claims for general average. (3) Claims for particular average. General Average The terms general and particular average are obscure and confusing to the layman; and, on account of the end- less variety of sacrifices and accidents which occur to vessels of the merchant marine and their cargoes, even admiralty lawyers, judges, and juries find difficulty at times in determining the correct classification of losses subject to litigation. Defined briefly, general average is a loss by sacrifice. 252 MERCANTILE CREDITS Particular average is a loss by accident. Common forms of general average sacrifices, which must be voluntary, are as follows: throwing cargo overboard to save the ship; damage to the unburned cargo by water poured over it to extinguish a fire; loss or damage to ship or cargo by the voluntary stranding of the vessel for the common safety. The theory of a general average loss or sacrifice is simple enough. For instance, we will assume that you are the owner of 100 barrels of cement on a vessel in distress at sea. For the safety of the vessel and balance of cargo, all your cement is thrown overboard, and the ship and other cargo thereby saved. It is only common justice that you should be reimbursed for your loss by a pro rata con- tribution from the ship and cargo saved by the sacrifice of your cement. When a shipper holds the proper form of policy, the marine insurance company takes care of his interest by paying the contributions levied upon him for general average. Particular Average While general average represents a voluntary loss by sacrifice, particular average signifies the damage to, or partial loss of, ship or cargo by some fortuitous or un- avoidable accident, and includes every form of loss that is not a total loss or a general average sacrifice. If a ship takes fire, and water is poured into the hold to extinguish the fire, the cargo damaged by the water would be a general average loss, this being a sacrifice; but the cargo damaged by fire only would be a particular average loss, because the damage from that cause was accidental. The usual marine policy covers total and general INSURANCE IN COMMERCIAL AFFAIRS 253 average losses, and is known as the "Free of Particular Average" policy, meaning that the underwriter is not re- sponsible for particular average losses. Another policy with a necessarily higher premium rate is known as the "Particular Average" policy, and covers total, general, and particular average losses. Lloyds Closely associated with the development of the British merchant marine, and with marine insurance the world over, is Lloyds a corporation having as its particular objects, first, the writing of marine insurance; second, the protection of the interests of the members of the associa- tion; and third, the collection, publication, and diffusion of intelligence and information with respect to shipping. This association of merchants, ship owners, under- writers, and brokers had its origin in a seaman's coffee house established by an enterprising man named Edward Lloyd, first heard of in the year 1688. It was his system- atic gathering of maritime information which made his coffee house the principal meeting place for those inter- ested in merchant marine affairs, and from this beginning has grown one of the greatest organizations of the com- mercial world. Fire Insurance Fire insurance is the most familiar branch of under- writing to the merchant, manufacturer, and banker, many of whom have no dealings in marine insurance, and but little acquaintance with the life policy. While history shows that for 2,500 years efforts have been made to relieve sufferers from fire by some form of public contri- bution, fire insurance in the sense known to us, was begun in London in the year following the great fire of 1666. In 254 MERCANTILE CREDITS this conflagration, 85 per cent of the buildings of the city were destroyed, with a loss of about ten million pounds, equal, it has been estimated, to three hundred million dollars in our day. There was no insurance, and the great metropolis did not recover from the effect for a number of years. It might be well here to compare this with the San Francisco fire of 1906. The Chamber of Commerce re- port states that about 3,000 acres were burned over, con- taining 520 blocks of about 25,000 buildings, with a loss of nearly $350,000,000 and insurance approximately $235,000,000. The benefits of insurance are here clearly shown. The general ratio of insurance to the value of property destroyed was thus about 70 per cent. In 1910 there were in the United States fire insurance companies of all kinds, to the number of 624 With total assets of $580,600,192 Annual income 295,644,7 1 5 Annual expenditures 256,681,453 Risks written 36,357,713,046 Average rate $1.0822 Insurance Rates Insurance rates are necessarily based on the character of the risk. A dry cleaning establishment using benzine and gasoline constantly, located in a frame building and exposed to hazard of fire from adjoining buildings, may have a rate of six to ten per cent, and even then some com- panies will not take the risk. Non-inflammable materials, however, kept in sprinklered, fireproof buildings, not ex- posed to fire from neighboring buildings, have been in- sured at a cost of about one-tenth of one per cent. Be- tween these two extremes the rates vary directly with the conditions. INSURANCE IN COMMERCIAL AFFAIRS 255 The California Form of Policy In California since the San Francisco conflagration of 1906, the law requires that only the California form of policy be used. This is a modification of the standard form of policy of the State of New York, which became mandatory for use in that state in 1887. It was carefully prepared, and, while not a perfect instrument, it is ac- knowledged to be the best form ever generally used. Bil- lions of dollars of contracts have been written on it, and many legal decisions have established its meaning and its substantial fairness to all concerned. It is an instrument of 2,536 words, and is written in plain, non-technical language. It should not be necessary to caution business men to see that their property is properly described in the policy, yet many are lax in this respect, and local agents are fre- quently more anxious to sell a policy than to describe properly that which the insurance is intended to cover. Co-insurance A co-insurance clause is a part of all policies issued in France, Germany, and some other European countries, but is not yet general in Great Britain and the United States. Ten of our states prohibit a co-insurance clause, and many objections have been made to this form of policy, but insurance experts generally are in favor of it as being a step toward a more correct scientific rating. An able writer speaks of co-insurance as follows : "The direction in which fire insurance calls most press- ingly for improvement is the extension of the principle of co-insurance. The importance of this can be understood only by remembering that the aggregate losses of the community by fire are chiefly made up of innumerable small fires and not of sweeping conflagrations. The ex- 256 MERCANTILE CREDITS perience of every company confirms the general truth, that the number of fires in which a building is totally destroyed, or in which the loss amounts to the greater part of the property exposed under the same risk, is comparatively very small. It may be asserted with confidence that in the grand aggregate of the business, much more than three- fourths of the loss occurs in fires in which less than one- tenth of the insurable value at risk is destroyed. "In an equitable adjustment of rates, the amount in- sured, as compared with the value exposed, is a prime element; and premiums might justly form a scale highest on the smallest fractions of value and diminishing rapidly as the percentage of insurance increases. "The correct principle is, that when a proper rate for a class of risks is found, the insured may protect at this rate any percentage of such risk, and in case of fire shall be indemnified for the same percentage of his loss. "The American clause provides: 'If at the time of fire the whole amount of insurance on the property covered by this policy shall be less than 80 per cent of the actual cash value thereof, this company shall be liable only for such portion of such loss or damage as the amount in- sured by this policy shall bear to the said 80 per cent o the actual cash value of such property.' "The most serious objection to this system is the fact that a fire may promise profit to the insured. The cor- dial support of the mercantile community in the great cities and of the most intelligent state officers has been given to it." Conflagration Loss The great problem of the fire companies is the con- flagration loss. This factor must receive attention from the insurer as well. To secure proper protection he INSURANCE IN COMMERCIAL AFFAIRS 257 should select companies who from their history have established a satisfactory record for care in assuming con- flagration risks, and a good reputation for settling losses. Probably the best guide we have in that respect in fire insurance is the report of the special committee of the Chamber of Commerce of San Francisco on settlements incidental to the San Francisco fire. The National Asso- ciation of Credit Men also published a somewhat similar report, and from these we learn which companies met their losses honorably, and which took advantage of the insurer by unfair settlements. As long as the Roll of Honor Companies are avail- able to you they should receive your business. The sacri- fices these companies made in the dark days of 1906 in San Francisco should bear fruit in our support for many years to come. Employers' Liability Insurance Employers' liability and workmen's compensation in- surance is an important development of the present gen- eration, and is largely the outgrowth of the English Em- ployers' Liability Act of 1880. This was followed by a similar act passed by the Massachusetts legislature in 1887, and other states have been continually passing and amending the liability statutes ever since. The nations of Europe have gradually abandoned the principle of law that required the employee to prove negligence in order to secure damages. This old rule has for generations worked the greatest hardship to those least able to bear it. The average laboring man when seriously injured is in no position to conduct a successful suit for damages against an employer of means, of greater experience, and who probably has more able legal advisers. In the event of the death of the employee, his 2 5 8 MERCANTILE CREDITS widow and children are even more helpless. In either case the victim's needs and expenses are multiplied by hospital and surgeons' bills, and his income is ordinarily absolutely cut off. The tendency of the times is clearly to place the burden of expense for accidents upon the industry itself, first by employers' liability laws and now by workmen's compensation laws or compulsory insurance. California's first step in this direction was the adop- tion of the Roseberry liability and compensation law, which became effective on September ist, 1911, and was in force until the close of 1913. This law was optional in allowing the employer to take his choice of electing to conform to its provisions and limiting his liability accord- ing to its schedule, or assuming the liability of the old common law which has no limitation. Only a small pro- portion of the employers of the state have elected to come within the provisions of the Roseberry law, so that less than ten per cent of the working population today come under the compensation features of the act. On January ist, 1914, the Roseberry law was suc- ceeded by the Boynton Workmen's Compensation Insur- ance and Safety Act, which for the first time in California introduces compulsory compensation excepting in agri- cultural pursuits and to domestic servants for all acci- dents to employees resulting in more than two weeks' dis- ability, and this compensation must be paid by the em- ployer regardless of who is at fault. Such advanced legislation with its new and serious problems will probably result in a greater necessity than ever for insurance to cover the increased obligations of employers, making a knowledge of the accompanying insurance problems especially important. The Boynton Act was really the work of the Cali- fornia Industrial Accident Board, which body advised the INSURANCE IN COMMERCIAL AFFAIRS 259 state legislature that the rates of the employers' liability insurance companies for workmen's compensation under the Roseberry law were excessive, and the board asked the legislature to establish a state insurance fund, begin- ning with the operation of the new law, to afford em- ployers' insurance at reasonable rates. The legislators accepted the recommendation of the board, and, not- withstanding the most bitter opposition of employers' liability insurance companies, the bill was passed, includ- ing a provision for a competitive state insurance fund and a state rate-making bureau with power to name liability insurance rates, just as the railroad commission can dic- tate freight rates. The purpose of the legislature in passing this statute was to reach a great social and economic problem the third greatest cause of poverty. The four great causes of poverty are : 1 i ) Sickness. (2) Lack of employment. (3) Industrial accidents. (4) Death of the father before his children have become self-supporting. In the important work of relieving the distress of this third cause, it is the aim of the proponents of the Industrial Accident Law to place upon the consumer the cost of providing a moderate compensation to injured employees and their dependents; and it is claimed that California has the best compensation, insurance, and safety act in the world. Even though every employer should expect to add the insurance cost to the selling price of his wares, as he would in the event of an increase of freight rates, the situation which many of them confront with the new year offers an interesting problem to the student of insurance. 2 6o MERCANTILE CREDITS Public Liability Insurance Public liability insurance is a direct outgrowth of em- ployers' liability insurance and is written to protect the employer in case of accident to third parties caused by his employees. In some industries this is a considerable risk, as, for instance, with building contractors. It is not un- usual to read of serious accidents to employees of one contractor caused by the employees of another, especially in the case of persons who are working several stories below others. The same principle covers vehicle and team insurance, giving protection in the event of damage caused to third parties by runaway or collision. Steam Boiler Insurance Steam boiler insurance as conducted in this country since 1866, carries with it the very useful periodical in- spection of the boiler, on which the owner generally relies to keep him informed as to its safety; and it is a fact that manufacturers of boilers are glad to carry this insurance on boilers in their own service so that expert inspectors can be relied on to make a regular examination and re- port. In spite of this care, however, there have been re- ported in the last forty-one years 10,501 boiler explosions in the United States, Canada, and Mexico, causing 10,884 deaths and injury to 15,634 other persons. The usual policy for a single boiler is for a maximum liability of $5,000 written for three years at one per cent, or $50, for the term. While fire insurance will carry a higher rate for a hazardous risk in practice, no insurance can be had for any sum on a boiler regarded as unsafe, and an owner would surely be liable for damages on the ground of negligence for any accident following the using of a boiler condemned as unsafe by a qualified inspector. INSURANCE IN COMMERCIAL AFFAIRS 261 Personal Accident Insurance Personal accident is an important division of casualty insurance, but does not often enter into commercial affairs. I see no reason why it should not be considered a valuable form of business insurance in the same way as is life in- surance, though necessarily to a more limited extent. As business insurance, the weekly indemnities should be dropped, and the policy carried, perhaps, on the life risk only. The premium for this is only $2.50 per thousand per annum, so that a $20,000 policy would cost only $50 a year. Accident insurance was begun in England in 1849 f r insuring against the consequences of railway accidents. In 1856 all kinds of accidents were included in one policy, and premiums were based on the hazard estimated to follow one's occupation. Credit Insurance Credit insurance has never become an important gen- eral factor in business. I know of but two companies one American and one English operating in the United States, and only one of these is represented on the Pacific Coast. In the operations of these companies during about 1 7 years to 1911, they received : In premiums $36,590,727.02 And paid for losses $16,815,780.63 This is a loss ratio of 46 per cent, which is fair to in- surers if the business is properly conducted. The pre- miums of the two companies for 1910 amounted to $1,434,987.43; and losses paid during the year were $784,618.63, or nearly 55 per cent. Credit insurance does not insure a man for his total loss, as the contracts are written to insure against ab- 262 MERCANTILE CREDITS normal losses only. This is arranged by providing in the contract that a usual loss of, say y 2 of i per cent of annual sales should be borne by the insurer. This is called the "own" loss. If the loss for the following year is i per cent, the insuring company would pay the differ- ence only between the "own" loss of ^ of i per cent and the actual loss of i per cent. On sales for the year of $1,000,000.00 A i per cent loss would figure. . . 10,000.00 An "Own" loss of ^ of i per cent would be 5,000.00 And the insurer would recover the balance of 5,000.00 Always provided that the balance did not exceed the amount of his policy. Credit insurance has not yet established a firm hold on business, as its average losses paid of less than $1,000,000 a year would prove. The capital invested is not large, and on the Pacific Coast there appears to be no competi- tion, doubtless owing to the difficulty of introducing the business. The credit losses reported by the mercantile agencies run over $150,000,000 a year, yet these insur- ance companies do not cover i per cent of the reported losses. There is merit in the theory; but the practice is difficult to work out. How to Insure The problem of concentrated and scattered risks is often confronted. Many wealthy concerns with suffi- ciently scattered risks carry the hazard themselves with- out insurance. This is thoroughly businesslike when the losses cannot be severe, and the risks are unquestionably small and scattered. Many houses insure their concen- INSURANCE IN COMMERCIAL AFFAIRS 263 trated risks and assume their several scattered risks. A mill may be insured to a large amount; but its separated buildings for offices, power house, stables, garage, store- houses and shops, may properly bear no insurance if no great value is at risk in each, and they are safely pro- tected from a general fire. Every concern carries some risks; for no one would take policies to protect from every possible danger. The important question is as to the most businesslike method to pursue. The necessity for carrying substantial insur- ance on our larger risks is usually imperative, but the wealthier the concern becomes and the more distributed its hazards, the more it can afford to carry its own insur- ance. This applies in practically every line. If a wealthy concern has several men who may be competent to manage it, the house may not need business life insurance. If several trained men are not available, life insurance should be considered. The cost of employers' liability insurance to a large employer will frequently justify him in using the same amount of money to make his own settlements with his men; whereas to a small company the amount at risk might be too great. Some of the great steamship companies are themselves carrying a large proportion of the marine risk, as their many ships are widely scattered. This was true with the owners of the Titanic. Some people thoughtlessly as- sume that everything should be covered by insurance, for- getting that insurance is a considerable expense, and that, if this expense can be saved, the savings will cover many of the ordinary risks of the business. The business men who do not insure their large risks from fire are, however, happily growing more rare, and partly for the reason that they cannot secure due credit consideration unless they do. 264 MERCANTILE CREDITS Defective Policies There have been many cases of improperly written policies with wrong or defective descriptions, in which the insurance companies have assumed that the policies meant something else, and have paid the bill. In another in- stance, an acquaintance of mine conducted a business as a partnership and forgot to transfer his insurance when he incorporated. After a destructive fire, the insurance companies compromised with him for the sake of policy; but when there are large amounts involved in a conflagra- tion, do not expect the underwriters to overlook your care- lessness. It is too much to expect of human nature. The moral is to buy your insurance from insurance companies of good reputation, and to place it with agents unques- tionably competent to advise you. Finally, remember that prevention saves loss. CHAPTER XIV CORPORATIONS BY JUDGE FRANK G. FINLAYSON When so large a proportion of the business of the country is carried on under the corporate form, it is abso- lutely essential that the credit man have at least a gen- eral knowledge of the organization of the corporation, its methods of acting and carrying on its business, and more particularly of the responsibilities and liabilities of the corporation itself, and of its officers, directors, and stockholders. For this reason a discussion of the more important points of corporate organization and pro- cedure are not out of place in the present volume. Nature of the Corporation A corporation may be defined as an entity, created and recognized by law, and endowed with certain attri- butes usually inherent in an individual; as, for example, the power to conduct business, the right to commence and defend actions in law, and, most important of all, the right to maintain a continuous existence notwithstanding constant changes in its officers and membership. These, briefly, are a few of the most important characteristics of corporations. Classes of Corporations Corporations are either public or private. Public cor- porations are endowed with certain governmental powers 265 266 MERCANTILE CREDITS which they exercise in certain subdivisions or localities of the state, as cities, towns, school districts, and irrigation districts. All corporations not classed as public, are pri- vate corporations. Another way of classing corporations is to distinguish, (i) those for profit, and (2) those for some purpose other than profit. As our purpose here is to consider only private cor- porations, or, in other words, business corporations organized for profit, we shall leave out of the question public corporations, and corporations not organized for profit, such as religious, eleemosynary, educational cor- porations, etc. Incorporation Laws We will take up first the methods of incorporation. The early English custom was to create each corporation by a distinct act of Parliament, or by grant of the Crown; and such act or grant constituted its charter. Today, in practically all our states corporations are organized under general laws. In other words, there is no special legisla- tive act creating each, but a general law under which any number of corporations may be organized. Capital Stock Let us say a word, first, about capital stock. I wish to emphasize particularly the distinction between the capi- tal of a corporation capital such as any individual may own and its capital stock. Capital, as distinguished from capital stock, or share capital, consists of the property owned by the corporation, without regard to whether it was contributed by the stockholders or not. The capital stock of a corporation, on the other hand, is that sum mentioned in the articles of incorporation as the sum for which the company is capitalized, and such sum may have CORPORATIONS 267 either a potential or an actual existence. For example, when the company is organized, and before any stock is subscribed for, the capital stock has a potential existence only; but when there are subscribers for the shares of that company, the capital stock has an actual existence, whether the money is paid in or not, for the reason that those who subscribe for the stock become indebted to the corporation to the extent of their subscriptions. For example, suppose a corporation is capitalized for $100,- ooo, divided into one dollar shares, and that all the stock is subscribed, but none is paid. There is, in such case, $100,000 due the corporation that can be collected $100,000 of debts and if they are good, collectable debts, it has assets of $100,000. Rights of Stockholders We will consider now the relation of the stockholders to the corporation. The stockholders have no direct ownership in any of the property of the corporation. They simply own the shares; and these shares are per- sonal property, even though the corporation may have nothing but real property. To illustrate; let us suppose that ten men own a lot in this city worth $10,000. Each of the ten men owns an equal share, the value of which is $ 1,000. Unless all agree to sell, the land cannot be sold; none of them can be forced to sell. Of course, each one could sell his individual interest, but the land itself could not be sold unless all agreed. Now, let us suppose that those ten men organize a corporation, capitalized, we will say, for $10,000. They convey the land to the corporation, and issue to them- selves all the stock of the corporation, each taking one- tenth, and they elect a board of directors. Those owning a majority of the stock will control a majority of the 268 MERCANTILE CREDITS board. They elect, say, three directors to manage the corporation, and these directors think it best to sell the land and buy other property with the proceeds. They may do so without securing the consent of each of the ten stockholders. One individual stockholder may strongly object to this sale; but he cannot help himself. The others can sell it the corporation, rather, can sell it because the stockholder no longer owns any interest in the land itself, but simply an interest in the corporation. The property owned by the corporation is real property; but the shares of stock are regarded as personal property. What, then, is the interest of the shareholder in a corporation? First, the right to receive his proportion of such dividends as may be paid by the corporation; and, second, the right to receive his proportion of such assets of the corporation as may remain upon its dissolution, after all creditors have been paid, these assets being dis- tributed among the shareholders in proportion to their respective holdings. These are the only rights the share- holder has, except those relative to the organization of the corporation. Subscribing for Stock How does one become a shareholder? By subscrib- ing for stock. It should be noted that the word subscrip- tion has a meaning in this connection broader than its usual significance. A man subscribes for stock when he agrees to take stock, whether in writing or otherwise. He need not sign his name to any document in order to be- come a subscriber, subject to all the liabilities and entitled to all the rights of a subscriber. The word subscription is generally used, however, because one of the most com- mon methods of subscribing for stock is to sign a paper in which each person subscribes for the number of shares CORPORATIONS 269 set opposite his name. But a man subscribes for stock when, by any contract, oral or written, he agrees to take any of the shares of stock; and he thereupon becomes liable for the payment of those shares. It is not neces- sary that a certificate of stock should issue. If I say to the secretary of a corporation, "I will take ten shares of stock in your corporation," and, if the secretary has authority to sell, and accepts my offer to purchase, I be- come liable as a shareholder then and there; and the secretary, on the other hand, has made a binding agree- ment to sell it to me, though the certificate may not be issued to me for years afterward. The law provides that a certificate must be issued when the stock is paid in full, though not necessarily be- fore; in case it is issued before payment in full, it must, in California, declare that fact on its face. A certificate is simply a muniment of title. It evidences the fact that the man whose name appears thereon is the owner of the number of shares mentioned therein. But he is a share- holder whether he receives the certificate or not. Stock Transfers Having explained how an individual becomes a share- holder, the next question is, How may he transfer his stock? A shareholder may transfer his stock to another by any agreement to transfer; and, as between the parties to the agreement, the transfer is full and complete when the agreement is made. The ordinary method is for the holder of the stock the transferer to indorse his name on the back of the certificate, if he has one, and deliver it to the transferee, whereupon the latter becomes the owner of the stock, as between himself and the original owner, but not as between himself and the corporation. The corporation will still regard the person to whom it 270 MERCANTILE CREDITS sold the stock as the owner of the stock, because his name still appears on the books as the owner thereof. In other words, as to the corporation the transfer of the stock is not completed until it has been entered on the books of the corporation. To complete the transfer the transferee must go to the secretary of the corporation, present the stock certificate, and request the proper transfer of the stock it represents. If the secretary objects, he should make a formal demand which might be as follows : "Here is this stock certificate indorsed on the back, and delivered to me by the former owner thereof. I demand that you note, in your stock and transfer book, the fact that these shares have been transferred to me." He may also demand the reissue of the stock in his own name. If the secretary refuses to make the transfer on the books of the corporation, the holder of the certificate may bring a proper action in court to compel him to do so, and may hold the secretary liable for damages if he has wilfully neglected to comply with the demand. If no stock certificates have been issued, A, the origi- nal holder of the stock, may make a bill of sale to B, and thus make B the owner of the stock. That is, you under- stand, the owner as between these two, but not as between either one of them and the corporation. As between them and the corporation, A remains the owner until the trans- fer is entered on the books of the corporation. Organizing the Corporation Let us now consider for a moment the organization of the corporation and the powers of its officers. In Cali- fornia and in most of the other states where general laws exist under which companies are incorporated, a number of men entitled to incorporate a company three or more CORPORATIONS 271 in California sign their names to articles of incorpora- tion which set forth among other things : the name of the proposed corporation, the amount of its capital stock, the number of shares into which it is divided, the par value of the stock, the directors for the first year, and the pur- poses for which the company is incorporated. The sub- scribers to the articles must go before a notary and acknowledge their subscriptions to the articles of incor- poration, or acknowledge the fact that they have sub- scribed to the articles. The articles are then filed in the office of the county clerk, and a certified copy is trans- mitted to Sacramento, to be filed in the office of the Secre- tary of State, who, if the articles of incorporation are in accordance with the requirements of the statutes, files them and issues a certificate of incorporation. The articles of incorporation after filing become the charter of the corporation. The next thing, after the company has thus come into existence, is to organize. Usually the stockholders meet at a certain time and place, agree on the by-laws, and sign them. The directors, who are usually named in the articles themselves, meet immediately after the adjourn- ment of the stockholders. At this meeting some one is elected to preside, and then the board is organized by electing the officers of the company the president, the vice-president, the secretary, treasurer, etc. Powers of the Directors Let us consider for a moment the powers of the direc- tors. The board of directors (a distinction must be drawn between the directors as individuals, and the directors act- ing as a board) has sole charge of the business of the corporation and the control of its property. In other words, the management of the corporation is vested in the 272 MERCANTILE CREDITS board of directors, which is intrusted with all discre- tionary powers. Ministerial powers and duties may be delegated, but discretionary powers such as possessed by the directors may not. It is a rule of agency that an agent in whom there has been vested a discretion may not re-delegate his discretionary power. Corporations, however, must be conducted by officers, and the board may confer administrative powers upon employees and agents. Let us say that a corporation owns a piece of land, and the question of its sale is under consideration. No officer of the corporation has the right to say whether or not that land shall be sold ; that must be determined by the board of directors, which cannot dele- gate this right to the president or any other officer. We will assume, therefore, that the board meets as a board, passes a resolution to sell the land, and also re- solves that the deed shall be signed for the corporation and in its name by the president and secretary. Under that resolution the president and secretary sign the deed for and in the name of the corporation. In this case the discretionary power of determining whether the land shall be sold is exercised by the board of directors ; but the mere administrative act of signing the deed has been delegated to the president and secretary. This example illustrates the difference between the discretionary powers which are vested wholly in the board of directors and cannot be delegated, and the administrative powers which may be delegated. Nor can directors, except at a lawful meeting and as a board, transact any business on behalf of the corpora- tion, or bind the corporation by their acts, although, under certain circumstances, the corporation may be estopped from questioning the assumed authority of the directors acting individually, Other cases of individual represen- CORPORATIONS 273 tation may arise. A director, for example, while per- forming some duty on behalf of the corporation might receive notice of some fact and this notice might consti- tute notice to the corporation. But no one director, nor any number of them, can, as directors, act authoritatively on behalf of the corporation, except when sitting as a board of directors. This is a very important thing to bear in mind. Secretaries of corporations sometimes go among the absent directors, and ask them to sign their names to an agreement relating to something that a minority of the board has done, or attempted to do, at a board meeting, there not being a quorum present. Sup- pose five directors constitute a quorum. Three meet and attempt to transact business, knowing, of course, that they cannot legally do it. After the so-called board meeting has adjourned, the secretary goes around and gets the other directors to agree to what has been done. He might as well ask the policeman on the corner to agree to it, for all the legal effect the signature would have. Only when meeting as a board with a quorum present can the directors act on behalf of the corporation. Powers of the Officers Let us now consider the powers which are vested in the officers of a corporation. It is frequently thought that the president of a corporation has very extensive powers, but this is not necessarily so. He has only such powers as are vested in him by the board of directors. Of course, he may have ostensible powers greater than the powers that have been expressly delegated to him. The corporation may allow him to continue a certain line of action, or may know that he is making certain contracts, assuming the authority to do so ; they may allow others to deal with him, who suppose that he has this power. In 274 MERCANTILE CREDITS such cases, the corporation would be estopped from plead- ing his lack of power. But he actually has only such authority as the board expressly delegates to him. The General Manager An officer usually vested with great power is the gen- eral manager. As the title implies, he has the general management of the business of the corporation, and may make any contract or perform any act on behalf of the corporation, provided it be within the company's general line of business. This, of course, does not include the exercise of certain discretionary powers, as in regard to the sale of land, but even in such a case the board might delegate to him the power to sell the land under certain conditions, leaving him to decide when the conditions exist. The Cashier Another officer with considerable power is the cashier of a bank. Custom has intrusted him with the per- formance of certain duties, and the courts assume, there- fore, that certain acts, when performed by the cashier of a bank, are authorized by his superiors. The mere title of cashier implies that certain things may and will be done by him. We have here another application of the doctrine of agency relative to ostensible authority; and where such authority is apparent to the world, the principal is estopped from denying that it exists. When the directors of a bank appoint a cashier, the public takes it for granted that they have turned over to him certain functions. Directors Trustees for the Stockholders Now, a word or two upon the relation of the directors to the stockholders, to the corporation itself, and to the creditors. The directors are trustees for the stockholders, CORPORATIONS 275 and are therefore held to the exercise of the highest fidelity or, to use the Latin expression, uberrima fides in all dealings involving the rights of stockholders. On the dissolution of a corporation, the directors become trustees for the creditors of the corporation just as dur- ing its existence they are trustees for the stockholders with- all the duties and obligations that trustees generally owe to their cestui que trust. No Dividends Can be Paid Out of Capital Now, as to the inhibitions which the statutory law in California imposes upon directors of corporations and which are much the same in the other states. In the first place, our code provides that the directors must not pay dividends except from surplus profits. To make clear the meaning of this, let us suppose that a corporation is capitalized for $100,000. All of its stock has been sub- scribed, and 50 per cent has been paid up, so that $50,000 has been paid to the corporation by the holders of its shares of stock. We will suppose that the company has loaned this $50,000, at 6 per cent, and has made $3,000 at the end of the first year. It has had no expenses, has not been conducting any offices or paying salaries, so that the $3,000 is a net profit, and dividends may be paid out of that $3,000, and distributed to the shareholders. But no part of the $50,000 paid in by them can be distributed in dividends; and, if the directors do this, they are guilty of a misdemeanor, for which they may be severely punished. Limitation of Indebtedness Another inhibition peculiar to California is this: Directors must not create any debts beyond the amount of the subscription of the capital stock. Let us say a com- 276 MERCANTILE CREDITS pany is capitalized for $100,000. Half of its stock has been issued. The amount subscribed is $50,000. It may create debts up to $50,000. Beyond that the direc- tors may not go. If they do, they are personally liable for the debts. Capital Must Not be Divided Before Dissolution A third inhibition is this: The directors must not pay dividends out of any part of the capital stock, nor with- draw any part of it, nor divide any part of it except on dissolution. In other words, in the case I have just sup- posed, where $50,000 has been paid in, the company be- ing capitalized for $100,000, no part of that $50,000 can be divided among the stockholders until the day of dissolu- tion. Then, if there is anything remaining after the credi- tors have been paid, the $50,000 or what is left of it may be divided among the shareholders. Contracts with Directors I said a moment ago that the directors of a corpora- tion are trustees for the stockholders, and are therefore held to the utmost good faith. One of the results of that doctrine is that a director may not make a contract with himself. If he does, it is voidable at the instance of the corporation, or of any of the stockholders suing in behalf of the corporation. Some of the courts have held that the contract is absolutely void; others hold that it is void- able, but that it will be upheld if the contract be fair and if the director has agreed to part with a fair considera- tion. The middle ground is that it is not absolutely void, but voidable at the instance of the corporation, or of any stockholder who may bring suit on behalf of the corpora- tion, and that the corporation may void the contract or regard it as voidable, whether it be a fair contract or not CORPORATIONS 277 The court will not inquire into the fairness of the contract It will say to the director, "You must not deal with the corporation for your own benefit." Nor can a director who is personally interested in a contract in which the corporation also is interested, make up a quorum at a directors' meeting. That is, suppose that there are five directors and three constitute a quorum. One of the directors wishes to make a contract with the corporation. He can make that contract; but he cannot, as a director of the corporation, take part in the making of it. If three directors meet, of whom he is one, there is no quorum for the purpose of making such a contract. There are only two directors present. To make a quorum, another director, not interested in the contract, must be present. In other words, where there are five directors in a corporation, and three make a quorum, there must be present three who have no personal inter- est, direct or indirect, in the proposed contract. Dummy Directors Let me say a word here as to 229, 233 bank, 50-64 bank references, 30, 133 character as factor, 16, 25, 33, 59, 74, 82, 89, 90 corporation applying for, 53- 58 department methods, 14, 16, 20-49 forms. (See "Forms") fraudulent, 182 information, 17, 22-39, 73, 64- TOI, 118-135 insurance of, 44, 261 investigation, 20, 96, 103 records, 34 retail man applying for, 58 risks, 50, 73, 103 Credit Man, duties of, 8, 21, 104 importance of, 7, 21 qualifications, 8, 16, 21, 32, 74 personal calls, 15, 33, 108 sales department and, 16, 21, 109 Credit Men, cooperation among, US Creditors, 196-245 cooperation of, 206, 221 foreign, 214 meetings, 199, 201-204, 212 protection of, 209 responsibility of, in bank- ruptcy, 235-238 Customers. (See "Applicants") sharp practices of, 12, 17, 133- 135 wealthy, 112 Debtors, Insolvent, 196-222 assignments, 205, 212-214, 216, 230 attachments, 215 attorneys of, 200 bankruptcy, 217, 221, 223-245 composition settlement, 214, 219 consultation with creditors, 199, 201-204, 212 extension, 208-211, 219, 220, 222 fraudulent, 210, 216 methods of settlement, 202 protecting, 203, 209 release, 216 sale of business, 205 Deeds, in escrow, 171 trust, 170, 174-176 Deficiency Judgments, 173 Destruction of Records, by bank- rupt, 240 Directors, 54, 271-278 Discharge in Bankruptcy, 239- 243 Dividends, on assignment of debtor's business, 214 from capital, 275, 276 from premiums, 132 Dummy Directors, 277 Efficiency Experts, 203 Extension of Time to Debtors, 208-211, 219, 220, 222 False Statements, 82-86, 119, 122-124, 149, 241, 244 Foreclosure, law of, 174 Foreign Creditors, 214 Forms, Bradstreet's report, 93- 95 collection, 37, 39, 40, 42 credit information, 26, 35, 36 financial statements, 27-31, 66- 72 guaranty of payment of ac- count, 47, 48 National Credit Men's Asso- ciation statement, 68-72 property statements, 28-31, 68- 72 salesmen's reports, 22, 23, 42 Frauds, 12, 17, 126, 133-135, I57 179-195, 200, 211, 216, 240, 243 G Guaranty of Accounts, 44, 46 INDEX H Homestead Exemption, 168 I Indebtedness, limitation of, 275 Indorsement of Notes, 54 Information, Credit, 17, 22-39, 64-101, 118-135 through mercantile agency, 17, 23, 73, 87-101, 118 Insolvency, 196-245. (See also Debtors") Instalment Collections, in Insurance in Commercial Af- fairs, 80, 246-264 business, 248 co-insurance, 255 credit, 44, 261 employers' liability, 257 fire, 80, 253-257 industrial accident, 258, 259 life, 247-250 marine, 250-253 general average, 251 Lloyds, 253 particular average, 252 personal accident, 261 public liability, 260 steam boiler, 260 Inventories, 81, 208 Investigations, credit, 20, 96, 103 Investments, 192-194 Involuntary Bankruptcy, 215- 217, 225 Judgments, 166-169, 173 Labor Liens, 151, 238 Lease, fixture, 49 Ledger Accounts, 38, 43-45 Liabilities, 56, 78, 127 stockholders', 113, 242, 282-284 Liens on Personal Property, 136- 158 bankers', 153 bottomry, 140 labor, 151 priority of, 140 vendor's, 151 Liens on Real Estate, 159-178 attachments, 167, 168 judgments and, 166-169, 173 license tax as, 161 mechanics', 177, 178 mortgage, 169, 170, 172-174 tax, 160-166 vendor's, 177 Limitations, Statute of, 161 Loans, 50-64 on collateral, 60-63 Lloyds, 253 M Mechanics' Liens, 177, 178 Mercantile Agencies. (See "Agencies") Misrepresentation, 149, 184-187 Mortgages, chattel, 142-147 real estate, 169, 170, 172-174 N National Association of Credit Men, 27, 67-73, 197, 229, 233 financial statements, 67-73 National Bankruptcy Law, 228 Notes, 50-64, 77, in, 112, 172 Officers, powers of, 273, 274 Ownership and Possession, 142, 154 P Partnership, applying for credit, 53 property statement, 68-70 Personal Property. (See "Prop- erty") Pledges, 141, I47-I5I Preferred Claims, in bankruptcy, 235^239 Professional Men, applying for credit, 51 Profit and Loss Statements, 123 Promoters, 278-280 Property, Personal, 78, 136-158 Civil Code as to, 137, 143 common law as to, 138 conditional sales, 115, 141, 154- 157 fraudulent concealment of, 241 liens on, 136-158 mortgages on, 142-147 pledged, 147-151 removal of, 145, 146 rights, 136 sale and transfer of, 136, 149- I5i warehouse receipts, 153 INDEX Property, Real, 56, 78, 159-178 attachments, 167, 168, 215 deeds in escrow, 171 fraudulent sales of, 180 judgments, 166, 167, 169 liens on, 159-178 mortgages on, 169, 170, 172- 174 tax sales, 163, 164 Torrens Land Law Registry System, 169 trust deeds, 170, 174-176 Property Statements, 28-31, 67- R Real Estate. (See "Property, Real") Reclamation Proceedings, 244 Records, credit, 34 destruction of, by bankrupt, 240 of applicant for credit, 76, 121 Referee in Bankruptcy, 234 References, bank, 30, 133 outside, 25, 26 Release, of debtors, 216 Reports, agency, 17, 23, 65, 73, 91-101, 118 board of trade, 34, 120 collectors', 37, 38, 40-42 salesmen's, 22, 42, 65 Retail Man, applying for credit, 58 Rights of Possession, 155 Sale, bill of, 49 conditional, 115, 141, 154-157 of business of insolvent debtor, 205 of pledged property, 149-151 sheriff's, 167 tax, 163, 164 Sales Credit Limit, 81 Sales Department, cooperation with credit department, 14, 16, 21-24, 41, 42 Salesmen's Reports, 22, 42, 65 Second Mortgages, 173, 176 Settlement with Debtors, four types of, 202 Silence Not Misrepresentation, 187 Statements, collection, 39-41 corporation, 55-58 false, 82-86, 119, 122, 124, 149, 241, 244 financial, 21, 25, 27-31, 64-86, 190 profit and loss, 123 property, 28-31, 67-73 written, 190, 191 Stock, Capital, 266-270, 279-282 actual value, 60-63, 282 promotion, 279, 280 watered, 280 Stock on Hand, 76 Stockholders, 113, 242, 267, 282- 284 Swindling Schemes, 128-135, 149, 157, 179-195 System, aid to efficiency, 9-19 in collection department, 106 Systems, collection, 36-43, 104- 117 credit. (See "Credit") Tax, city, 164 franchise, 160 inheritance, 165 license, 161 liens, 160-166 poll, 162 preferred claim in bankruptcy, 238 sales, private, 163, 164 special, 164 titles, 163, 164 Time Limit, for payment of ac- counts, 38 Titles, tax, 163, 164 Torrens Land Law Registry System, 169 Transfers of Stock, 269 Trust Deeds, 170, 174-176 Trustees in Bankruptcy, 229, 233, u Unearned Increment, 130 Vendor, liens of, 151, 177 sales by, 157 Voluntary Bankruptcy, 225 W Written Evidence, 189 Written Statements, value of, 190, 191 AUG 4 . Oil L IS 80m- 1,' 15 UNIVERSITY OF CALIFORNIA LIBRARY