The liability of a creditor to a collection agency can be classified in two categories:
- Liability to pay commission; and
- Liability to pay compensation.
Generally, liability to pay commission and liability to pay compensation arise when a creditor assigns a collection agency to collect the amount due from debtor. A creditor must give a commission to the collection agency for the amount collected and returned to the creditor. If the creditor revokes the assignment before collection of the debt, then the collection agency will not be entitled to the commission. Thus the collection agency is to receive commission only for the amount that he/she has collected towards the debt.
A creditor can escape having to pay commission under the following circumstances:
- if the conduct of the collection agency is contrary to public policy[i]; and
- if the collection agency engages in any unlawful practice of law[ii].
Once the collection agency has started work to collect the debt, the creditor cannot remove the collection agency from performing their duty without giving compensation. A creditor is not allowed to escape from liability to compensate the collection agency by claiming that the assignment to collect the debt was imposed on a contingency basis.
In United Mercantile Agencies v. Commissioner, 34 T.C. 808 (T.C. 1960), the court observed that the collection agency is not entitled to compensation unless and until the collection agency has moved to collect the debt for a creditor. The plaintiff/corporation was engaged in the collection of delinquent accounts. Upon dissolution, the plaintiff/corporation assigned the duty of collection of debt to the shareholders. Since the plaintiff/corporation did not take any steps to collect the debt, the plaintiff /corporation had no right on the income collected by the shareholder/assignee from the delinquent accounts after assignment. The court further held that the plaintiff/corporation had not earned any commission from the assignee/shareholders and hence the plaintiff /corporation did not have a taxable income.
[i] FTC v. Check Investors, Inc., 502 F.3d 159 (3d Cir. N.J. 2007)
[ii] Ramirez v. Apex Fin. Mgmt., LLC, 567 F. Supp. 2d 1035 (N.D. Ill. 2008)