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For contingency fee based plaintiff’s attorneys, a business credit card can offer one way to partially finance certain firm expenses. However, credit cards usually have limits, and always carry penalties and fees. Virtually all credit card companies report customer payment history to the credit bureaus, so while consistently good payment performance can help improve your score, missed and late payments will have a detrimental effect.
Pros: Credit cards are fairly easy to obtain, do not require collateralization and, especially if a firm has less than perfect credit or is just starting out, they may be a good option to help ease a cash flow crunch. Other benefits to using credit cards include:
Cons: Credit Cards can cause serious damage if not treated correctly. Issues to be wary of include:
DO Finance the Right Firm Expenses with Credit Cards
It is a good idea to decide upfront what kinds of expenses should be paid on the firm’s credit card.
DON’T Finance Short-Term Expenses with Long-Term Debt
For example, the expert witness fees paid for on a credit card that contributed to a case settlement double its original valuation may justify the expense of using the credit, whereas that office coffee run may be long forgotten by everyone but the person paying off the interest on it months down the line.
DO Prepare for your ‘Business’ Credit Card to Come with a Personal Guarantee
Though most credit card programs marketed as a ‘business’ line of credit, they will almost always require a personal guarantee from the applicant. A small bank coupled with a stellar credit history is your best bet to find traction with your card application.
DON’T Assume that Personal Guarantee on that ‘Business’ Credit Card Will Entitle You to the Same Rights as Consumers
The CARD Act, passed in 2009 and effective 2010, sought to increase protections to consumers and foster accountability on the part of credit card companies. Credit issuers were required to issue notice to consumers in the event of any ‘significant changes’ to their accounts and unfair practices such as unannounced rate hikes, excessive fees, and withholding information about how charges and fees were accumulated on an account were curtailed. Unfortunately, these protections were NOT extended to businesses. A bill was introduced earlier this year (Small Business Credit Card Act of 2013) to correct this imbalance, however the benefits to business owners are undoubtedly far down the road if at all. In the meantime, law firms should be wary of the following common practices on their business credit cards:
Choosing a good issuer is key. Some organizations have voluntarily extended the same protections as consumers to their business cardholders as well. Bank of America, American Express, and Capital One have adopted some or all of the CARD Act’s policies.
DON’T Take Your Available Credit Limit For Granted
Perhaps the greatest risks to your law firm in opening a business credit card are the sudden potential roadblocks from other financing channels the account can put in your path. Banks have been known to reduce their customer’s available credit limit without prior notice or warning. Unless the spending decrease will trigger penalties, the issuer may not even give prior notice and just “close” the account. Credit card issuers can decide to change your card limit for any number of reasons, mostly as a result of unfavorable payment history or credit factors, but it can also reduce risk in the issuer’s portfolio in the event of economic red flags. A sudden drop in available credit can negatively impact your Credit Utilization Ratio (Debt/Available Credit) which can be as much as a third of how your credit score is calculated. For example, if you have $2,500 out on a credit limit of $10,000 – your utilization ratio will be 25%. If your issuer lowers your limit to $5,000, then your utilization will suddenly double to 50%.
DON’T Consider ‘Card Hopping’ A Sustainable Strategy
Many card programs offer fantastic ‘teaser’ rates to pull in new customers. Zero percent interest rates, no balance transfer fees, better reward programs can all be tempting when facing a cash flow crunch and volatility with your current card. However, at some point the availability of that next card is going to run out and your firm may be saddled with a higher interest rate than bargained for after the teaser period is up. Rapidly opening and closing accounts will also put a dent in your credit score and restrict access to other types of financing.
DO Utilize Multiple Financing Channels
While credit cards can offer wonderful benefits to
contingency fee based law firms – it’s important to balance the risks involved with other attorney financing alternatives. During the past decade – many specialty lenders including Case Funding Inc. have emerged exclusively to address the financing needs of attorneys and law firms. Their loan programs have been designed specifically for contingency fee based law firms and are an alternative to credit cards that should be considered.
How does credit card financing compare to a law firm loan from a specialty finance company like Case Funding?
Both credit cards and law firm loans will carry higher interest rates than a traditional bank loan – but are both much easier to secure for contingency fee based plaintiff’s law firms and are both commonly used by these attorneys. Credit cards are able to extend credit to law firms with a personal guarantee from the applicant and by spreading the risk across their massive membership body. Because credit card issuers are able to offer credit based on a formula, their rates, fees and limits may be very volatile if major changes occur within either a member’s account (i.e. late payments, end of ‘teaser’ periods) or within the issuer’s own aggregate risk assessment. Specialty law firm lenders are able to offer financing through an expertise in the contingency fee law firm’s greatest asset – their cases. They offer financing based on industry knowledge rather than just a formula. A law firm loan will offer more flexibility than a credit card with multiple repayment options (i.e. interest-only payments until settlement, ability to swap out pledged cases) coupled with a stable interest rate – affording the law firm a greater ability to plan for the future.
The bottom line is that while credit cards can offer a means to pay for law firm expenses, they are usually limited in size and can come with strings attached. Conversely a more traditional working capital loan or line of credit established with a reputable funding company will be available in substantially larger amounts and begin the process of building a long term borrowing relationship.
Topics: CARD Act, Credit Cards, Financing, Law Practice Management
Professional Practice Updates