Don’t Pay Twice

In the latest installment of our “Logistics and the Law” series, our legal expert focuses on the growing double-payment problem and offers a few suggestions for avoiding—or at least minimizing—the risk of this emerging phenomenon.

By Brent WM. Primus, J.D., Primus Law Office, P.A. -- Logistics Management, Feb-2010

Believe it or not, one of the most critical areas of the law relating to transportation and logistics relates to money—in particular, the payment of freight charges.

When a shipper engages a broker or when a shipper or a broker books a load with a carrier, they expect to be billed and to pay for the charges for moving the freight. What they don’t expect is to have to pay the charges twice. Unfortunately this does happen and, in the last few years, has happened with increasing frequency. This emerging issue is called “the double payment problem.”

In this installment of the ongoing series titled “Logistics and the Law,” we will focus on this double-payment problem and offer a few suggestions as to how to avoid, or at least minimize, the risk.

3 variations of the double payment problem

There are three variations of the double-payment problem. The first is that of the “going-out-of-business broker.” The problem arises when, in the last weeks or months of its business life, a broker continues to book loads, collects payment for the carrier’s charges (as well as the broker’s commission), and then fails to pay the carrier.

In this variation, there is little, if any, notice of a problem until a shipper calls a broker to find the phone disconnected or when a shipper receives an invoice from the carrier that provided the underlying transportation services.

The second variation is something we’ll call the “double-brokering carrier.” This situation arises when a load is tendered to a carrier with the understanding that the carrier will be providing the actual transportation. However, instead of providing the transportation itself, the carrier uses its broker authority and tenders the load to another carrier.

The shipper or broker who tendered the load to the original carrier pays the original carrier, but that carrier—i.e. the “double-brokering carrier”—fails to pay the actual carrier. Again, the first time the shipper or broker who tendered the load may learn of the problem is when a bill for freight charges arrives from the carrier that provided the actual transportation.

The third variation is the “fraudulent broker.” This is a relatively new phenomenon involving a criminal element in the transportation industry. The gist of this variation is that the fraudulent broker solicits loads that it then tenders to carriers with every intention of collecting from the shipper but with no intention whatsoever of paying the carrier.

Variations 1 & 2

The variation of the “going-out-of-business broker” has been around for some time. The “double-brokering carrier” is relatively new, but, based upon the calls I’ve received over the last year, is happening with increasing frequency as the sheer number of brokers increases and the economic times get tougher.

When these situations end up in Court, the judge is put between a rock and a hard place. This is because what shipper’s call the “double-payment problem” the carriers call the “no payment problem.” From the carriers’ point of view, they moved the load, bought the fuel, paid the drivers, and now deserve to be paid.

As a result of this tension, two competing legal theories have developed. The first theory is the well-established principle that under the traditional bill of lading contract the consignor has primary liability for payment of the charges on “prepaid” shipments; and if the consignor fails to pay, then the consignee must pay.

For “collect” shipments, the consignee has primary liability; and if the consignee fails to pay, then the consignor has to pay (unless it signed the no recourse provision of the bill of lading known as “Section 7”). In other words, since the consignor and the consignee both benefitted from the transportation of the goods, it is only fair that at least one of them has to pay the carrier.

However, the plot thickens when another entity is added in addition to the consignor, consignee, and carrier. Unlike the situation described in the above paragraph where a consignor or consignee has failed to pay the carrier, what happens when the consignor or consignee has fully paid an entity with the good faith assumption that the entity is either paying the carrier or is the carrier?

To address this situation, a legal principle known as “equitable estoppel” arose over the years. This principle applies in certain situations where Courts have held that it would not be fair or equitable to ask a party to pay twice.

One situation involves a “prepaid” shipment where the Courts have held that if a purchaser-consignee has paid the seller-consignor’s invoice then they should not have to pay the carrier because they have already paid for the freight charges.

Another situation is where a consignor or consignee has in good faith paid a broker. If the facts show that the broker was a true intermediary and the carrier was extending credit to the broker, the fairest result would be to have the risk of default by the broker borne by the carrier. Unfortunately for shippers, in recent years the Courts have been more sympathetic to the unpaid carrier then to the shippers.

An example of this is a case known as Oak Harbor Freight Lines, Inc. v. Sears Roebuck & Co. decided in 2008 by the Ninth Circuit Court of Appeals. In this case, Sears dealt with a particular broker for many, many years. When the broker went out of business, it turned out that the broker had not paid Oak Harbor Freight Lines $400,000 of Oak Harbor’s freight charges. The Ninth Circuit Court of Appeals held that Sears must pay twice—that is, had to pay Oak Harbor Freight Lines for the same shipments for which Sears had already paid the broker. The Ninth Circuit was not receptive to the fairness arguments advanced by Sears.

Variation 3

There is no way of knowing exactly how many “fraudulent brokers” are in existence, but now and then they do get caught. Two recent cases clearly illustrate the harm they can cause.

In 2008, a six count federal criminal indictment for computer and mail fraud was issued against Viacheslav Berkovich and Nicholas Lakes, also known as Dmitry Livshits. In 2009 they both pled guilty and were sentenced to prison. The full plea agreement indictment may be read in the on-line library at transportlawtexts.com website .

The essence of their scheme was to use various “load boards” (web-based systems for posting available loads) to accept loads as a carrier and then to act as a broker to tender the load to an actual carrier. To accomplish this they registered a multiplicity of entities as motor carriers and brokers. They also started a factoring company—a business which, in the context of the transportation industry, buys the accounts receivable of trucking companies for a discounted amount and then collects the bills from the trucking company’s customers.

In the three actual instances described in the indictment, the amount of money that the perpetrators offered to the actual carrier was approximately 20 percent higher than the amount that they had accepted the load for as a “carrier.” This is the exact opposite of how a legitimate broker operates; that is, offering the actual carrier an amount lower than the amount that the broker has agreed to accept. If nothing else, this alone demonstrates the intent of never paying the actual carrier.

The computer fraud count of the indictment arose out of the fact that the defendants hacked into U.S. Government computers. Specifically, they accessed the SAFER system and changed registration information of bona fide trucking and brokerage companies already registered to make it look like the perpetrators were somehow affiliated with the valid entities. They also substituted bogus telephone numbers and e-mail addresses belonging to the perpetrators for those of the legitimate companies.

As part of the plea agreement, the two defendants were ordered to pay 3.7 million in restitution. From this it is reasonable to surmise that shippers and brokers across the country were receiving payment demand notices from carriers for 3.7 million dollars in freight charges that they had already paid.

Published reports indicate that 1.4 million dollars was recovered by the government from the defendants; however, it has not been reported as to how much, if any, of this was paid to the victims of this fraud.

Currently pending is an indictment that was issued in August of 2009 in the U.S. District Court of Harrisburg, Pa., against three individuals alleged to be involved in a similar conspiracy. The 42 count indictment alleges that the defendants had defrauded companies out of more than one million dollars.

Solutions to double-payment

So, what should you do? In preparing this article I contacted Steve Fernlund, the executive director of the Freight Transportation Consultants Association (FTCA). As the FTCA is an organization whose members are heavily involved in freight bill auditing and payment, I was looking for advice based upon the collective wisdom of the FTCA as well as his own professional experience.

Here is what he had to say: “As you know, there’s no sure fire way to eliminate the risk. This may seem obvious, but one way is to always know who you’re doing business with. Check payment practices and credit rating agencies to make sure there is minimal risk that the carrier and/or broker will default on its obligations. Have a standard procedure to qualify carriers and brokers and follow that procedure in every transaction.”

In addition to the basics of due diligence, the proper use of contracts and contract administration can also provide protection, although not absolute, against being exposed to liability for double payment. Shippers and brokers both need to have written contracts in place with their carriers specifically requiring them to move the load themselves and not to tender it to another carrier.

However, simply writing and signing such a contract is not enough. My experiences have revealed that many carriers will sign such a contract but then simply ignore the prohibition against tendering to another carrier through their brokering authority. This means that a shipper or broker has to monitor the carrier to make sure they are complying with the terms of the contract.

One way to do this is to spot check delivery receipts to see if the carrier named as the delivering carrier is the carrier with whom you have the contract. Please bear in mind that I fully understand that this is a lot easier for me to write then it is for someone to do in practice.

When shippers are using brokers, they should have a written contract with their broker which requires, amongst other things, that the broker will have written contracts with its carriers. In turn, the broker’s contracts with its carriers need to (a) require that the carrier specifically designate the broker as its agent for collection and (b) waive any right to collect from the consignor or consignee if the broker has been paid. Again, to be effective, there needs to be a process in place to monitor compliance.

There are perhaps only two ways for a shipper to guarantee that it will not have to pay the same freight bill twice.

The first would be to adopt a procedure whereby no check would be written to a carrier unless or until there is an accurate, trustworthy delivery receipt documenting the fact that the delivering carrier was indeed the same entity as to whom the check was made payable.

However, I have been told by many people in the industry that for many reasons, not the least of which is the sheer volume of transactions involved, that it would be virtually impossible to implement such a process.

The only remaining option is for a shipper to require a surety bond for any broker with whom it does business. For example, a shipper would first determine the dollar amount involved with respect to any particular broker for a particular time period, say six months. If this number is $100,000, then a surety bond in that amount would be purchased to protect the shipper in the event of a broker default.

The difficulty with this as a practical matter is that surety bonds can be difficult to obtain, especially if the involved broker has less than perfect credit. Another problem is that most sureties (the person issuing the bond) require substantial collateral—for example, 150 percent of the face amount of the bond, which, in our example, would be $150,000. Most brokers would be either unable or unwilling to do so. Another obstacle is that there would have to be a negotiation between the shipper and the broker as to who would be responsible for payment of the bond premium.

To conclude, shippers and brokers exposure for liability for having to pay the same freight bill twice will always be with us. However, due diligence, coupled with well-drafted transportation contracts, will go a long way toward not having to pay twice.