Written By: Tom Ogg, Co-Owner – TravelProfessionalNEWS.com
The ongoing failure of companies that commingle client deposits and final payments into their operating accounts to be spent as if it were earned profits should be criminal in my opinion.
Having owned a wholesale tour company during the financially troubled years of the late 1970s and early 1980s, we operated our tour company based on the concept that we held all client deposits and final payments in trust until they were distributed to the appropriate supplier(s) as payment in full for the file. Only then, did we move the remaining profit from the trust account into our general operating account.
While this format protects the client’s funds as they should be protected by any fiduciary, companies that choose to commingle client funds into their general operating account have already made the decision to violate their fiduciary responsibility in hopes of using the funds to grow their business.
The Client Deposit and Final Payment Ponzi Scheme
Here is how a Ponzi Scheme is defined by Wikipedia. “A Ponzi scheme is a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors. The scheme leads victims to believe that profits are coming from legitimate business activity (e.g. product sales and/or successful investments), and they remain unaware that other investors are the source of funds. A Ponzi scheme can maintain the illusion of a sustainable business, as long as new investors contribute new funds, and as long as most of the investors do not demand full repayment and still believe in the non-existent assets they are purported to own.”
Imagine if you were buying a new home and you sent your deposit to a fiduciary who then decided to use the money to buy a brand new automobile. They may think “Well, I should get more deposits down the road that I can use to fund the settlement of the transaction.” You can see how corrupt this kind of thinking can be.
Travel suppliers who commingle client deposits and final payments into their general operating account and then use the money for general business expenses such as advertising, salaries, technology and so forth are not spending their own profits, but client’s funds that is not theirs to spend.
When Do Client Funds Become Supplier Profit?
A travel reservation file may contain several components that make up the raw costing. A typical Hawaii file may consist of airfare, transfers, car rental, sightseeing, hotel and resort reservations and other components. The tour operator acts as an aggregator for all of these components and generally collects a deposit upon confirmation and then a final payment a month or more before departure. These funds include the cost of the components in the reservation, the travel agent’s commission and the profit from the file when liquidated. The reservation costing is unique to the file and the costs are known to the penny.
Unfortunately, most supplier to component agreements do not require prepayment for services prior to the client’s usage of the components. As an example, a tour company may be on an open account with a property who then bills the tour operator on a monthly basis based on voucher lift at the property. It is not uncommon for a tour company to delay paying for as long as possible to have the use of the funds.
The simple answer to the question of when client funds become profits is “When each component has been paid in full for the client’s reservation”
The complex answer would be “When the balance of client deposits and final payments equals the non-liquidated components of a file.”
Here are some examples of recent travel bankruptcies where consumers lost their deposits and final payments.
2019, Thomas Cook
Thomas Cook stranded over 600,000 customers around the world and owed over $800,000,000 in customer deposits and final payments along with general debt exceeding $11 Billion.
Had 24.3 Billion in debt
2020, Latam Airlines
$17.96 Billion in debt
2020, Thai Airways
$10 Billion in debt.
$7.85 Billion in debt.
2020, Norwegian Air
$7.34 Billion in debt.
$7.27 Billion in debts
$4,760,000 in client funds never refunded.
While this is just a look at a few of the larger and more shocking bankruptcies, in practically every case client funds had been commingled into the general operating account long before they were earned. And, the CEOs, CFOs and upper management knew that they were spending money that was not theirs.
In each case the erosion of client funds goes beyond simple mismanagement and incompetence and falls into a classic ponzi scheme where today’s clients are funding yesterday’s clients.
How to Recognize a Supplier Commingling Client Funds
While many times it is extremely difficult to recognize suppliers that are having financial trauma, a close look at one of the industries most dramatic failures shines a light on behavior that may indicate problems exist.
The Hawaii Express was a low fare airline that started service between LAX and HNL in the early 1980s. It went into competition with the likes of UAL, Western Airlines, Pan Am, World Airlines and Continental. They started with 2 DC-10s and later chartered a 747 and offered three flights a day during their peak. They created total chaos in the airline industry as the other trunk carriers were able to offset losses on the LAX to HNL run by subsidizing the low fares from profits on other itineraries.
While only in business for 17-months, The Hawaii Express was in chaos the entire time. Staffing turnover, poor performance, financial difficulties, misuse of customer funds, questionable sales promotions and the commingling of customer funds were evidence of its complete demise. The interesting thing about the Hawaii Express is that when it was finally grounded, it had sold more seats in the future than it had actually operated during its tenure. This was caused by its advanced ticket sales offering to “fly to Hawaii next year for only $87 if you buy your ticket this week”. Of course, this kind of offer is designed to generate immediate cash needed to continue operating.
Signs a Supplier May Be Having Financial Difficulties
While suppliers may be having difficulties financially, the last thing they will do is admit to it. Instead they may increase advertising, reduce pricing (and yields) in favor of generating more cash or delay paying bills as long as possible. Here are some signs that should alert your sense of caution when selecting a travel supplier.
Supplier Unstability: If a travel supplier stops hiring and is laying off employees, taking forever to pay bills, is having “accounting problems”, making product offerings that seem “to good to be true”, is losing customers because of bad service, key executive staff is leaving, ex-employees, clients and sub-suppliers are complaining about the supplier’s performance, these are all signs that the supplier may be having financial difficulties.
Sales: When suppliers are facing a shortage of cash flow, they may introduce sales to stimulate the inflow of cash. These sales may be for future travel or a combination of current and future travel. Sales by lessor established suppliers are always a concern as they may not have the same buying power as their larger competition and are simply dumping prices in hopes of stimulating cash.
Deposit and Final Payment Timing: If a supplier has increased the deposit necessary to confirm a reservation, or worse yet, asking for final payment well in advance of the actual departure date, you should elevate the level of caution that you use in booking the supplier. Offers that offer discounts for immediate payment should be highly suspect.
Future Travel Credits Rather Than Refunds: During the pandemic many suppliers offered future travel credits rather than refunds. Shoretrips is a great example of this. They only offered future shore excursion credit for cancelled tours. Of course, when the assets of Shoretrips were sold out of bankruptcy and the buyer did not take on the nearly 5 million dollars in debt, the future travel credits became completely worthless. If a supplier has offered future travel credits instead of refunds in the past, don’t book them unless you give full disclosure to your client.
Slow Refunds: If a supplier is taking a long time to refund clients because of “accounting problems” or some other “check is in the mail” excuse, you should avoid booking them as they may be using deposits received today to pay deposit refunds. The longer the wait for a refund, the more likely the supplier is having cash flow problems and is commingling client funds.
Travel Insurance Companies Will Not Insure a Supplier: Always sell third party travel insurance that covers the financial failure of end suppliers. And, if you cannot find an insurance company that will insure a supplier that you are considering, do not sell that supplier no matter how good the deal sounds.
What is the Best Way to Sell Travel in 2021 and Beyond?
As the pandemic winds down, more travelers become immunized and the pent up demand for travel unleashes itself, you must disclose and choose carefully. Helping clients understand the reality of the post-pandemic reality of travel is essential to successfully negotiating the future. So here ate things that you can do to help your clients make great decision and also limit any liability that you may potentially have if the worst case scenario of supplier financial failure occurs.
Complete Transparency: You should be completely honest with clients about the potential for financial failure with suppliers. You can be honest without scaring them out of booking by also sharing how they can take precautions against the potential financial loss if a supplier does cease to operate. One of the real issues during the next phase of recovery in travel and tourism is going to be suppliers that gave future travel credit in lieu of refunds. They have likely spent the funds paid by the client trying to get through the pandemic and are now faced with providing over a year’s worth of travel product when the future travel credits are redeemed.
You can easily see the challenges that suppliers will face when future travel is booked with future travel credits that will then have to be funded. Who knows what the outcomes will be? Certainly revenue models will have to change so that the supplier can generate operating revenues while serving the clients. It is likely to be a very difficult road to go down for many suppliers. So here are ways to advise clients to protect themselves.
Use Disclosure Statements: Every detail known about a supplier’s past financial history should be discussed and disclosed with clients. While general disclosure statements that deal with terms and conditions, cancellation policies, agency disclosure and so on are excellent places to start, you should also disclose if the supplier has issued future travel credits, rather than refunds for cancelled travel. This is extremely important since suppliers that have issued future travel credits are now having to redeem those credits that do not have any revenue stream associated with them. This is very concerning as if the supplier did not have the money to refund the client, how likely are they to be able to afford to provide the travel?
You should do all disclosure statements in writing and have your client’s sign them as acknowledgment they have had disclosure and understand the potential risk.
Sell 3rd Party Travel Insurance: In the scenario mentioned above, the answer is to sell your client third party travel insurance which also includes protection from the financial failure of the supplier. Never book the supplier’s insurance as if they did cease operation, it is highly unlikely that the insurance would offer any satisfaction whatsoever.
Use Credit Cards: Section 75 under the Consumer Credit Act provides for the client protection if an airline or tour company files for bankruptcy. This protection occurs only when using a credit card, but does no occur when using a debit card. It also covers additional expenses or consequential loss. An example would be if your airline goes out of business and you buy a ticket from an airline that is more expensive. Many credit cards designed specifically for travelers offer additional benefits such as travel accident insurance, travel medical insurance, travel cancellation insurance, lost luggage and travel delay coverage.
You should have your clients contact their credit card company in advance of booking to make sure that they understand the terms and conditions of their Section 75 and ancillary benefits.
Avoid Booking Risky Suppliers: So we discussed the various signs that a supplier may be having financial difficulty and these should present it should send up a red flag begging for additional investigation. Your clients are susceptible to advertising and readily assume that everything is on the up and up. It is your job to let them understand that if a supplier is requiring final payment upon confirmation or doing BOGO sales, that these may be signs of a weak financial constitution.
Most important is making your client aware of what to do if something does occur so that they can spring into action to try and resolve the situation quickly.