Giving Credit Where It’s Due
Businesses Must Take the Necessary Steps to Protect ThemselvesThe Great Recession taught many of us a number of lessons in dealing with our own business and that of our customers. As the businesses that survived the recession learned, in addition to monitoring expenses and trying to carefully guard scarce resources, there are protocols that can be implemented on a regular basis to protect ourselves.
One such instrument is a commercial credit application. This article is not intended to discuss consumer credit transactions; rather, it is simply trying to elaborate on some of the mechanisms that might be used in a commercial setting.
Most entrepreneurs know that two types of credit are available — secured credit and trade credit. Secured credit is typically borrowing from a bank or other institutional lender, which places a lien on business assets and provides a business with working capital or term debt for equipment and other asset acquisition. The majority of credit, however, is trade credit from one business to another. Trade credit is an unsecured promise to pay for the delivery of goods or services.
Most businesses decide on an informal basis what credit terms to provide to their various customers. In order to do this effectively, many use credit-reporting services, and others employ informal procedures they have developed and implemented over time. This writer advocates that a complete credit application should be had from all trade creditors, which can provide information that could prove critical in determining whether to extend credit, how much credit to extend, and what to do if there is a default in payment.
Generally, on a credit application you want to start with the exact name of the account debtor. Whether it is a corporation, limited liability company, partnership, or an individual, you should be careful to specify its correct name. Oftentimes, businesses use a ‘trade name,’ and you should look at the secretary of state’s Web site to verify the correct entity name. The credit application should not be done in the trade name. Further, a responsible person in your organization should review each credit application prior to any credit being extended.
Under the credit application, I would recommend obtaining information as to the owner of the real estate, as well as the owner of any equipment. It is helpful to obtain bank-account information because you have the ability at times to attach certain bank accounts prior to judgment if a default occurs.
In Massachusetts, as in most states, legal fees are the responsibility of each party unless the rule has been varied by contract or statute. As such, you generally want to include a sentence such as, “the undersigned agrees to pay all costs of collection, including reasonable counsel fees if any invoice or other obligation is past due.” By having a representative of the customer sign the credit application and agree to these terms prior to extending credit (not simply placing them on an invoice), you have a better chance that you will be awarded counsel fees if a collection action is started.
You may wish to include terms for service charges as well, and these would also need to be stated in your terms and conditions.
Often, you may be able to secure a guarantee whereby an owner of a business will become personally responsible for the debts of his or her company. This becomes a bargaining consideration and could prove useful. Again, you want to be cautious that the person who executes the personnel guarantee is not a salesman, but rather the owner of the business.
Some companies that extend large amounts of credit or sell large pieces of equipment actually take a security interest in the items being sold. This, too, can be accomplished through a credit application if a security agreement has been included.
If you are operating in the state of Connecticut, then it is imperative that you include the so-called Connecticut pre-judgment waiver paragraph in your document, which allows you to attach assets without notice in certain cases.
If you use general terms and conditions, you want to be sure that an account debtor has agreed to them, and I would advocate that these general terms and conditions also be placed directly on the credit application.
While this article is intended to simply be a brief overview of some of the protections afforded with a credit application, you should remember that the application can be as large or small as necessary to fulfill the needs of your business in determining the critical questions outlined above.
Peter Shrair is managing partner of the Springfield-based law firm Cooley Shrair; (413) 781-0750.