The most indispensable method for a business to avoid a customer’s account becoming a bad debt is to extend credit, from the outset, which maximizes payment security and recourse should the customer default. All too often, clients contact our office to institute legal action to collect a debt obligation with few safeguards in place to facilitate recovery.
Over the years we have developed a security checklist which can assist a business in minimizing instances of bad debt charge-off:
Require the principal of a corporate business customer to execute a personal guaranty, assuring payment, in the event the business defaults on its obligation. Although requesting the execution of a personal guaranty may be awkward under certain circumstances, it is a good business practice which impresses upon the customer the commitment to timely payment.
Consider memorializing the amount of the debt obligation in a promissory note executed by an individual principal of the customer’s business. The advantage of the promissory note is that in most instances, there are no legal defenses which can be asserted against the collection of the note. The promissory note should specify the interest rate and should be payable upon demand.
Require the customer to provide all relevant insurance certificates, including comprehensive general commercial, premise and auto liability, crime insurance, and fidelity bonds. If appropriate, the customer should name your business on the insurance certificate as a loss payee. Workers compensation insurance should also be available to preclude claims for damages arising out of work-related injuries on your premises.
Require written credit applications containing banking information, references, and financial statements. Information should be verified and a credit bureau or “D & B” report run on the prospective credit applicant, where allowed, to confirm financial viability.
The terms of the parties’ business dealing should be memorialized in a written agreement. A written contract which embodies more than a mere “proposal” is indispensable to recovery of a defaulted debt obligation should the customer need to be brought to court. Payment terms should be clearly defined, including down payments or retainers, progress/installment payments, and, if necessary, security deposits. Time for performance, interest provisions, remedies upon default, and provision for arbitration of disputes should also be disclosed in writing. Of course, we recommend inclusion of a provision for the payment of attorneys’ fees should the obligation go into default.
A letter of credit. This device requires the customer to segregate certain funds at its bank to assure payment of the credit obligation in event of the customer’s default. It is like an escrow account for the benefit of the creditor.
Recordable financing statements. Under the Uniform Commercial Code, the business extending credit may want to require the execution of UCC financing statements which create a security interest in current and after-inquired inventory and/or other personal (non real estate) assets of the corporate customer. These financing statements are filed with the Secretary of State and, as public record, provide the business recourse in the event of a liquidation or sale of assets by a customer. The person acquiring the covered assets is deemed on notice that your business has a prior (senior) interest in those assets.
Exercise your business’s right to file mechanic liens/notice of contract, if necessary, when providing labor, supplies or materials to a customer’s real property in conjunction with the erection of a building or improvements thereon.
Becoming a diligent and proactive business in extending credit will maximize payment and recovery of debt obligations, as well as foster respect and compliance from your customers.
Not every suggestion on this checklist is appropriate in every business environment, nor is the list exhaustive. Still, it should provide a foundation for sound fiscal policy while affording the customer the flexibility of payment terms.
