Avoiding Collection Problems

With the extended economic downturn we have witnessed a substantial increase in the number of collection cases that we are handling for our clients.  While we are more than happy to handle collection matters we also believe that we owe it to our clients to stress the importance of proper planning to avoid collection litigation whenever possible.

Any business that sells goods or services faces three possible scenarios:  first, and preferably, you can sell your goods or services and get paid promptly for them.  The second scenario is to sell your goods or services and not get paid for them.  Thirdly, you can choose not to sell your goods or services to a potential customer.  Personally, I would rather not work and not get paid rather than working and not getting paid.

Owners of small businesses must use caution when evaluating a potential customer or client.  It is often better to decline a potential transaction if there is a significant risk of nonpayment.  Here are some tips for evaluating a potential customer and securing future payment for your goods or services:

Credit Analysis:  Have your potential customer complete a detailed customer application.  This should include details on the name and type of business, whether it is a corporation, partnership, limited liability company or other entity; you should obtain the names and addresses of all of the owners of the business (shareholders, partners, members, etc.); you should request banking and trade references which should be contacted and followed up; you should obtain a financial statement and the most recent tax return for the business, and you should perform a credit check on the business and its owners.  Credit checks can be performed through Dun & Bradstreet, PRW, TransUnion, and similar organizations.

Security.  If you lend money or extend credit in connection with the sale of goods or services, you can secure the obligation to pay by obtaining a mortgage against real estate from your borrower/customer.  The amount of the mortgage would be equal to the maximum credit you would be willing to extend.  A mortgage gives you a lien on real estate which would allow you to seize and sell the property to satisfy your debt in the event of a default.

Another type of security to consider is a letter of credit, where your customer’s bank issues a promise to you that if your customer does not pay or perform as agreed you can demand payment of the letter of credit.  Such a letter of credit should be unconditional and irrevocable.

Sellers of goods can record a security lien against the goods being sold by filing a UCC-1 Financing Statement against the customer which describes the goods as collateral for the debt.  For example, if you were selling machinery to a buyer in exchange for future payment you could secure the payment by a recorded UCC lien against the machinery.  If the payment is not received you would have the right to take back the machinery and your right to do so would come ahead of the rights of other creditors.

Finally, consider obtaining personal guarantees from the individual owners of the business.  Many small corporations and similar entities are undercapitalized and easily choose to walk away from their debts when times get tough.  You can avoid this scenario by having the individual owners of the business personally guarantee its debts.

Be Selective.  If potential customers are not willing to provide security or are not willing to guarantee payment personally on behalf of their businesses, it is a strong indicator of a serious credit risk.  Reputable individuals will stand behind their small businesses.  By asking for security and/or personal guarantees you can effectively “smoke out” bad debts before they occur.

Monitor Receivables.  Lastly, once a customer is signed up, you must continue to monitor closely their payment history.  Receivables that creep up or payment intervals that go from 30 to 60 to 90 days are strong early indicators of a problem.  Sales should be discontinued as soon as possible when a troublesome trend begins to appear.  Better not to sell than to sell and not get paid.

We cannot stress enough the importance of proper planning in this area.  We have conducted seminars for several of our larger clients to improve their credit procedures and helped them avoid unnecessary collection activity.  We would be happy to work with you to improve your bottom line through proper credit management.

— Kevin Palmer

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