10 Easy Steps to Protect Your Business When Extending Credit
May 22, 2019
As a business lawyer, I am often asked how businesses can best ensure that their customers pay outstanding bills in a timely manner.
For all but the largest businesses, this is more than a theoretical question – when a customer fails to pay one or more invoices it has a dramatic impact on cash flow and the bottom line.
Here are ten steps you can take to increase the chances that your business will more effectively and efficiently collect receivables:
- Gather relevant and important information before you extend credit. This includes full and complete legal names, physical and mailing addresses, Federal tax identification numbers, social security numbers, drivers’ license numbers, birth dates, banking information (including the name of the bank, account numbers, and routing numbers), and the names and addresses of all officers and directors. The time to ask for this information is before you extend credit, not when your customer is already in default and owes you money.
- Insist that your customer sign a formal written credit agreement and/or credit application (the “contracts”). While it is perfectly legal to extend, and receive, credit without a credit agreement or credit application, having a formal written, and signed, document will ensure that both you and your customers understand each other’s duties and obligations, and the consequences of not following through with them.
- Confirm that the contracts properly identify the customer to whom you are extending credit. If the customer is a corporation, limited liability company, or other business that registers with the Secretary of State, make sure (1) they are up to date on all required filings and (2)the name on the contracts matches the name on file with the Secretary of State. If the customer is a sole proprietorship and/or does business by a name other than its formal legal name, make sure the “doing business as” name is on the contracts.
- Include a provision in the contracts entitling you to reasonable attorney fees if the customer defaults and you have to hire a lawyer to collect the debt. Under North Carolina law (N.C.G.S. § 6-21.2), “reasonable attorney fees” are 15% of the unpaid balance. While that may be more or less than you actually end up paying a lawyer, if you have the reasonable attorney fee provision in your contracts, then you will be able to recover that amount over and above the actual debt. The reasonable attorney fee provision is only valid if it is in a writing signed by the customer, so make sure it is in the written and signed contracts.
- Include a litigation venue provision in the contracts. In lawsuits against consumers, you will, most likely, be limited to filing suit in the location where the contract is signed or where the debtor lives. But in commercial lending cases, a venue provision may enable you to make sure the litigation is more conveniently located for you.
- Include a choice of law provision in the contracts. Different states have different laws, and some may be better, or worse, for your business, your industry, and/or debt collection. Talk to your legal advisors to determine the state laws that work best for you, and then choose that state’s laws, without taking into account that state’s conflict of laws provisions. And remember – a choice of law provision applies only to substance, not procedure; so the venue you choose, not the state whose laws you choose, will likely still govern the statutes of limitations that apply.
- Include an interest provision in the contracts. Similarly, make sure the contracts include a clear and identifiable default date, the date the interest begins to accrue. Make sure to put both the due date for the bill and the applicable interest rate if the bill is not timely paid on the invoice.
- Get personal guaranties! Personal guaranties need to be in writing, and creditors most often obtain them from owners, directors, and officers of the borrower. North Carolina is a tenancy by the entireties state, so also obtaining a guaranty from a spouse is ideal – but doing so is limited by various Federal and state laws, so you need a legitimate business and/or credit related reason to obtain a guaranty from the spouse; make sure you document that reason at the time you obtain the spousal guaranty.
- Keep clean and legible copies of all documents. In an age where server space and cloud computing have enabled anyone and everyone to maintain anything and everything electronically, there is no reason to not have, at a minimum, a clean and legible electronic copy of every document relating to all of your customers.
- Update your contracts regularly. Keep in mind that laws change, customers change banks, directors and officers come and go, business owners sell their businesses, and your own business and/or industry needs will also change. As a result, you need, at regular intervals, to have your customers reapply for credit by completing a new credit application and, if and when you agree to continue granting them credit, sign an updated credit application.
- (BONUS!!) Do not let your customers fall too far behind with their payments. Make sure you have a process in place for contacting customers when they do not timely pay their invoices, especially if it becomes a habit. Typical plans involve taking different steps when a bill is 30, 60, and 90 days past due. Keep in mind that, the sooner you take action with a customer who has not paid on time, the more likely it is that you will get paid. And finally, if a customer falls too far behind – stop extending additional credit!
Brian Bernhardt focuses his practice on IRS tax controversies, tax litigation against the IRS and the Department of Justice, and advising nonprofit organizations on tax and governance matters. Brian also has experience as a creditors’ rights attorney, where he has represented creditors throughout North Carolina in all types of consumer and commercial collection matters. With over 20 years of experience, he is an invaluable resource for any business, non-profit organization, or individual in need of tax or governance advice.