Mahan Law Blog

Thursday, October 9, 2014

Extend Credit to Customers?

Unless you are a cash only business, which in my estimation would deter a significant client base, you DO extend credit to customers.  Checks have to clear bank accounts, credit card transactions must be processed (and are subject to 60 day dispute period), and third parties such as insurance companies and government agencies all delay business cash cycles.  What is even more likely is that you provide payment terms to your clients by a form of delayed billing (i.e. Net 30) or even payment upon completion.  Extending credit to customers is necessary to grow just about any business, but there are several considerations your business should make before extending credit term.

First, always have clear contract terms with customers.  Even a simple contract with your customers, such as a new client form, can spell out desirable terms should customer relationships break down.  The main clauses that are beneficial in Ohio and Kentucky are attorney's fees, interest and costs provisions.  Should you have to pursue legal action to collect upon an account you can shift your attorney's fees and court costs to be paid by the debtor if it is in a contract.  Additionally, because collection activities can take years you will want to earn interest on the unpaid principal.  Ohio and Kentucky each have usury laws that set the maximum amount of interest depending on the type of transaction.  However, an interest clause must be in a contract and not merely written on the face of an invoice after services were rendered.  In my experience the industry standard for unpaid accounts is 18% annually, but can be more or less depending on the transaction.  If you are in the business of making several small transactions it is imperative to have these two clauses in a simple contract or else the legal costs of collection would outweigh the principal amount recoverable.

Second, if dealing with a company consider obtaining a personal guarantee from an owner.  A personal guarantee shifts debt obligations to an individual person instead of a business.  Not only does the threat of personal debt collections increase the probability of a quick resolution, it also opens the doors to a number of additional asset sources.  Obtaining a personal guarantee requires specific language in a written contract along with other strict requirements set by the individual state.  

Third, consider creating a security interest.  Article 9 of the Uniform Commercial Code makes it possible to secure debt obligations by attaching a legal interest to debtor's collateral.  For instance, if your business sells a large good on credit terms, such as a furnace, then at minimum you should retain a security interest in the furnace until paid off.  Otherwise, the furnace would become an asset of the customer or even possibly a fixture to a landlord's property.  If the customer's business goes under or files for bankruptcy the asset could be sold at auction to pay off the many other creditors--not just you.  However, with a properly structured security interest you could retain a priority interest in the furnace, repossess same, and keep all proceeds from the sale yourself.  Your attorney could also seek relief from a customer's bankruptcy and retrieve the equipment instead of waiting for the bankruptcy process to be completed.  

Finally, do not throw good money after bad or sit on your A/R.  Know when to call the ball!  If a customer has credit terms of Net 30 and they are 90+ days behind do not continue to extend credit terms or services.  Essentially you are doubling down on your accounts receivable and the likelihood of getting paid decreases as time goes on.  If you wait too long to try and collect on your accounts receivable you will find that people and businesses move, memories of the transaction fade, addresses change, phone numbers change, businesses sell or go out of business, etc.  Eventually, debts can become legally uncollectible for being stale (or outside the statute of limitations).  Even if you turn your debts over to your attorney or collection company the fresher accounts are always worth more and should yield a higher rate of return back to you.  

The Mahan Law office regularly advises clients on its receivables and structures business transactions to protect your ability to collect upon non-paying clients.  We even provide flat rate small business retainer plans that cover just about all of your company's legal needs, including collections, upon a reasonable monthly retainer.  Please contact attorney Anthony Mahan for more details.

Our office is conveniently located in Newport, Kentucky (less than two miles from downtown Cincinnati), but we handle cases throughout the states of Ohio and Kentucky. We also routinely meet with our clients at their offices or homes if more convenient.

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