February 2019 Finance, Real Estate & Bankruptcy Law News
February 18, 2019
There is nothing quite like obtaining a new customer or getting a new big sale - the prospect of recurring revenue from a new source, the validation of business strategy, or the culmination of a successful negotiation.
However, there is nothing more disheartening than when a new customer is unable or unwilling to pay for the product you just shipped or services you just provided. Perhaps there is one thing that is worse, when a long-term customer fails to pay.
Every business has been in this situation. It is an inevitable cost of doing business. Fortunately, there are a number of things that can be done to increase the likelihood of recovering on a defaulted account. Much like many things in life, the best debt collection practice is prevention. By planning and acting thoughtfully and strategically, businesses can greatly increase the likelihood they will collect accounts receivable without issue. This starts with gaining an understanding of the customer or potential customer.
In retrospect, customer red flags are obvious. But in the rush to close a deal, many sellers get swept up in the excitement and overlook clear signs of potential issues. That is why it is essential that businesses conduct due diligence on individuals and companies with whom they do business, prior to doing business with them.
Accordingly, before doing business with a customer and especially before extending credit to a customer, businesses should:
Have each customer fill out a thorough credit application, which will include financial information about the customer and describe the terms of the transaction. While some customers may balk at such a request, reluctance to demonstrate creditworthiness may itself be a red flag. The application can be prepared for you by your attorney. Include a guaranty for the owner(s) of the business in the credit application to provide another avenue to collect.
The potential customer (business) is less likely to default if the individual is also liable for the debt owed. Have business reports run on the customer, such as a Dunn & Bradstreet report. (If you are unsure how to obtain a business report, you can contact counsel to have the reports run for you). You can also ask industry peers about their experiences, if any, with the customer.
Review prior litigation history. Odds are that if a company is financially troubled, or is healthy but prone to not paying, there is a litigation trail to discover. Document all communication. Clear records of meetings, phone calls, written and email correspondence can help avoid and, if necessary, resolve disputes - in litigation or not - over the sale of goods or services.
In the event the potential customer is not willing to complete a credit application, you should require payment in advance or accompanying with the provision of goods or services.
Many times sellers simply extend credit to buyers without a credit application, never ask for payment in advance or simultaneous with supplying goods or services, and as a result, do not have the information needed to collect from the customer after a default. While it may not be possible in every situation, particularly when the customer has significant purchasing power, getting paid upfront makes debt collection issues go away.
Regardless of whether credit is extended, get all transactions in writing. Handshake deals work great . . . until they don’t. A clear, comprehensive, written contract increases the likelihood of success if a customer defaults and refuses to pay.
Include important details such as the goods being purchased, the quantity and quality of goods, the price and time of payment, and the time and method of delivery. It is also during the back and forth of contract negotiations that a seller can seek additional payment protection from the customer, such as a deposit, guaranty or security interest.
There is nothing extraordinary about insisting that business be conducted in accordance with these best practices. The degree of reluctance of a customer to, for example, complete a credit application, share information or enter into a written contract, is often directly proportional to the likelihood that the buyer will default on its obligations down the road.
Better not to make the sale now than to deal with the debt collection headache later. Unfortunately, despite taking all the right steps, things can still go wrong. Customers fail to pay – forcing businesses to collect debts. What is the best way to recover?
If a customer withholds payment for goods shipped or services provided, then you should cease extending additional credit. As the old adage goes, if you are in a hole - stop digging.
There are a number of factors to consider here, such as the type of contractual relationship at issue (order by order or long term supply contract), as well as the reason for non-payment (defective product or inability to pay), but a customer’s failure to pay for goods or services is often an indication that it won’t be their last. Consult with legal counsel when faced with customer non-payment. The last thing you want is to take an action that causes you to breach the contract. Additionally, developing a collection strategy early creates a better likelihood of recovering.
Be the squeaky wheel when trying to collect a debt from a customer. If the customer is not paying you, they are probably not paying other creditors either. Troubled companies are often juggling a number of accounts payable issues - paying sellers as necessary to keep the lights on, the doors open and the supply of goods flowing. It is often a desperate situation and businesses that take a passive approach with a defaulted customer are not likely to get paid. No “great opportunity” with a customer is worth accommodating non-payment of receivables, and those who act firmly and decisively are much more likely to get paid first.
Begin litigation earlier rather than later. Defaulted customers will often respond to a lawsuit, where they would not to direct payment demands from the business. While costs can quickly add up in litigation, a resolution is likely to occur more quickly.
Notably, all businesses should consider whether the customer may have a counter-claim against it, as a lawsuit to collect a debt can quickly turn into a defense against various counter-claims brought by the defendant/customer. It is important to determine (to the extent possible) a customer’s ability to pay before litigation is commenced. There’s no reason to throw more good money after bad if a debtor company is insolvent. Counsel can assist you in researching and determining whether pursuit of the debt in litigation is worthwhile.
Many litigation cases are resolved with settlement agreements, where the customer executes what is called a “pocket judgment” that will only be entered if the customer fails to make the settlement payment. This can create a “win-win” for both you and the defaulted customer, as you will get paid, and the customer will not have a judgment entered against it, provided it makes all required payments.
While litigation can be a frustrating process, it can go a lot smoother if the pre-sale steps outlined above - including completion of a credit application, documenting communications and using written contracts - are implemented. Experienced legal counsel can help to develop an effective litigation strategy in light of the facts and circumstances at hand.
Do not give up hope if your non-paying customer files for bankruptcy. Many businesses assume that there will be no assets available or chance of payment when a customer files bankruptcy. To the contrary, all is not lost when a customer files for bankruptcy relief. Many bankruptcy cases, particularly Chapter 11, 12 and 13 reorganizations, involve distributions to creditors. Upon receiving notice of a customer’s bankruptcy, contact an attorney.
This is necessary because there are many deadlines and these cases are very time-sensitive. Plus, experienced counsel can evaluate whether a claim is entitled to a higher priority than the customer/debtor is proposing or whether there are other rights you may be entitled to. Counsel can quickly tell you whether your claim is worth pursuing in the bankruptcy case.
Bottom-line: act quickly or risk losing rights. There is no single “silver bullet” that businesses can use to improve the collection of debt, but by adopting the strategies outlined above, you can increase the likelihood of getting paid. The point is to think through these issues in advance in order to build in protections before a sale transaction is completed, and to be able to take decisive action in the event of a payment default. Not having a systematic plan in place often leads to poor collection results, and the relinquishment of legal rights.
If you have any questions about your plan for debt collection, please contact Patricia Scott at 517.371.8132 and firstname.lastname@example.org or Scott Chernich at 517.371.8133 and email@example.com.
This article was originally published in March 2016 and has since been updated.