In a perfect world, every customer would pay their bills within the time provided, usually within thirty days. In reality, we oftentimes find that getting paid is one of the most frustrating and unglamorous of jobs. This article describes some methods of improving your chances of avoiding bad debt.
As a business owner, it is in your best interest to get the customer to agree to all provisions regarding the terms of payment before the transaction is consummated. After the customer takes possession of your products, your leverage regarding payment essentially vanishes. Accordingly, it is important that the sales agreement contain language that simplifies the collection process in the event of non-payment.
One common method of ensuring payment involves obtaining a personal guarantee. This is particularly important when selling to a first-time business customer since, in all likelihood, that business’ credit history is unknown to you. A red-flag should go up anytime a business refuses to sign a personal guarantee; it is a message that the business owner(s) will not stand behind the business’ obligation to pay. Under this circumstance, you should consider completing the transaction using a credit card. These days, it is rare for a business not to have a corporate credit card, and this fact (the absence of a corporate credit card) may be due to a poor credit history as determined by various lending institutions. If a financial institution determines that a particular business is a poor credit risk and, therefore, refuses to provide that business with a credit, it may also be unwise for you to extend credit to that business.
Failing to obtain a personal guarantee, or a credit card, leaves open the option of having the customer obtain a letter of credit. For small transactions this may be impractical due to the expense involved for the customer; but letters of credit are regularly relied upon for larger transactions. By using a letter of credit, the risk of non-payment is shifted to the issuer of the letter of credit. With respect to large transactions, letters of credit may be the only option since the amount involved may exceed the limits of the credit card.
This author recognizes the fact that some business owners believe that they lose a competitive advantage by requiring a personal guarantee or a letter of credit and, consequently, consider uncollected debt a cost of doing business. For those individuals, I recommend including a clearly-worded jurisdiction and venue provision in the sales agreement. The topic of jurisdiction and venue clause was discussed at length in a previous article [Fireworks Business #248, Sept. 2004]. A jurisdiction and venue provision is particularly helpful when transacting business with an out-of-state customer since the expense of collecting debt (from an out-of-state customer) can easily exceed the amount of most small transactions. Similarly, the customary one-third collection fee charged by collection lawyers will cut into your expected profit; in the end, you may recover what is essentially the cost of the goods.
Whether you seek to attempt collection on your own, or seek outside assistance, it is highly recommended that you prepare and serve, preferably by regular mail and certified mail, return receipt requested, a demand letter. A demand letter is just what it says; a letter explicitly demanding payment of a sum. The demand letter may be only one sentence long; however, it should contain the words “demand for payment” in one fashion or another, and should also include the amount due as well as a copy of any outstanding bill or invoice.
In closing, a legal maxim taught to every law student is particularly applicable to the topic of collecting bad debt: Equity aids the vigilant, not those who slumber on their rights. This is a fancy way of saying in you need to chase bad debts from the start, not months, even years, later. The older the debt becomes the less likely that you will collect it.
