Publications

How to Improve Your Chances of Reveiving Payment From a Risky Customer

Nicholas D. Krawec, Esq.
Bernstein Law Firm

While granting credit to customers is a necessity for doing business, it is always a risk. You, as a small business owner, must look for ways to enhance your position as a creditor, so as to minimize that risk and improve the likelihood of receiving payment from customers. The methods detailed here are the most common ones on the road to payment.

Ways to improve your chances of receiving payment:

Credit and sales components must work cooperatively. Credit managers are, and must be, the sticklers for making an evaluation of the customer's background and creditworthiness. Sales people, while they fear offending the customer and possibly losing the sale, must reconcile themselves to the necessity of credit checks.

Reach into as many of the debtor's pockets as possible by:

1. Getting the written personal guaranties of payment of principals of the debtor company including partners, shareholders and spouses, if necessary. Agreement of the principals' spouses is particularly important since Pennsylvania law adopts the concept of "tenancy by the entireties," where creditors of only one spouse cannot ordinarily attach jointly held marital property to settle the one spouse's debts. If property of the guarantor(s) you would look to in order to get payment is jointly owned marital property, then obtain a spousal guaranty as well.
2. Retaining a security interest in the various assets of the debtor company. Enter into a security agreement with the debtor which gives you security interest in not only the goods you sell the debtor, but also in inventory, equipment, furniture, fixtures, accounts receivable, etc. Because secured creditors generally receive payment before unsecured creditors, your security interest in the personal property of the debtor enhances your position if the debtor files bankruptcy. Before negotiating and signing a security agreement, consult with an attorney; this procedure can be fraught with pitfalls.
3. Including with the credit application, or as part of the sales agreement, a confession of judgment clause. By agreeing to the clause, the debtor agrees beforehand that if he defaults, a judgment may be entered against him without trial. As a creditor, you could then file a complaint in confession of judgment in any court of record an issue an execution against the debtor's business assets.

A confession judgment, a lien against real state owned by the debtor in the county where it is recorded, appears on any credit report or property search and acts as a lien against real estate until it is stricken by the court or satisfied. Such a lien could hinder the debtor's efforts to obtain future credit, and that possibility may, in itself, force the debtor to remit payment.

Security or other creditor enhancement, whether a security agreement or a confession of judgment, should be obtained at the outset of your dealings with the debtor--when his business is going well, he is optimistic and he wants credit from you. After he defaults on his obligations to you, and probably to other creditors as well, he will feel too vulnerable to sign anything.

And if that doesn't work?

If you have taken these precautions and the debtor still doesn't pay, turn to the legal process. If you have a confession of judgment executed by the debtor, contact your attorney, have the judgment entered and issue an execution against the debtor's business assets and business property.

If you do not have any of the above-listed protections but you do have a debtor in default, you must file suit to obtain a money judgment, in which case, it becomes a race to the courthouse with other creditors. There is also the possibility of collecting nothing because you did not have the proper credit security or creditor enhancements described earlier.

If you think the debtor may have improperly dealt with business assets or transferred assets to friends or family for little or no consideration, check with the debtor's other creditors. It may be worthwhile to file an involuntary bankruptcy against the debtor if he has also defaulted on his obligations to other creditors. This approach gives you the resources and power of a bankruptcy trustee to find out what happened to the assets, and perhaps to undo (i.e., set aside) the improper transactions.

Again, it is best to consult experienced bankruptcy counsel if you find yourself in the situations described here.

Remember, you can minimize your risks when granting credit to a customer, by keeping a watchful eye on the debtor and his business operations.

Whatever the debtor can do to forestall his "day of reckoning" puts money in his pocket-- your money. Whatever you can do to obtain security and leverage to accelerate the debtor's "day of reckoning" puts money in your pocket.

For additional information on perfection of security interests and the usage of other credit enhancements, please see the other articles in this Publications section.