BUSINESS CONTRACTS AND PROVISIONS TO IMPROVE COLLECTION OF RECEIVABLES
During these times of economic turmoil, small businesses need to protect themselves against the risk of non-payment of customer accounts. The following is advice on how to proactively manage credit through business contracts and other tools:
Put Your Business Deals in Writing
When negotiating a financial transaction, whether it is for the provision of services, the sale of goods, or the establishment of a business partnership, it is important to put the terms of the deal in writing. In other words, it may be wise to hire an attorney to draft the appropriate business contracts. If the parties to a business deal come to the table beforehand to discuss the terms of the agreement (the scope of the parties’ duties, the monetary consideration, etc.), and then reduce that discussion to a written contract, it is less likely that a payment dispute or other difference of opinion will arise later on. Through such a process, the parties will have already fleshed out any misunderstandings, before committing to the deal. Also, if a dispute should subsequently arise, you have documentation as to the parties’ agreement and you will not have to rely on memory.
Have Attorneys’ Fee or Late Fee Provisions in Contracts
Often times, when financial distress hits, customers may only be able to pay certain of their regular monthly bills. Give your customers incentive to make your bill a priority by charging late penalties. To do this, the contract, lease, or other operative document must contain specific language that sets forth the applicable late payment penalty schedule. Likewise, to the extent you wish to pass the costs of collection onto the non-paying customer, the contract should have a provision expressly stating that the debtor (customer) will be responsible for all attorneys’ fees and costs incurred should the creditor (your business) have to institute collection efforts. Many businesses include language about late fees on the invoices only, which could pose a problem in terms of later showing that a late fee was an agreed-upon part of the contract. An attorneys’ fee provision in the initial contract will also provide additional timely payment incentive.
Under the Maine Consumer Credit Code, however, the contract may not require that the consumer pay the attorney’s fees or other collection costs in consumer credit transactions involving a credit sale or lease. Consumer credit transactions are those in which the customer’s transaction is for personal, family, or household purposes, where payment is to be made in installments and a finance charge is or may be assessed. For example, a company that leases or sells furniture to a customer on credit, for use in the customer’s home, has entered into a consumer credit transaction with that customer. With respect to consumer credit transactions not involving a credit sale or lease, the agreement may require that the debtor pay reasonable attorney’s fees not in excess of 15% of the unpaid debt after default, but the agreement may not provide for the payment by the consumer of any other collection costs. An example of a consumer credit transaction not involving a sale or a lease is when a company performs services, for personal, family, or household purposes, and agrees to be paid in installment payments, charging interest or a finance charge. The Maine Consumer Credit Code may also limit the amount of late penalties that can be assessed in certain consumer credit sales.
Obtain Personal Guaranties
When your customer is a corporation or a limited liability company, the corporate structure of the business protects the individual owners from personal liability for the company’s debts. To protect against a company simply closing its business doors and walking away from its monetary obligations, obtain personal guaranties from the owners of the business. With respect to closely held corporations or family-owned companies, you may wish to obtain personal guaranties not only from the buyer or lessor, but also from those with the “deeper pockets” in the family, perhaps from the parents. Information about all of the company’s principals can be ascertained through the use of a thorough credit application.
Secure Collateral for Services Rendered or Goods Supplied on Credit
Any loan or provision of equipment, goods, or services on lease or credit should be as collaterally secured as possible. A promissory note for real estate should be secured by a mortgage on the real estate; a promissory note for personal property should be secured by a broad Uniform Commercial Code filing on all of the assets of the borrower. A loan for the purchase of a car (including seller financing) should be secured by the car itself. A lease agreement should be secured by a monetary deposit or other asset. Collateral interests must be “perfected” in order to be enforceable in the event of a default. Perfecting a security interest in collateral means that you have taken all of the necessary legal steps and filed all of the required paperwork to provide notice to the debtor and to other creditors that you have a valid lien against the debtor’s property.
Exercise Lien Rights and Other Available Creditor Remedies
Certain Maine laws provide for lien rights and other “self-help” remedies for non-payment. For instance, Maine’s mechanics lien law allows contractors, suppliers, and others who have made improvements to real estate to look to the property itself to compel payment of money owed, even without having a contract with the property owner. The deadlines and notice requirements under Maine’s mechanics lien law must be strictly followed. A mechanics lien must be recorded in the appropriate Registry of Deeds within 90 days from the last day that work was performed on the property or that materials or equipment were supplied to the property. A complaint must then be filed in court to enforce the lien.
Maine also has some other unique lien rights. For those who furnish canned corn, grain, or fruit, potatoes, hay, or lumber, certain lien rights to those goods and/or their finished products may be available to secure payment for the goods furnished. For those who repair or service vehicles, vessels, watches, jewelry, clothing, appliances and other items, automatic liens on those goods may be established for the reasonable compensation for any labor or materials expended on the items. These liens may even take priority over other creditor claims to the same goods.
Additionally, to the extent you are holding money or property of a customer who owes your business money, you may have “set off” rights, allowing you to take that money or property and apply it to your customer’s delinquent account. A common example of a set off is when a debtor has a mortgage or other personal loan with a bank where the debtor also has a checking account. If the customer defaults on the personal loan with the bank, the bank may, without notice, take money from the checking account and apply it toward the personal loan.
Protect Your Rights in the Event of a Customer’s Bankruptcy Filing
Business and individual consumer bankruptcy filings have been on the rise. When a customer files bankruptcy, there may be certain actions that need to be taken quickly, including stopping the shipment of goods in transit or recovering delivered goods sold on credit. There are also deadlines for filing with the Bankruptcy Court proof that the debtor owes your business money. When you learn that a customer who owes your business money has filed for bankruptcy protection, you should immediately stop any collection efforts. This does not mean that you automatically lose your right to payment, but you will need to work with an attorney to ensure that any rights to payment out of the bankruptcy process are protected.
In sum, it is crucial that a business stays on top of its credit accounts. If a customer is not paying your business, there is a good chance it may not be paying other creditors. Steps should be taken to protect your business interests immediately, as there may be a risk of a bankruptcy filing or insolvency. Manage your business’s accounts receivable, re-evaluate credit lines to high-risk customers, and make sure that business contracts contain provisions that both lower the business’s risk of non-payment and also provide incentive to its customers to keep current on their bills.
This article is not legal advice but should be considered as general guidance in the area of business contracts and collection issues.