According to the 2016 Small Business Survey conducted by the Federal Reserve Bank of New York, 37% of businesses in the survey fell into the "at-risk" or "distressed" category. Put another way, this means that over a third of those businesses were considered financially problematic. If you are a supplier, vendor, contractor, or any business that provides credit to third parties you need to get on the bandwagon and get yourself a very robust credit application to allow your company to avoid or minimize risky business relationships. For those companies that may have a credit application chances are that it is outdated. Of course, credit applications are not static documents and they need to be updated and changed to fit both surrounding legal and industry changes as well as to conform to changes in the way you now conduct business.
1. Credit Applications can accomplish several different purposes.
In the first instance, a comprehensive credit application can aid in the decision to extend credit to your potential customers. Additionally, it can serve as a tool to gather information in the event of non-payment. Lastly, and perhaps just as important as anything else, a robust credit application can function on its own as a separate and enforceable legal document. This may become necessary should the relationship between your company and your customer not get resolved and that litigation becomes the only alternative to resolving any dispute. Quite often, the information that is included in the credit application is the information supplied by a customer. Thus, it can act as an admission against that customer should any dispute arise as it relates to the terms and conditions of any transaction.
2. What kinds of information should the credit application contain?
A. The Credit Application must ask for relevant and current business information. The answer to this question varies from client to client and industry to industry. Having said this, however, the basic credit application should seek information as it pertains to whether the business is incorporated or a sole proprietorship, trust, or partnership. All tax information must be provided such as federal tax identification numbers or social security numbers if you are dealing with a sole proprietor or individual. Other information must include, billing and business address, phone number, email address, cell phone number of the party responsible, the incorporation date, and length of time the company has been in business.
That is just the start, however. You want to inquire as to whether the potential customer has been in bankruptcy or if they are involved in any litigation and for what reason. You will also want to know if the company or individual has had any judgments against them. In some cases, my clients have been getting credit applications completed for both the company and any guarantor. If you have a guarantor, you may want to do your own credit application as to the guarantor. Of course, just because someone signs a guarantee does not make them able to pay any indebtedness if and when the company defaults. Having said this, and depending upon the nature of the transaction and the amount in question, obtaining credit information on any guarantor attached to the transaction may serve your company well and further protect its interests in the event of a problem down the road.
B.Customer financial data. You need to obtain information regarding total assets, total debt, annual sales, annual net income, average working capital, and the amount of credit requested. Also, there should be language in the credit application that permits your company, as a creditor, to increase credit, decrease credit, or eliminate credit altogether depending upon any change of circumstances. These rights must be reserved in the application itself.
C.Bank and Trade References. Make sure you get at least three active accounts for each customer and bank contact information. As to trade references, you should get these as well but keep in mind that potential customers will only give you references that are positive. A great way to verify any information provided by this potential customer is to subscribe to a credit reporting bureau such as Dun and Bradstreet. This can provide you with valuable information that will otherwise support or put into question the information provided by the potential customer.
D. Payment of reasonable attorney's fees in the event of a collection. I know that many clients balk at including a provision for attorney's fees in their credit application. However, should you need to go into court it the inclusion of this specific language will provide you with some sense of comfort to know that the customer may be liable for your company's legal fees and the costs incurred in the course of any collection? As a practical matter, and from my experience, including this clause in the credit application can often force a customer to rethink its position of not paying you when they know they could be held responsible for your attorney's fees down the road. If you are concerned that you will lose a potential customer if such a clause exists in your credit application in the first instance then perhaps this is not a business relationship that you will want to have.
Your credit application acts as a protective shield for your company. It allows you, as a creditor, to take control of any new or existing business relationship. The Katz Law Group has drafted numerous credit applications for many different companies both in Massachusetts and across the Northeast. We can help you navigate this area so that your company can take full advantage of this protection. Please feel free to call us at 508-480-8202.
In Why Your Company Needs an Effective Credit Application (Part 2) we will drill down on some other issues in this area to provide you with greater insight as to how you can really make this document even more valuable to your business.