There may be times when it makes sense for your business to extend credit to customers or clients, giving them additional time to pay what they owe. At the same time, you want to make sure that extending credit doesn’t result in your never getting paid. This article briefly considers both extending credit and collecting on unpaid debts.
Professional and Service Businesses
In some cases, such as medical and dental offices being paid by insurance companies, or lawyers, accountants, and other professionals taking an advance payment (a retainer), the issue of extending credit to individual patients or clients may be avoided.
However, where advance payment, or payment through a third party such as an insurance company, does not apply, there are several basic steps you can take to reduce the risk of a person not paying you for your services:
- give the person a written statement of your billing procedures
- prepare a retention letter for the person, and have the person sign it (in some states, such a letter is legally required for lawyers handling certain cases)
- when using a retention letter, make sure to be specific about (a) how many days the person has before payment is due, and (b) any interest or finance charges for late payments; and
- consider running a credit check on the person; this is generally a quick and inexpensive process—but you should make sure you inform the person before running the check, and adhere to the rules of the Fair Credit Reporting Act.
Wholesale and Manufacturing Businesses
It’s common practice for wholesale and manufacturing businesses to extend credit—and to have clear credit policies. Policies can vary depending on the kinds of customers you have. Just a few of the potential points to include are:
- the number of days after the bill date that payment is due
- the amount of any finance charges or interest
- the amount of any discounts for early payments
- if and when credit checks are required
Keep in mind that a policy of charging interest on overdue bills can act as an incentive to your customers to pay on time; the same is true for early-payment discounts.
It is common practice to have business customers complete a credit application. Once completed, a good credit application should give you at least a couple of pieces of useful information, including:
- the legal form of the business (sole proprietorship, limited liability company, corporation)
- references; and
- information—and authorization—to order a credit report.
Knowing the legal form of the business gives you some idea of where you can go to collect if bills are unpaid. With a sole proprietorship, you should be able to go after the proprietor’s personal assets; by contrast, with a corporation, you are likely limited to the corporation’s business assets.
References may give you some insight into the customer’s finances. However, most customers will try to provide the most positive references they can find, so if they’re hiding something, it may be difficult to discover.
When it comes to credit reports, be aware they are not always 100% accurate, and that a customer may be able to give a solid explanation for an apparent problem.
When working with businesses that shield individuals from financial liability, such as corporations or limited liability companies (LLCs), you may want to consider asking for personal guarantees from corporate officers, LLC members, or the like. This may allow you to go after individual assets if the business itself can’t pay its debts. Similarly, if an individual customer seems to have questionable credit, you might ask whether another, more clearly solvent person will co-sign for the credit.
If your business sells equipment or merchandise, or does construction work, it is possible to obtain “security” when extending credit. In other words, you may have special rights to reclaim or sell a customer’s property if the customer doesn’t pay.
More specifically, if you sell equipment or merchandise, the Uniform Commercial Code (UCC) has rules where you can file a financing statement with a local government office in relation to a particular sale to a particular customer. Filing the statement gives you priority to reclaim the property you sold in the event the customer goes bankrupt.
If you do construction work, you likely have the option to place a “lien” on real estate on which you have done work. With a lien, if your customer doesn’t pay you, you have the right to foreclose on the property in order to get the money you are due.
Consumer Credit Laws
If you’re extending credit to customers, you should be aware of several important federal laws:
- the Truth in Lending Act states that you must clearly and accurately disclose your credit terms to customers, including such things as annual percentage rates, finance charges, amount financed, and total number of payments the customer will make in paying off a debt
- the Equal Credit Opportunity Act states that, when making credit decisions, you cannot discriminate on the basis of race, color, religion, national origin, sex, marital status, age, or the receiving of public assistance
- the Fair Credit Reporting Act concerns information in consumer credit reports; among other things, it gives consumers the right to know what’s in their credit reports, to add limited comments where they believe information is inaccurate, and to be informed if their credit report was used to deny an application for credit; and
- the Fair Debt Collection Practices Act places specific limits on what steps collection agencies can, and cannot, take to collect on an unpaid debt.
More details on all of these laws are readily available on various government websites.
Tips for Getting Paid on Time
It may be impossible to extend credit and yet guarantee your bills will be paid 100% of the time. However, there are certain basic steps you can take to reduce unpaid bills.
- Bill promptly; unless you have an arrangement where, for example, you bill on a calendar-monthly basis, get your bills out as soon as possible.
- Bill clearly; make sure the customer knows exactly what the bill is for and who to contact if there’s a question.
- Bill “proactively”; state on the bill (or on the cover letter) that the customer should contact you if there are any problems.
- Be prompt and clear with past due notices.
- Keep relevant records, including copies of past payment checks (which can show where customers have bank accounts) and copies of all correspondence with customers.
With some customers, you may get to a point where you will need to make phone calls and send special letters. When making phone calls, it’s important to avoid harassment. When it comes to collection letters, develop and keep on file basic templates that you can quickly customize for each particular customer.
The federal Fair Debt Collection Practices Act, mentioned above, does not apply to businesses trying to collect their own debts. However, states often have their own laws placing some limitations on what you can do to collect on a business debt. For example, lies, threats, abuse, and harassment are generally off-limits. If you are doing your own collection work, you should consult the relevant laws in your state.
Once you’ve gotten beyond a certain point with a non-paying customer, you are left with a few basic options. First, you can go to small claims court. This will take up some of your time, and still leave you with additional work to collect the money from the customer once you’ve obtained a judgment in your favor. Second, you can hire a collection agency. However, the agency will take a share of whatever amount is collected, and therefore reduce the amount you’ll actually receive if and when the matter is resolved. Third, you can hand the matter over to a lawyer—although, as with using a collection agency, this will cost money and therefore reduce the amount you’ll receive if and when the matter is resolved.
Nolo has a variety of other articles on credit and collection, including such matters as creditor and debt collection lawsuits and debt collectors and collection agencies. There are also various federal and state government websites that are worth reviewing; just one example is the FTC’s FAQ page on debt collection for consumers. For broader coverage in a single book, Legal Guide for Starting & Running a Small Business, by Fred Steingold (Nolo) contains an extended section on credit and collection issues