Improving Your Credit and Collection Systems

Alex BarthetContracts, Forms

I am sure you have processes in place to collect debts. But as a construction law firm that helps folks in the industry collect their debts, we have seen the best and worst practices. In this article, we will discuss how to improve your collection practices and how to protect your interests.

Shore Up the Basics

Get it in writing: Make sure the agreement that you have with your customer is in writing. This might sound obvious, but recently, we had a case involving a new client who owns a plumbing supply house. His credit agreement was literally just an information form that the customers filled out. This client does millions of dollars in sales, and all it had was just a simple fill in the blank sheet which allowed it to run some basic credit information on the customer. No real terms and conditions of consequence were included. Reexamine the process that you have in place.

Make sure the credit application includes favorable terms. When you receive a purchase order it may reflect terms and conditions either on the document or, what we are seeing more and more now, a reference to a website with a series of terms and conditions. When you either sign or fill the purchase order, the law implies that you have accepted those terms and conditions. You need to be very careful about the terms and conditions that govern your transactions. We see this as a problem, sometimes with our supply house customers who routinely fill credit application or purchase orders that have terms and conditions that are contrary to their own terms and conditions, and their own credit application.

The number one term and condition that is most contentious is ‘pay when paid’.  A supply house will almost never agree to terms for payment that says pay when paid. But a supplier may inadvertently agree to such a condition if they fill a purchase order that says the contractor will pay the supply house only when he or she gets paid. So, make sure you read and understand the terms and conditions for every transaction. Also, let your team understand that you want your terms to govern every purchase order you fill and that you want to avoid someone’s unfavorable terms from creeping into your deal.

What are some of the terms that you should add to your credit agreement?

  • Payments – when are you going to get paid?
  • Interest – if someone owes you money in Florida, the law is that if your agreement says nothing about interest, you receive the legal rate. If you have a written agreement, you can set a higher rate of interest. Most agreements allow the highest rate of interest which is 18 percent. You will only be entitled to 18% interest rate if you have a written agreement that says so.
  • Recovering collection cost – you want to make sure that if you have to hire a lawyer to collect a debt that the fees and cost associated with that collection effort can be recovered. You can only do that if you have that term in your written agreement.
  • Warranty – what warranty are you providing? Many supply houses like to pass on to their customers only the warranty they receive from the manufacturer. To make that enforceable in Florida, you need to spell that out in your credit application.
  • Indemnity – You want the right to look to somebody else to recover a loss not of your making.
  • Time for performance – if something keeps you from delivering the materials on time because you didn’t have access to the site, then you don’t want to be responsible.

Having these terms and conditions in your agreement will protect you. What you need to do is to audit your existing accounts, and see who has what terms, or no terms. Then consider starting afresh with a new agreement.  Have a lawyer or your staff review the document that currently forms your understanding between you and your customers. When was the last time it was updated?

We have one client that updates its terms and conditions every time it has an issue so as to avoid another occurrence of that same issue. The terms and conditions in its agreement is a kind of living document. You should be doing the same thing. So audit your accounts to see who has a written agreement and who has an old agreement. Update your current agreement and then start fresh by getting new clients to sign the new agreement.

Here is a pro tip. it is sometimes better to have no contract than a contract with unfavorable terms.

As a subcontractor, this is often the case.  For instance, you are a subcontractor on a project and you are told to start work. As you are working, you are negotiating the contract. After some time, they tell you to sign their contract in order to keep working but you’ve already started. When they hand you the contract, there are terms and conditions with which you do not agree.  What you need to be able to do is to say no. Don’t feel compelled to sign their document. We had a client who was negotiating back and forth with a contractor. He was an electrician and he thought he was making progress in the negotiations. He was about 30% through the job at this point, and then the contractor said “look, if you want to pick up the next check, I need you to sign my contract with no changes whatsoever.” Had he come to us before that, our advice would have been “Don’t sign the agreement; you’re better off either with no agreement or stopping work because at this point you just have a handshake agreement. There is no obligation for you to continue to perform. Lien the job for whatever you are owed and move on to the next job because the terms and conditions you are asked to sign are so onerous that you should never sign. Unfortunately, he didn’t do that.  He felt compelled to sign the documents to pick up his check.  That turned the tables and now the contractor had a whole host of different contractual reasons to really put the screws to him, and it eventually resulted in litigation. Remember that sometimes, it is better to walk away with no contract than to try to accept someone else’s unfavorable terms.

Cap the credit you provide. Always limit your exposure by capping the credit you give to your customer. Don’t be afraid to cut your customer off. For instance, if you decide that you are going to give $50,000 worth of credit to somebody and now they have run through their $50,000 credit, don’t be afraid to say “no more –  we are not going to extend any more credit; if you want more credit, you need to pay down the balance.” Extending additional credit has to be done carefully because your customer will almost always agree to take as much credit as you are willing to give. This benefits them, with very little risk to them and great risk to you.

Bill regularly. If you don’t send the bill, don’t expect to be paid. Customers should be able to set their watch by how often you bill. Some supply houses bill almost immediately every time an order is made and then they send a monthly statement. As a general contractor or subcontractor, you probably send a periodic payment request maybe on the 25th of the month, or at different stages of the project. Whatever your agreement says or whatever your processes, make sure that it is followed and that the customer can count on the fact that they’re going to receive their bills regularly. The other thing that you need to be able to do is to consider billing disputed amounts. This can include work that constitutes a pending change order. This is a big issue for subcontractors. What we do when a client who is owed money (which may include amounts that are not yet billed) comes to us, is advise them to make sure that they generate the bill for all of the undisputed and disputed amounts. We then send that out with a corresponding lien.

Protecting Your Interests

Always secure your rights to get paid. Here are the three best ways that you can secure those rights.

  • Personal guaranty

A personal guaranty means you have the right as one extending credit to go after and recover the money that is owed to you, not just from your direct customer but anybody that signs the personal guaranty. Maybe it’s a principal, a shareholder or the owner. All you need to do is to have them sign on the dotted line and importantly, you need to have them to sign with no corporate designation.

For example, the credit application could be signed by John Smith, president of ABC plumbing. There is a separate section on the same document called the personal guaranty which has the personal guaranty terms and conditions. The personal guaranty section expressly states that this person that is signing is also guaranteeing the debt of the company, and that signature block says John Smith as an individual, is guaranteeing the debt. Some clients just include a line in the terms and condition that the signer agrees to personally guaranty the debt. That generally is not an enforceable personal guaranty. You should have the signature of the guarantor with no corporate designation.

  • Joint Check Agreement

Another great way to protect your rights to be paid is to get someone else to agree to pay you in addition to your customer. A joint check is effectively a two-party check. It’s a check issued by the contractor to both the subcontractor, and the supply house.  The plumber gets a check which says ABC plumbing and XYZ supply house. The two-party check has to be endorsed by both parties to be negotiated with the bank. But a joint check agreement is an agreement in advance with the contractor or the subcontractor or the owner, or whoever is going to be issuing the payment that states the check being issued shall include both subcontractor and supplier.

What you have to understand about joint check agreements is that if you sign the joint check agreement that is given to you by the contractor it’s likely going to be written in favor of the contractor. Most joint check agreements that are written by contractors, to pay subs and their suppliers, have a lot of disclaimer language –  it doesn’t obligate them to continue to pay; they can cancel it anytime; they have no liability whatsoever. That’s not a great way to protect yourself as the party extending credit. So, you need to either modify their agreement, or have a form joint check agreement in place ready to go. Tell the contractor that you would love to supply them labor or materials on the job but you would need whoever is going to be issuing the joint check to sign your corporate joint check agreement. Have that as a document in your portfolio of documents, so that you’re ready to go and as part of your collection process.

  • Construction Lien or Bond Claims

Ensure that your lien rights are secured. Don’t let these slide or make any exception. Jobs whose lien rights are not secured are often the jobs where you are going to have lots of money withheld, and a contractor or owner that goes out of business. Have a process in your office that you can bank on. That no matter what, any job over a certain amount of money, gets noticed and liened within the 90 days. The general rule is that the notice to owner must be served no later than 45 days. If the job is bonded, you would serve what’s called the notice to contractor, no later than 45 days from your first work. Also, you have 90 days from your last work on the job to record the claim of lien or serve your notice of nonpayment. These are the outside dates. You can decide to lien the job while you’re still working on it or send the notice of nonpayment while you’re still on that job. The longer you wait, the more risk it creates. So, try to do it sooner rather than later. Lastly, you have no later than one year from your last work on the job for bond claims, or one year from the recording date of the claim of lien. Before this last deadline, you need to file a lawsuit to preserve your rights. There is no such thing as re-recording the lien or sending a new notice of nonpayment. You have to file a lawsuit to either foreclose on the lien or sue the surety within that one year. You shouldn’t be waiting anywhere near a year. Take the necessary action much more sooner than that.

Pro tip on the personal guaranty:  if you really want a great security, you need to get the husband and the wife to sign the guaranty. You cannot touch assets that are jointly owned by the husband and the wife if the guaranty is signed by just one of the two. The only way you’ll get access to those joint assets in most cases is if the guaranty is signed by the husband and the wife. Not that it’s bad just to get the husband or the wife to sign, but if you want real protection for certain accounts, know that you need both the husband and the wife.

Be a Reasonable Bulldog

  • Contact delinquent accounts often. It is obvious but a lot of folks just don’t like doing it, as they feel uncomfortable. You need to do it verbally and in writing. You can be nice but be firm when you do it. You may do it weekly, and sometimes even several times a week for those really stubborn accounts. Be prepared to reject excuses and at the same time offer options.
  • Offer multiple methods of payment. Ideally you like to get a check but your customer wants to pay with a credit card. Go ahead and take the credit card.
  • Payment Terms. Be flexible with your payment terms. Try to creatively work down debts. Your customer might be willing to pay a thousand dollars a week for 5 weeks to retire his/her debt. Be willing to offer those options.
  • Partial payment. Maybe your customer can’t agree to a long-term payment plan or even a short-term payment plan. All they can do is to pay what they have at that moment. Take it. There is no reason you should be rejecting partial payments as long as you are not giving up any more rights than the amount of money that you’re getting. Reduce the debt. Instead of fighting over $10,000, maybe you can only fight over $4,000. So, anytime anyone is willing to give you a partial payment, and you’re not giving up any more rights than the amount of money that you are getting, you should be willing to accept it.
  • Additional security. You can place some additional security as part of the waiting process. For example, if you didn’t have a personal guaranty before, you can send the document to the customer as a condition for you waiting on payment. Or maybe if you have a personal guaranty with the husband, you get the wife on if you agree to keep waiting.
  • The squeaky wheel always gets the grease. The more you hassle those who owe you, the more likely it is that you are going to move to the top of the line in getting paid.

Always be willing to resolve disputes quickly and in writing. Do your best to resolve any issues on the job as quickly as possible. Maybe the work wasn’t great or it arrived late or damaged. It is always better to give up a credit in exchange for a prompt payment.

Pro-tip: Don’t just agree to give a credit. Always condition your credit in exchange for prompt payment. Also, ensure you document that agreement in writing.  For example, you can send an e-mail or a text message to the customer telling him or her that you would reduce the amount they owe you if they can pay before a specific date. If you don’t get the money before the date you specified, then the condition hasn’t been satisfied.

Avoid emotional decision making. Leave your emotions at the door. This is business, so make business decisions. The clients that spend the most money with us as lawyers are the clients that become too emotionally involved in being proven right. We counsel our clients on a regular basis to make rational business decisions, even if that means taking a little less.

Don’t delay in initiating the legal process. The longer you wait to enforce your legal rights, the harder it is going to be to collect. If you try everything you can to get paid and it still hasn’t worked, don’t wait month after month. Hire a lawyer and pursue the collection process aggressively. The sooner you do it, the more likely you are to get paid.