Wesley F. Agee
wfa@jenkinsfenstermaker.com

Extending Commercial Credit in Tempestuous Times

What a scary time it is! Volatile Stock markets.  Global Credit Markets are strained.  Talk of a world wide recession or depression.  Falling housing prices.  Increased unemployment. Fear.  Need I say more?  Granting credit to your customers is necessary for your business, but there is always risk, especially in these tumultuous times.  Many businesses will face tremendous difficulties.  As a small business owner, you must try to minimize that risk and improve your chances of receiving payment from your customers.  Here are methods which should improve your chances of being paid:

1) Your sales and credit departments must cooperate.  The sales staff fears offending customers and losing sales, but they must understand it is necessary for your company to conduct credit and background checks of customers.  Credit managers must obtain detailed, accurate and extensive credit information before and during a transaction and maintain or improve this information.

2) Request and obtain the written personal guarantees of payment by the principals of your customer, including shareholders and partners.

3) Try to become a secured creditor.  A secured debt is an obligation to pay money that is "secured" by specified property, known as collateral, in the event of non-payment.  Secured debt on personal property, such as equipment, inventory, goods, and personal property is created by retaining a security interest in the various assets of your customer.  A security interest is a lien on personal property.  "Personal property" is anything other than real estate.  Equipment and inventory are examples of personal property.  On the other hand, a mortgage (or deed of trust), a judgment or tax lien will create a lien on real estate.

Enter into a security agreement with your customer which gives you a security interest in not only the inventory and equipment you sell the customer (purchase money security interest), but also in the customer's other inventory, equipment, furniture, fixtures, accounts receivable and other similar items (non purchase money security interest). 

The beauty of a purchase money security interest is that this type of lien on personal property has "super priority status" over previous liens, if done properly.  If you sell equipment and/or inventory to a customer on credit, you can retain a purchase money security interest in the equipment and/or inventory you sold as collateral to secure payment of the balance of the purchase price.  Purchase money financing has an exalted history, one in which the courts have traditionally established preferential rules designed to protect the new money injector.  A purchase money security interest is a security interest in specific equipment or inventory which trumps an otherwise senior blanket security interest in the same collateral.  The typical example of the importance of the purchase money security interest is when the customer has an ongoing relationship with its local bank which has a blanket security interest in all the customer's assets and after-acquired property.  For example, the customer decides to acquire some additional equipment and the seller agrees to finance it.  Ordinarily, that equipment would be subject to the bank's blanket lien and the equipment seller would be in a second priority.  But, if the equipment seller follows some very specific procedures, it may achieve a purchase money security interest status, and therefore may trump the bank as to this new equipment.  Therefore, a properly perfected purchase money security interest trumps prior blanket liens, landlord's liens, buyers in the ordinary course, and judgment liens.

A properly perfected security interest in your customer's assets can give you various remedies in the event of non-payment, including repossession of the collateral in some circumstances.  Secured creditors generally receive payment before unsecured creditors in a bankruptcy proceeding, so obtaining a security interest in the personal property of your customer, increases the possibility of payment or partial payment if your customer files for bankruptcy.  Prior to negotiating and signing a security agreement, consult with an experienced business attorney who can guide you through the many requirements to become a secured creditor.  Collateral should be obtained by signing the security agreement at the beginning of your dealings with your respective customer, or when they are optimistic and their business is going well.  After your customer owes you, and perhaps other creditors, they usually will not cooperate by signing anything.

If you have taken these precautions and your customer still does not pay, you must consult with an experienced business attorney about your remedies under the security agreement and the law.

If a creditor has not paid you and you do not have written personal guarantees or security interest in various assets of your customer, an experienced business attorney may advise you to either (a) try to restructure deals to obtain collateral and a revised payment schedule or (b) file a lawsuit to obtain a money judgment.  This latter option may become a race to the court house with other creditors and it is always possible that you will collect nothing because you did not obtain the proper credit security up front.

If you think your customer may have dealt with business assets improperly or transferred assets to friends or family for little or no payment, an experienced bankruptcy attorney may advise you to file an involuntary bankruptcy proceeding against the customer if they owe money to other creditors.  An involuntary bankruptcy proceeding gives creditors the vast power of a bankruptcy trustee who can investigate what happened to the business assets and possibly reverse any improper transactions.

In these volatile times you can minimize your payment risk when extending commercial credit to a customer by doing your homework about your customer's credit worthiness and background and by getting the written personal guarantees of the principals of your customer and obtaining a security interest in the assets of your customer's company.

Part of the benefit of reading our newsletter articles is to let you know there are options out there.  This is not a manual on Security Agreements or creditworthiness but it does tell you there are things that can be done.  If you think there is a sale or extension of credit that you want to try to secure, even after the fact, the attorneys in the Business Services Section of Jenkins Fenstermaker, PLLC can assist you.