Editor’s Note: Paul A. Fanning is a member of the Financial Institutions Section and Creditors’ Rights Practice Group of Ward and Smith, P.A.
Whatever your business model, collecting past due accounts for goods or services provided is the last thing you want to worry about. Implementing simple procedures and policies at the beginning of a credit relationship often can eliminate many of those concerns. Being proactive and organized on the front end of credit transactions may save you both time and money.
Hope for the Best, but Plan for the Worst – Put it in Writing
The first step is to compose and require credit documentation. Credit documentation is a general term that encompasses a broad range of documents. Common examples include a credit application, financial statement, credit agreement, promissory note, guaranty agreement, monthly billing statement, and invoice.
Credit documentation serves several purposes. It can assist you in determining whether to extend credit and, if so, how much. Credit documentation evidences the existence of the debt and defines the debtor and creditor. Credit documentation should set forth the specific terms of a credit relationship, including the credit limit, payment terms, events of default, interest rate (if any), and reimbursement of attorneys’ fees if legal collection action becomes necessary. Credit documentation also can provide information about the debtor which will assist you in collecting the debt if it goes into default.
Know Your Customer
Perhaps the most effective way to avoid a bad debt is to know your customer. At the beginning of a credit relationship, it may be prudent to spend a little time learning about the reputation and wherewithal of the customer. One of the best ways to accomplish this task is to require the customer to fill out an application that requests financial and reputation references. Don’t be afraid to call the references. Another resource is a credit report or, if your potential customer is an established business, a Dun & Bradstreet® report.
It also is important to know both the customer’s legal status and the customer’s legal name. For example, your customer could be an individual, sole proprietorship, partnership, corporation, limited liability company, or some combination of these entities. It is important to know with whom you are dealing and who will be responsible for payment of your bills.
To avoid confusion or a "convenient" misunderstanding, require the potential customer to provide the customer’s precise legal status, legal name, Social Security number, or, if the customer is not a natural person, tax identification number. Insist on the full name, address, and telephone number of each person or entity with whom you will extend credit or provide goods or services. In addition, request documentation showing the true identity of the individual or company and its legal status. Most individuals have a driver’s license, complete with address and photographic identification. A corporation or limited liability company authorized to do business in North Carolina will be listed on the North Carolina Secretary of State’s website. A search can be conducted at http://www.sosnc.com.
More is Better
Legally married couples enjoy a unique and favored status under North Carolina law. Generally, one spouse is not responsible for the individual debts of the other spouse. Commonly, a married couple’s most valuable asset is their residence or other real property. Unless they are both liable for a debt, these valuable assets will not be available to you if collection becomes necessary. As a result, it often is better to have both spouses sign your credit documentation if the potential customer is an individual or a partnership consisting of individuals.
Likewise, it often is prudent to obtain signed guaranty agreements from owners of closely held businesses. Generally, owners of a business entity such as shareholders of a corporation or members of a limited liability company are not personally responsible for debts incurred by their corporation or company. Often, and intentionally, shareholders or members will have valuable assets, while their business entity does not. In addition, when times are bad financially, shareholders and members tend to pay debts that they have co signed or guaranteed over debts that they have not. One possible solution is to require the business owners and their spouses to sign your credit documentation or to sign written guaranties.
Money Now versus Money Then – Interest
Interest is a concept that can be agreed upon by the parties. Be aware, however, that North Carolina has certain usury (maximum interest) laws that must be considered in setting an interest rate for your unpaid bills. However, there is no limit on interest charged for commercial transactions.
Parties can agree to an interest rate, finance charge, or late fee (these are often interchangeable terms). For example, a contract establishing an unsecured account or credit line may provide for interest, finance charges, or other fees at a rate not to exceed 1½% per month computed on the unpaid portion of the balance of the previous month, less payments or credit within the billing cycle, or computed on the average daily balance outstanding during the current billing period. If there is no agreement or the contract does not contain an express provision about interest, a notation on an invoice that there will be due and payable 1½% per month interest or finance charge for unpaid items or services past due 25 days from the billing date is valid. North Carolina does not permit interest or finance charges to begin accruing on consumer accounts before 25 days after the billing date. If there is no agreement, the contract does not provide for it, and there is no notation on your invoice or billing statement, you will be entitled to collect the legal rate of interest (currently 8% per annum) from the date of breach (the date the payment becomes past due) until the bill is paid.
Recovery of Attorneys’ Fees
Under certain circumstances, you may collect reimbursement of your attorneys’ fees. To do so, there must be a written and signed agreement evidencing the debt which specifically includes a provision permitting recovery of "reasonable" attorneys’ fees in the event you hire an attorney to collect the debt. A further requirement is that your customer, upon default, receive written notice from you of your intent to enforce the attorneys’ fees provision contained in the written agreement. The notice must provide that your customer has at least five days after the date of the notice to pay the outstanding balance without incurring liability for attorneys’ fees. The notice also should provide that if the outstanding balance is paid within such time, the obligation to pay attorneys’ fees is null and void.
In most cases, North Carolina law requires that a lawsuit or other court action actually has to be filed in order for you, as the creditor, to be entitled to attorneys’ fees. No fees are recoverable by you just because your attorney drafted and sent a demand letter. North Carolina law also specifies that only "reasonable" attorneys’ fees may be collected, and defines reasonable as 15% of the outstanding balance as of the date suit is filed.
The squeaking wheel gets the grease first. This is often true in the debt collection context. A customer may receive many bills in a given month. All else being equal, the creditor who calls and writes the most is likely to receive payment before other, more passive, creditors. For that reason, it is a very good idea to monitor the status of your past due accounts regularly and initiate regular communication with the account debtors. However, be careful in how you communicate with a customer who is past due in payment. Communication for harassment or other improper purpose is against the law.
For example, start with an invoice. If the invoice remains unpaid for 30 days, send a reminder invoice with a late fee added. If the invoice still remains unpaid, place a telephone call to the account debtor. Keep regular and professional contact and communication. If done correctly, this serves several purposes. It confirms receipt of the invoice. It provides an opportunity to learn about any reasons for nonpayment. It lets the customer know you are providing goods or services for them and you expect timely payment in return. Periodic reminders and communication will go a long way toward reducing past due accounts.
In summary, document your credit relationships, know your customer, be diligent and proactive with collection procedures, and be knowledgeable about the collection process. Doing these things will help you and your business stay focused on those things that are important to make your business successful.
© 2008, Ward and Smith, P.A.
Ward and Smith, P.A. provides a multi-specialty approach to the representation of technology companies and their officers, directors, employees, and investors. Paul A. Fanning practices in the Financial Institutions Section and Creditors’ Rights Practice Group. Comments or questions may be sent to email@example.com.
This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.