Yes, you need a Written Credit and Collection Policy
Many companies do not have a written credit and collection policy because they believe it is more trouble than it is worth. One of the benefits of a written policy is that it can reduce bias and subjectivity in the credit decision process.

If your company is going to offer credit – it needs a written credit and collection policy. Taking the time and effort to develop a well written policy will help you make consistent credit decisions so that all customers will be treated equally. It can also be used as a training tool, and it can help ensure continuity in the credit department when key personnel are on vacation, ill, or leave the company.

A Credit and Collection Policy must be kept current and customized to the way your credit department operates. Some of the questions that a properly written credit and collection policy will answer include the following:

-Will a credit application be required?
-Does the application need to be signed and if so, by who?
-Will a personal guarantee be required and if so, who must sign it?
-Will financial statements be required from the customer and/or the guarantor?
-How will the creditworthiness of the customer and guarantor be determined and who will make that determination?
-Who will review the application and the information received from the credit investigation, and what will constitute an unacceptable credit risk?
-If a decision is made to open the account on the requested credit terms, how is the customer notified and by who?
-If a decision is made not to open the account or not on the requested terms, how is the customer notified and by who? Also, whose responsibility is it to send the proper declination letter?
-What forms of security will the company find acceptable to help reduce credit risk?
-What are your terms of sale?
-Will an extension of payment terms be considered and, if so, who must approve the extension and what form will this approval take?
-What is the credit limit authority of the credit manager?
-Who in management can override credit decisions and in what form will that override take?
-When and how frequently will customers be contacted about past due balances?
-At what point would an account be placed on credit hold?
-Who authorizes credit holds and who should be informed of the credit hold?
-How often will the credit application be updated?
-Who has the authority to place accounts for collection?
-What method will be used to calculate bad debt reserves?
-At what point will an account be considered for write off?
-What are the goals of the credit department?
-Who is responsible for responding to trade reference requests received from other creditors? It is also important to know what information to provide and what not to provide.

All credit department personnel need to understand and comply with the Fair Credit Reporting Act (FCRA) and the Equal Credit Opportunity Act (ECOA). Actual and punitive damages can result for violations of either of these Acts.

The Credit and Collection Policy should be shared with sales and upper management. A well written Credit and Collection Policy will make it clear to sales and upper management why certain decisions are made, and therefore minimize potential problems between the credit and sales departments.

Keep the policy up to date; include procedures to help minimize credit risk; make sure that the policy is not so vague that it can be interpreted differently by each person in the credit department; include a chain of command so that everyone knows what their credit granting authority is.

Having a well written and up to date credit and collection policy can help prevent problems and minimize the loss of customer goodwill.

Obtaining a signed credit application is an integral part of extending credit to a customer. The application provides the information necessary to help determining the credit risk and to establish a credit limit. It also authorizes you to contact the bank and trade references and agree to your terms.

A credit application should include the following information. It can be changed to meet your company’s requirements as necessary.

-Customer Information
-Legal name of business
-Business and billing address
-Business phone number, fax and email address
-Date of incorporation and length of time in business
-Names of owner(s) or principal(s)
-Financial information

-Credit limit requested

-Bank information

           -Name and location of bank
-Account number
-Bank contact person and phone number
-Trade references (at least three)
-Name, address, phone and fax numbers
-Current audited financial statement when justified by the requested credit limit
-Signature block

        Owner or authorized party must sign and date application
-Terms and Conditions (Language must include):

-Declaration that the information provided is correct
-Authorization to contact references
-Acceptance of your terms & conditions
-costs and expenses if terms are in default
-venue and jurisdiction

-A Personal Guaranty should also be signed by a principal of the company when applicable. Even if a corporation is creditworthy, a creditor may require the personal guarantees of the partners, directors or officers of a business, and the shareholders of a closely held corporation.

Now that you have permission to contact their references, you need to do so.

A trade reference request should include the following questions.

-Date account opened
-Credit Limit
-Recent High Credit
-Current balance
-Past due balance
-Terms
-Days beyond terms
-Average days to pay
-Date of last sale
-Pay habits (within terms, slow, etc.)

-Comments
It is also necessary to verify that the business name on the submitted credit application is their correct legal name and that they are in good standing with the Corporation Commission or Secretary of State’s Office.

The results of a recent survey of members of the Commercial Collection Agency Section (CCAS) of the Commercial Law League of America (CLLA) show that at three months delinquent, 30% of accounts receivable will not be collected; at six months delinquent, over 45% of accounts receivable will never be recovered; and at twelve months delinquent, almost 80% of delinquent accounts will have to be written off. The results of this survey are an update from a similar survey conducted by the CCAS in 1997.

In our current economic times management understands that it is more important than ever to manage your costs of doing business. They understand that cash flow is the engine that drives businesses large and small and that delinquent accounts are the brakes that bring companies to a screeching halt. The current economic conditions have pushed many companies to extend the time they will permit an account to age prior to instituting formal collection efforts. This loosening of payment requirements may be severely impacting company’s cash flow and bottom line. This chart clearly demonstrates the importance of taking immediate action when an account ages past its due date. Past due accounts can play havoc on a company’s liquidity and tie up staff time that could be put to much better use. Companies must take a hard line on past due receivables and turn to professional help when their efforts have not proved successful.

In our current economic conditions, we are still seeing an increased level of defaults and litigation that involve failing businesses, especially small and undercapitalized businesses. Most business customers fully intend to pay when they apply for credit. However, you still need to protect yourself from the adverse economic impact when those customers do not pay. One of the best ways to insure that you get paid when dealing with a business is to obtain a personal guaranty.

If your customer does business as a corporation, a limited liability company or other form of entity with limited liability, then you may only look to the company for payment when things go bad. That is unless you have a signed writing stating somebody else or some other entity will be responsible for paying your customer’s bill if your customer doesn’t. We refer to this signed writing as a personal guarantee or a corporate guarantee. Corporate guarantees work similarly to personal guarantees except that the issuing entity should execute a resolution giving the entity the authority to make the guarantee.

One aspect that is often overlooked in guarantees is whether the guarantor has the ability to pay. Many companies just have the entity’s principal sign the guarantee without ever looking into that person’s credit history or assets. If the person has no ability to pay, what good is the guarantee? A credit report should be obtained so you know what the guarantor’s credit history looks like.

A word of caution is needed here! The FTC is a federal regulatory agency responsible for enforcing certain legislation, including the Fair Credit Reporting Act (FCRA). The National Association of Credit Managers (NACM) requested the FTC to provide an opinion regarding whether a vendor extending commercial credit must obtain consent prior to pulling a consumer credit report to be used for business purposes, or for a personal guaranty of business credit. The FTC states that a vendor must obtain the consumer’s consent prior to pulling a consumer credit report. As a general rule, the FCRA requires a trade credit grantor to obtain written authorization from an individual to run a consumer credit report. Before the FTC opinion, there appeared to be an exception to the FCRA in that consent seemed not to be needed if there was a legitimate “business purpose” in connection with a credit transaction. The FTC opinion does not recognize the business purpose exception.

The FTC notes that the business exception “provides no authority for a vendor to obtain a consumer report in connection with a credit application for any commercial purpose.” The FTC opinion also does not recognize a right to pull a consumer credit report for a personal guaranty without first obtaining consent.

A personal guaranty can help overcome the creditworthiness of a newly formed small business which often times is formed on a shoestring and the guarantor may have better creditworthiness than the business entity. It may also help the customer be more responsive to collection efforts because individuals tend to take their credit standing more seriously and would like to avoid any action that may adversely impact their credit score and history. With a personal guaranty on the line, your business customer will be less likely to simply walk away from your obligation.

It is imperative that the personal guaranty be signed by the guarantor as an individual, not as someone acting in their capacity as an Officer or Director of a company. Their signature should not include titles like President, CEO, Managing Member, etc.

Some companies use a personal guarantee included in the body of their credit application form, while others use it after the application signature line as a separate section with a separate signature line. Personal guarantors will look for ways to avoid individual liability for the debts of the company. To that end, it is best that the personal guarantee be separate and apart from the application and the Guaranty should be notarized to reduce the risk that the guarantor may assert as a defense to payment that the signature was forged.

The Equal Credit Opportunity Act, Regulation B imposes rules concerning extension of credit. Paragraph 7(d)(6)states:

1. Guarantees. A guarantee on an extension of credit is part of a credit transaction and therefore subject to the regulation. A creditor may require the personal guarantee of the partners, directors, or officers of a business, and the shareholders of a closely held corporation, even if the business or corporation is creditworthy. The requirement must be based on the guarantor’s relationship with the business or corporation, however, and not on a prohibited basis. For example, a creditor may not require guarantees only for women-owned or minority-owned businesses. Similarly, a creditor may not require guarantees only of the married officers of a business or the married shareholders of a closely held corporation.

2. Spousal guarantees. The rules in §1002.7(d) bar a creditor from requiring the signature of a guarantor’s spouse just as they bar the creditor from requiring the signature of an applicant’s spouse. For example, although a creditor may require all officers of a closely held corporation to personally guarantee a corporate loan, the creditor may not automatically require that spouses of married officers also sign the guarantee. If an evaluation of the financial circumstances of an officer indicates that an additional signature is necessary, however, the creditor may require the signature of another person in appropriate circumstances in accordance with §1002.7(d)(2).

Caution needs to be taken regarding spousal guarantees. Under Regulation B, § 202.7(d)(1), generally a creditor may not require the signature of an applicant’s spouse or any other person (other than a joint applicant) on any credit instrument if the applicant qualifies for the amount and terms of the credit requested under the creditor’s standards of creditworthiness. This rule applies to all open-end and closed-
end, secured and unsecured extensions of consumer credit and business credit.

If a creditor routinely requires spousal guarantees, for example, without first ascertaining whether an applicant is creditworthy, then conditioning the extension of credit on the spousal guarantee violates § 202.7(d)(1).

There are exceptions to the general rule. A creditor is permitted to take into account state property laws that directly or indirectly affect an applicant’s creditworthiness. For example, if a married applicant requests unsecured credit and resides in a community property state, the creditor may under § 202.7(d)(3)require the signature of the applicant’s spouse on any instrument necessary to make the community property available to satisfy the debt in the event of default.

The bottom line is that a personal guaranty should always be requested when the credibility of the business applying for credit is in question. The spousal guaranty should also be obtained when appropriate.

If you have any questions please do not hesitate to contact our office.

The Equal Credit Opportunity Act (ECOA) and Regulation B prohibits creditors from discriminating against credit applicants on the basis of race, color, religion, national origin, sex, marital status, age (provided the applicant has the capacity to contract), or because an applicant receives income from a public assistance program or has in good faith exercised any right under the Consumer Credit Protection Act. The Federal Reserve Board’s Regulation B at 12 C.F.R. Part 202 implements ECOA, and the staff’s official interpretations are incorporated in Part 202, Supp. 1.

At first glance many companies believe that the ECOA only affects consumer credit. Think again. A lack of knowledge of the specific requirements under the ECOA may leave sellers exposed to claims of discrimination by individual consumers, potential non-consumer buyers or, more importantly, from a class action filed against your company. Violators of the Act can face class-action suits. If found guilty, the offending institution could have to pay out punitive damages totaling the lesser of $500,000 or 1% of its net worth.

Under Regulation B, § 202.7 (d)(1), generally a creditor may not require the signature of an applicant’s spouse or any other person, other than a joint applicant, on any credit instrument if the applicant qualifies for the amount and terms of the credit requested under the creditor’s standards of creditworthiness. This rule applies to all open end and closed end secured and unsecured extensions of consumer credit and business credit.

If an applicant does not meet the creditor’s standards of creditworthiness, then the creditor may condition approval of the credit application upon the applicant either (1) furnishing the signature of another person (cosigner, guarantor or similar person), but the creditor may not require that person to be the applicant’s spouse, or (2) securing the credit extension with sufficient collateral (or in the case of an application for secured credit, additional collateral) to satisfy the creditor’s standards. Therefore, if a creditor routinely requires spousal guarantees, for example, without first ascertaining whether an applicant is creditworthy, then the conditioning of the loan on the spousal guarantee violates §202.7(d)(1).

There are exceptions to the general prohibition against requiring signatures of non-applicant spouses for creditworthy applicants under § 202.7(d)(1). A creditor is permitted to take into account state property laws that directly or indirectly affect an applicant’s creditworthiness.

Unsecured credit-non-community property state: If an applicant requests unsecured credit and relies in part on property the applicant owns jointly with the applicant’s spouse to satisfy the creditor’s standards of creditworthiness, the creditor may under § 202.7(d)(2) require the signature of the applicant’s spouse only on the instrument(s) necessary, or reasonably believed by the creditor to be necessary, under the law of the state in which the property is located, to enable the creditor to reach the property being relied upon in the event of the death or default of the applicant.

Unsecured credit-community property state: If a married applicant requests unsecured credit and resides in a community property state, or if the property upon which the applicant is relying is located in such a state, the creditor may under § 202.7(d)(3) require the signature of the applicant’s spouse on any instrument necessary, or reasonably believed by the creditor to be necessary, under applicable state law, to make the community property available to satisfy the debt in the event of default if:

(i) applicable state law denies the applicant power to manage or control sufficient community property to qualify for the amount of credit requested and

(ii) the applicant does not have sufficient separate property to qualify for the amount of credit requested without regard to community property.

Secured Credit: If an applicant requests secured credit, a creditor may under § 202.7(d)(4) require the signature of the applicant’s spouse on any instrument necessary, or reasonably believed by the creditor to be necessary, under applicable state law, to make the property being offered as security available to satisfy the debt in the event of default. Even if a corporation is creditworthy, a creditor may require the personal guarantees of the partners, directors or officers of a business, and the shareholders of a closely held corporation. In accordance with Regulation B, a creditor is prohibited from requiring the signature of the guarantor’s spouse in the same way that it is prohibited from obtaining the signature of an applicant’s spouse and the Official Commentary to Regulation B states that the signature rules of § 202.7(d) apply equally to guarantors. Thus, if a creditor first determines that the guarantor is not creditworthy based upon his or her individual assets, then, in accordance with the signature rules of § 202.7(d), the creditor may require an additional signature and that signature may be required to be the guarantor’s spouse’s in appropriate circumstances (i.e., in accordance with § 202.7(d)(2) (unsecured credit), § 202.7(d)(3) (unsecured credit involving community property) or § 202.7(d)(4) (secured credit)). In any event, while a creditor may require officers of a business to personally guarantee the business loan, and may require the guarantee of another person in appropriate circumstances, the creditor may not automatically require that spouses of married officers also personally guarantee the loan.

Credit Response or Declination Notice as required by the ECOA:

• Providing Notice: Within 30 days, business creditors must provide notice to an applicant of any adverse action. Under the statute, the term adverse action includes the revocation or denial of credit to an applicant, and change in the terms of a credit agreement already in existence, and/or a refusal on behalf of a creditor to grant credit in substantially the same amount or upon substantially the same terms as requested.
• Notice must be sent by the creditor if credit on the requested terms is denied or if credit is approved on less favorable terms than what was requested or less favorable than the creditor’s normal terms. The notice must contain a statement of the action taken; the specific reason for the adverse action; the name and address of the creditor; a statement informing the applicant of their right to request a written statement of the specific reasons for the adverse action within 60 days; and a copy of ECOA Notice 701 (a), along with the name and address of the federal agency that administers compliance.
• If a written request is made, the creditor must send a writtenstatement giving the reasons within 30 days. It is recommended that you draft a standard declination letter, which includes a declination statement, your name, address, phone number, fax number and/or email address, the reason(s) for the declination (which may be by checkboxes), and the ECOA Notice 701 (a). Specific reasons for the adverse action may include:
  • Delinquent credit obligations
  • Need for additional references
  • Unfavorable trade references
  • Inability to verify references

The ECOA requires that an applicant’s records be kept for 60 days after notifying the applicant of the action taken. If the applicant requests in writing the reasons for the adverse credit decision during the 60 day period, the creditor must retain the applicant’s records for at least 12 months.

Please contact our office for additional information, or a sample of a Declination/Credit Response Form.