Risks of Extending Credit

Multiple arms with hands holding cash.Growing your company is probably your foremost priority. It might be tempting to jump into the major leagues, but doing business with the big boys can lure you into making questionable choices. Regardless of your industry, extending credit can quickly get out of hand. You can find yourself in a position of extending tens of thousands, if not hundreds of thousands of dollars, in credit without realizing it. It can happen almost overnight. If you’re not a bank or a financial lender, chances are your company cannot and should not handle the risk of nonpayment for goods and services delivered. As tempting as it might be to win a contract from one of the big boys, their outstanding credit you extend can cost you your business.

Here are just a few examples of clients who found themselves having overextended credit before seeking professional assistance with receivables. Some are still in business today; others – sadly – are not.

Extending Credit To A Bankruptcy Trustee Seemed Like a Safe Bet

I’m am currently representing a small business lender. A bankruptcy trustee requested work from one of the companies they financed in a construction job. It was a post-petition claim, made after the bankruptcy filing. (Post-petition debt is all debt incurred after filing a bankruptcy case. These debts will not be part of the bankruptcy case and require payment from the debtor.)

The borrower thought they would definitely receive payment since the trustee had requested the work. The small business went right in and made a strong effort to complete the job. However, in a short time, they were into the project for $850K.

The project folded rather quickly, leaving no chance for the borrower to repay its loan to my client or other creditors. Although our client has a security interest in the customer’s assets, the only asset is the company’s receivables, which is mostly comprised of the $850K receivable that will prove to be uncollectible. There is little or no chance that my client will realize any recovery on their loan from the corporate borrower or guarantor.

General Contractors Crush Family-owned Company

A few years ago I posted photos on social media of a visit to one of my fabrication clients. The visit impressed me. I saw first-hand the beautiful workmanship that this company produced. They had an illustrious history of years of business with a list of successful projects.

Unfortunately, they began to take on projects from large general contractors well-known for non-payment. Rather than stopping at one or two of these projects after not receiving payment, the client kept taking on more work from these general contractors.

To make matters worse, the client would not pursue their customers for payment beyond past demand notices. They were afraid of pushing too hard and losing the customers.

I am sad to report that today the metal fabricator no longer exists. They shut down after 40 years in business when they were no longer able to make payroll. The GCs that hired them are, however, still in business.

When Accounting Firms Don’t Add Up

Accounting firms engaged by clients and asked to do work for multiple entities all at once can find themselves overextending credit. Even when you receive a retainer prior to commencing with the work, the retainer is quickly exhausted. Bills from the accounting firm that are not sent out for thirty days and have payment terms of net 30, which means 60 days of waiting, can often find themselves into the engagements for thousands, if not hundreds of thousands of dollars.

Accounting firms often risk problems with these larger and more complex accounts, regardless of how attractive they appear to be. The cost of money and the risk of non-payment are heavy burdens that could put a firm out of business.

A colleague and I met this past week and discussed the most common challenges clients face. After they see stars or $$$ signs, they may not be thinking of the potential exposure. Sometimes they can get in too deep with no way out. This is compounded when you consider the cost of money. Remember, they must continue to make payroll, cover overhead expenses and pay suppliers. Once they hesitate to “pull the trigger” to obtain payment, they risk losing their chances of payment. Then they discover that doing business with the big boys can cost.

No business owner or manager can deny the euphoria of bagging a large client or project. It takes a lot of discipline to evaluate the risks inherent in what looks like a big win. There may be a bit of shame or fear, or maybe both, as the days click by and payment has not materialized. Making choices now is a quagmire. How many letters and phone calls do you make? How tough should you get? Are you willing to lose this client? Can you afford to lose some or all of the outstanding debt? How long should you allow this to go on before stopping the job or pulling out? Do you need a lien? When does a client become a liability? When do you engage a debt collection attorney?

If you want answers to a specific case or would like to learn more about how to protect your company, get in touch with us for a consultation and let’s see if we can help you enforce your rights to payment.