If you are a business owner, you have agreed to accept and deal with various risks most nine-to-five employees avoid. By showing up for work for specific hours, employees are generally guaranteed to be paid. Business owners, on the other hand, don’t get paid unless a costumer walks in the door, places an order, requests a shipment, etc. Also, your business may provide many goods or services on credit. You must deal with—and attempt to minimize—the risk of not being paid after providing goods or services. This post addresses, from the perspective of an attorney who regularly attempts to help clients who deal with non-payment, five points that will help your business avoid unpaid accounts receivable and, when they cannot be avoided, help you recover unpaid accounts receivable.
1. If Possible, Get Paid Upfront
Although obvious, this suggestion is worth stating. Ideally, your business will receive payment before providing any services or goods. It is difficult, if not impossible, to have unpaid accounts receivable when you are always paid in advance. But payment in advance is not always possible—of course—depending on the nature of the business, the clients, and many other factors.
2. Require a Personal Guaranty
Usually, smaller businesses are at greater risk of going under than larger, well-established businesses. If your business provides goods or services to a small business on credit (before getting paid), you risk going unpaid if that business encounters difficulty and goes out of business. When the business is dissolved or no longer has assets, you are out of luck. One way around the corporate protections that prevent you from seeking payment directly from business owners is to require a personal guaranty.
A personal guaranty is a legally binding promise that a person will fulfill the financial responsibilities of another person or entity. For example, an owner of a small business can sign a personal guaranty that he or she will be personally responsible for any debts his or her company incurs to your company. If the company doesn’t pay the debt and goes out of business, the owner would be personally responsible for the entire debt. You could go after this owner’s personal residence, vehicles, boats, bank accounts, and other assets to recover the amount owed. Having a personal guaranty also motivates owners to succeed and overcome business difficulties rather than throw in the towel and leave you hanging dry.
3. Require Collateral
Another method of insuring payment when you provide goods or services on credit (before getting paid) is requiring some type of specific collateral that can be used to satisfy the debt if it goes unpaid. This type of collateral is often called security. It turns an unsecured debt into a secured debt, which is always preferable.
Collateral—or security—may make more sense in larger transactions and can include items such as equipment (trucks, cars, boats, backhoes, diggers, etc.), accounts receivable, and even real property when appropriate. For instance, you could draft a trust deed to secure a debtor’s obligation, which would allow you to sell the property if the debtor didn’t pay and use the sale proceeds to satisfy the debt.
Another benefit of having collateral—in addition to a higher chance of recovering the unpaid debit—is that you can often avoid the time and expense of litigation.
4. Use a Written Contract with Interest and Attorney Fee Provisions
Many business contracts are formed through smiles, friendships, and good intentions. This is not necessarily bad unless a party breaches the contract and leaves a debt unpaid. A written contract spells out parties’ obligations, making it harder to dispute, misunderstand, or ignore the terms of the contract. It also makes the contract easier to enforce in court—it helps avoids he-said-she-said arguments.
A written contract can also make unpaid accounts much less risky by including two important provisions: interest and attorney fee clauses. Having interest spelled out in a contract, although important, is not as crucial. If a contract does not state an interest rate on unpaid accounts, the default rate under Utah law is ten percent (10%) per annum. If you want a higher interest rate, such as eighteen percent (18%) per annum, and if you want compounding interest, this must be stated in the contract.
An attorney fee provision is often a crucial provision if unpaid accounts go to collection. Under Utah law, if a customer doesn’t pay, he or she is usually not responsible for collection costs, such as attorney fees, unless the contract states otherwise. This sometimes makes smaller debts unrecoverable. For example, if a debt is only $5,000, the cost and risk associated with debt collection may be too high to justify pursuing the debt. You could easily spend more than $5,000 chasing a debt. An attorney fee provision minimizes the risks associated with collection. If you can get a judgment and locate money or assets, the customer will have to pay all the associated costs and work, in addition to the underlying $5,000. Your loss is greatly minimized.
This does not mean debt collection has no risks. Even with an attorney fee provision, there is no guarantee that assets exist or that the debtor won’t file for bankruptcy, among other risks.
5. Use a Contract Appropriate for Your Industry
Know your industry or make sure you work with an attorney who does. Each business will be tied to specific laws, regulations, or legal standards that will affect what should be included in your written contract as well as provisions that will help you minimize risks in your particular branch of business. For instance, if you own a self-storage facility, there are various provisions that must be in your contract with clients, which allow you to recover unpaid rent. If you are in the business of selling goods (such as computers, bicycles, plumbing supplies, boats, etc.), there are other provisions in a contract that will help you (when you seek amounts owing on unpaid invoices) avoid unfounded claims that the goods your provided were defective. In short, it is worth the money to hire an attorney with expertise in your area of business so that you can best advance and protect your business interests.
Assistance with Unpaid Accounts Receivable
If you are just starting your business and would like help with some of the issues discussed above, or if you are a long-time business owner dealing with the stress and difficulty of unpaid accounts receivable, I am happy to help. I offer a free consultation. My direct dial is 801-365-1021, and you can e-mail me at [email protected].