Credit Applications and Related Legal Issues

After a number of years in the industry, it might be easy for a credit professional to overlook the credit application as something that’s more a part of the landscape than anything else. However, if an account goes bad, a haphazard credit application could make the collection process a lot more difficult. “Credit executives seem to have an attitude of ‘I’ve been around for a long time, I know everything there is to know about credit applications,’”
said Wanda Borges, Esq. of Borges & Associates, LLP in a recent CMA webinar.

Borges noted that while this may be the case, she’s noticed seasoned credit professionals in other presentations obviously being reminded, enlightened and refreshed about some easily overlooked and commonly forgotten credit application strategies. “I hope today for all of you on the line I will either refresh you as to some things you forgot about or teach you some things you never thought about with credit applications,” she added.

Borges delivered on this wish in her teleconference, entitled “Credit Applications and Related Legal Issues,” by offering attendees a quick and effective guide to all the ways a company should protect itself from customer
default and legal exposure using its credit application.

One of the first considerations to make when constructing a credit application is what information needs to be collected. “My primary rule of credit is ‘know thy customer,’” said Borges, who offered a thorough list of what
details should be collected up front to put the creditor in a more advantageous position. Specifically, Borges discussed the importance of getting corporation details, ownership details and to include stipulations about references.

Ownership details, Borges noted, can be of great use should a collection effort be necessary. “You want that information so you can go find them,” she said, adding that every application should require home addresses and ownership interest information for each owner of the business entity. For references, Borges suggested that credit grantors require at least three trade references and also stipulate that they can get references from the customer’s bank. “The trade credit reference is actually going to be the best of their trade credit references,” she said. “You are not limited to the references they give you.”

Borges’ presentation also offered participants text to include in a credit application to protect a creditor from exposure to laws like the Fair Credit Reporting Act, the Equal Credit Opportunity Act and the Fair and Accurate Credit Transactions Act’s disposal rule. She also offered tips on how to clearly organize the application to make sure the customer understands it and can’t reasonably plead ignorance in a court case.

Credit Applications Are Important Legal Documents

The role of credit applications in the credit and collections process was explained in a CMA teleconference Sept. 11, 2006, entitled, “Credit Applications Are Important Documents.” The presenter was Lynnette Warman of the Dallas-based law firm of Jenkens & Gilchrist.

Warman said that the credit application might serve several functions such as gathering pertinent company information, establishing a security interest, securing personal of corporate guarantees and establishing credit terms. “It’s important to get all the information you need from your customer,” Warman added; and advised getting the credit application completed with all the information it requests.

Some of the critical information she mentioned that should be obtained in a credit application included the legal name of the customer, legal names of the owners and manager and the street address of the customer—not a post office box. Warman stressed the importance of making sure the information is completely accurate. She recounted a Kansas State Supreme Court decision in March, where a company lost a security interest in a priority dispute because the first name of a principal of the debtor company was incorrectly spelled.

The organizational structure of the customer must be properly identified, she noted: whether it’s a sole proprietorship, a partnership, or an LLC can affect what actions for non-payment might be taken against it. “Each type of company has ramifications if you are trying to sue them for non-payment,” she said. She pointed out, for example, that if there is no personal guarantee from a corporation, there might be no recourse for non-payment. She also mentioned that with a sole proprietorship, one is able to sue the individual—as well as the business—for unpaid bills.

The information presented by a customer on a credit application should be verified. Warman noted that with the advent of the Internet, finding and verifying company information is easier: many Secretaries of State are now charging for corporate information they once provided for free, but it is more easily obtainable over the Internet. She also advised making sure all appropriate signatures are included on the credit application and that it is legible.

Stating in the credit application what court should have jurisdiction over any disputes has become more recognized by the courts, Warman said, and that it is important to also include that it is the customer’s responsibility to alert the creditor about any changes in its ability to pay. Any change in credit terms from the credit application should be sent out in the form of a written notice to the customer—and the credit application itself should be reviewed every couple of years to make sure it conforms to the latest requirements of relevant laws relating to business credit.