Extending Credit During an Economic Downturn

The current economic downturn has resulted in many challenges for business owners and managers. Companies want to maintain existing customers and find new opportunities, but money is tight all around. As a result, requests for credit from existing and new customers are on the rise. At the same time, valued employees may be facing economic challenges due to the economy and may seek a loan from their employer. In a variety of circumstances, it makes sense to offer credit to customers in order to keep production moving. Similarly, many employers consider making loans to employees. Once a company decides to extend credit, it is important to take steps to ensure that debt will be paid.

Loans to customers

In the commercial context, the lender and borrower are seen as having equal power to bargain. An agreement is made regarding the terms of the loan so the parties can transact business. When the agreement includes credit terms, an important component of the deal is requiring that the customer or debtor complete and sign a Credit Extension Application and Agreement. The Agreement should outline the terms and conditions, and request certain information from the customer which will assist your organization in not only evaluating the credit-worthiness of the customer, but will provide invaluable information if a dispute arises between you and your customer, and legal action is needed to collect your money.

The Agreement should set forth detailed rights, duties and obligations of the parties, including interest rates on unpaid balances, recovery of collection costs, recovery of attorneys fees, limitations of liability, limitations of warrantees, applicable law, as well as the location and forum for any legal action or alternative dispute resolution. Details such as choice of law, forum for legal action and who pays costs of recovery become very important if the creditor has to pursue the debtor for payment.

A company should review and update its Credit Extension Application and Agreement annually, to ensure its terms remain current. One problem encountered by companies when Credit Extension Application and Agreements are updated is securing the completion of a new Agreement by existing customers, who already have debts to the company. This problem can be avoided by including on the Credit Extension Application and Agreement a provision which incorporates into the Agreement the terms and conditions set forth on the invoice in the underlying transaction. With this provision, the company can update its terms and conditions with each transaction. Additionally, the creditor can make modifications to the terms and conditions when it becomes aware of difficulties with a debtor or product line, or when there is a change to law.

Attempting to collect past-due accounts from customers has become increasingly difficult given the current economic climate. However, with the proper Credit Extension Agreement in place, that task can be made far easier and, thus, the level of “bad debt” can be reduced dramatically.

Loan to Employees

Loans to employees present a different challenge. Many employers are inclined to approve these requests, expecting that the loan will be easy to collect through payroll, and will avoid productivity loss from an employee distracted by financial problems. However, because of labor laws, there are restrictions on the employer’s right to self-help in collecting the debt. Furthermore, by the time an employee is asking to borrow money at work, the employee is likely in a serious financial situation, and one more loan may not reduce the financial stress.

Once a decision is made to lend to an employee, there are two important things that should be done. First, write a policy that specifies when and if a loan will be made available. Employees talk, and once the first loan is made, the second request may not be far behind. Second, have the employee sign an agreement before any loan is issued. Without this, the loan cannot be collected through payroll.

A loan agreement with an employee should include the ability to withhold payments from payroll and an agreement to pay in full at termination. When considering the amount of a loan, the employer should be aware that this type of loan is usually subject to the 10 percent of gross wage withholding limit for “unlisted items.” If an employee is already subject to a levy against wages, the employer may not have the ability to withhold repayments. All of these issues should be considered before a decision to lend is made.

No business is immune from today’s economic climate. More than ever, careful deployment of resources is needed to ensure return on investment. If extending credit is a resource of choice, then collecting that debt is the only way to achieve that return.