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Credit Extensions are Loans

Originally Published: June 2010

Insist on a Completed Credit Application

With the onset of the recession in 2008, businesses have found it difficult to obtain credit lines from banks. As a result, more and more businesses have been using trade credit terms to fill the gap. Most fail to appreciate, however, that, like a line of credit, credit extensions to buyers are essentially loans.

Now, if you were to go to your banker for a loan, you would expect him to require a completed application. So, it makes sense that when a potential buyer asks you for credit terms, which basically is an interest-free, short-term loan, you should also require a credit application. Apples to apples, right?

So why do many credit grantors shy away from using credit applications? Fear. Fear that requesting completion of the credit application will result in the loss of a sale.

With businesses just beginning to recover from the global recession, every sale is critical. And, while making the sale is important, getting paid is what sales is all about. This is where utilizing a credit application can make all the difference.

A well-constructed credit application should be one of the cornerstones of any credit professional's credit extension policy. Properly constructed and executed, it can:
  • aid in the decision to extend credit to potential customers,
  • serve as a point of reference for gathering information in the event of non-payment,
  • function as an enforceable document if litigation becomes necessary.
Any financially sound buyer with good credit credentials should have no objection to completing an application. If anyone does object, it should alert you that something may be wrong – either the buyer is already trading beyond his financial limits or has something else to hide. If a potential customer refuses to buy from you because you insist on a credit application, the sale was probably headed for disaster anyway. So, even in this case, requiring a credit application helped you to make a sound credit decision by weeding out a potential bad debt situation.

Essential Elements of a Credit Application

The Sample Credit Application (pdf format) which accompanies this article was designed for use by an American seller with an American buyer. However, with the minor changes below, it should also work for international transactions. (Note: You should seek the advice of a qualified attorney in the design of your credit application.)

Elements we recommend be included in a thorough credit application:

All logistical and legal data on the customer, including their exact legal corporate name, legal status (i.e. corporation, partnership, LLC, etc.), relevant state or national identification numbers, the names of all principals or corporate officers, and of course place of incorporation, address, and phone and fax numbers.

This detailed profile will help you locate an evasive customer in the event of non-payment. The exact legal status of the business is vital in terms of future collections. For instance, if the business is a corporate entity, unless you have a signed personal guarantee, it will not be possible to attach the owner’s personal assets.

Bank account information – in the event you have a judgment and need to attach company assets.

Trade references, preferably in your own industry.

Unfortunately, the customer usually provides only his “good” references. Still, you should check the ones included on the credit application. Then utilize another source, if possible, like an industry credit group.

Personal Guarantee of the primary shareholder. Recommended for any new customer in business less than 5 years, or new foreign customers on which you are unable to obtain extensive credit information and references. Make sure you get the guarantor’s home address, tax identification number or Social Security number (in the U.S.) and the equivalent information from foreign customers.

A staggering number of businesses do not survive their first five years of operation and it is often difficult to obtain much credit information on new foreign customers. Thus, it should be a rigid credit policy that a Personal Guarantee is required of any business fitting these profiles.

The Personal Guarantee is an added protection for you. If the buyer company does not have the ability to pay your account, a Personal Guarantee makes it possible to collect from the shareholder’s personal assets. Understand, however, that it is only as good as the financial worthiness of the guarantor.

On the Sample Credit Application, take particular note of the section "For Proprietors, Partners and S-Corporations." Also note the second to last sentence in the Personal Guarantee, which reads: "I authorize the seller and their assigns to obtain a consumer credit report and to contact my references as necessary."

You might wonder why these clauses are included on a commercial credit application.

The U.S. Fair Credit Reporting Act (FCRA) requires sellers, when selling to consumers, to obtain specific written permission from them before obtaining a consumer credit report.

In the U.S. commercial sector, sellers have routinely depended upon consumer credit reports when the buyer is a proprietor, partnership or s-corporation since, in these instances, it is the individual’s credit-worthiness, not the company’s, that is being considered for trade credit.

Commercial credit grantors have traditionally held they should be exempt from FCRA jurisdiction when a trade debt transaction is the basis for ordering such reports. And, in fact, the Federal Reserve Board, which is charged with enforcement and oversight of the Equal Credit Opportunity Act, has held that trade debt is exempt from the provisions of that law.

Nevertheless, obtaining the customer's consent to pursue a credit report is still recommended as the best strategy to avoid any potential controversy.

Terms and conditions. If the account ends up in court, you'll need to prove that the buyer was fully aware of the terms and conditions of the sale. Absent a formal contract of sale, a signed credit application that includes this information is your proof.

Arbitration clause. Including an arbitration clause in your credit application gives you a tactical advantage over the debtor. It permits you to specify jurisdictional location and method of recovery when your customer operates in a market where a credit application is not a recognizable or enforceable document. Arbitration is also generally much faster and less expensive than resorting to a lawsuit, especially in a foreign country. See our article, Final and Binding Arbitration.

Credit grantors should make sure this clause reflects their location and language, as well as the number of arbitrators and the name of a competent arbitration authority in their country.

The particular clause in this Sample Credit Application (page 2, para 2) is structured so that any arbitration proceeding will be undertaken as inexpensively as possible. Since most of the trading world recognizes the 1958 New York Convention on the Enforcement of Foreign Arbitration Awards, including this clause in your credit application is an added protection in case of dispute. (For the full text of the Convention and a complete list of countries that are signatories, visit www.adr.org)

Include the same clause in other documents, such as your order form or order acknowledgement.

The International Credit Application

There are a number of special conditions that should be considered with foreign buyers.

  1. Make sure the credit application is signed by an authorized person. In the United States, there is the concept of “strength of title”. This means, for instance, that a Vice President’s signature on any corporate document would be legally binding on the company, even if he was not authorized by the company to sign on its behalf. 

    In most other countries, however, there is no such concept. The only person that can legally sign documents for a company (including credit applications, contracts and other documents) is the person who signed the official company register and was named as the person authorized to contract for the company. If another person signs, the document will not be legally binding.

    Many countries now have online access to the company register. In any search engine, just search on “company register” and the name of the country where the customer is located. While some countries will have this information only in their own language, many provide bilingual information in English and the country’s native tongue. If you can’t get it in English, use translate.google.com, a free service.

  2. If at all possible, make the credit application bilingual.

  3. Ask for the customer’s Swift code or IBAN number.

    The Swift code is a standard format of Bank Identifier Codes approved by the International Organization for Standardization (ISO). It is the unique identification code of a particular bank, in this case the customer’s bank. The IBAN (International Bank Account Number) is an international standard for numbering bank accounts.

Don’t Let a New Customer Talk You Out of the Credit Application

In the US and many western countries, the use of credit applications is an established commercial practice. However, there are some foreign markets in which use of credit applications is either completely unknown or very limited. In these instances, there is no reason to forego your requirement. If your customer balks at the prospect, you can always claim it is a requirement of your bank or your credit insurer.