This is a topic I promote on a regular basis. Why? We receive collection matters on a regular basis for businesses that have ceased doing business and there are no assets worth pursuing. The creditor is not supposed to be happy when payment is not received. But it is you, the creditor, that is in the best position to set yourself up to get payment. Signed credit applications, contracts and engagement letters are good things and I encourage you to get them from your customers. I also encourage you to understand the form in which your customer does business.
If your customer does business as a corporation, a limited liability company (LC, LLC) or other form of entity with limited liability, then you may only look to the company for payment when things go bad. That is unless you have a signed writing stating somebody else or some other entity will be responsible for paying your customer's bill if your customer doesn't. We refer to this signed writing as a personal guarantee or corporate guarantee. Corporate guarantees work similarly to personal guarantees except that the issuing entity should execute a resolution giving the entity the authority to make the guarantee. So as we talk about guarantees, the concepts apply to both personal and corporate guarantees. If I use the term person, it includes entities. (Also, don't exclude other types of entities just because we called them "corporate" guarantees.) And remember, you can have multiple guarantors on one account.
An often overlooked item in guarantees is whether the guarantor has the ability and willingness to pay. Many companies just have the entity principal sign the guarantee without ever looking into that person's credit history or assets. If the person has no ability to pay, never has and never will, what good is the guarantee? The best thing a guarantor could do to protect himself/herself is to make sure all of the assets he/she wants to keep are in somebody else's name along with any income streams. What does that do for you as the creditor when you need to collect? Not much! Next, what does the guarantor's credit history look like? Pull a credit report. Have you ever gone into the secretary of state's data base and conducted a "principals search?" You can see the other entities the guarantor (usually just individuals here) has been involved with. How many of them have gone down in flames? Credit report anyone?
The law states that in order for a person to be liable for the debts of another there must be a writing memorializing the agreement and it must be signed by the guarantor. That agreement should include terms such as whether the guarantor will be liable for interest and at what rate, collection fees and attorneys' fees in addition to the principal balance due. You can be negotiable with this contract. Perhaps the guarantor only guarantees the first $10,000 or the guarantee is only valid for the first two years of the relationship.
If there is more than one guarantor, you should state that the guarantors are jointly and severally liable. This means they are liable together and each is liable for the whole amount. Again you can negotiate and have each guarantor be responsible for a different percentage of the debt. Up to you.
You should also include language that allows you to pursue the guarantor directly and immediately without having to prove the underlying debtor can't pay. (This effectively turns the guarantee arrangement into a "suretyship". Don't worry about the term - it's like being a co-signor on a loan.) You should state that it is a continuing guarantee, unless you negotiated a term limit. Guarantees are effective indefinitely unless otherwise limited. Things like death and bankruptcy can cancel the ongoing nature of the guarantee but won't cancel it retroactively. You just have to deal with it in a different arena. The guarantor can cancel the guarantee by notifying you in writing but the guarantee will still be effective for the debt incurred up until the time you received notice.
We haven't talked about obtaining social security numbers, authorizations to pull credit reports or giving the Equal Credit Opportunity Act notice because it would make this article too long. As with all things in life there can be many variations on this theme. One example of these items is on our website at http://www.nacmint.com/ Click on news and resources and then forms.
Use guarantees more often. You'll like life a lot better if you do. I guarantee it.