Special Conditions
There are times when certain conditions prevail when it is desirable to lessen the credit risk associated with open book account terms. These special conditions involve the use of guarantees, security, or contra sales.
Guarantees exist where open account terms are extended to the customer, but the seller has the guarantee of a third party and, in the event of default by the customer, the third party will become liable for the amount involved. For example, you might be asked to sell a rather sizeable amount to a company whose financial condition is weak. It might be possible to make the sale if you obtain the guarantee of a wealthy stockholder of the company. It is not uncommon for a seller to obtain guarantees from the parent company of subsidiaries, where the financial condition of the subsidiary is poor or unknown, but the financial condition of the parent company is satisfactory.
Where a guarantee is desirable, it is important that it be drawn up and worded appropriately. It should be clear whether the guarantee is a continual one or if it applies only to a single transaction. In accepting guarantees, it is important to assess the credit worthiness of the guarantor, and to determine how many other similar guarantees are outstanding. An example of the type of guarantee form that may be used is as follows. However, legal advice should be obtained in regard to the format for each type of business.
GUARANTEE
TO………………………………………………………………………………………………………………………………………….. In consideration of you having at my/our request agreed to supply and/or to continue to supply to………………………………………… LIMITED whose registered office is situated at………………in the State of………………….. called ‘the Debtor’ ) with goods and services from time to time I/we HEREBY JOINTLY AND SEVERALLY agree with you as follows:
To be answerable and responsible to you for the due payment by the said debtor for all such goods and services as you may heretofore have supplied or which you may hereafter from time to time at its request supply to it notwithstanding I/we shall not have notice of any neglect or omission on its part to pay for such goods and services according to the terms agreed on between you and it.
That this agreement shall constitute a continuing guarantee to you for the whole debt which shall be contracted by the said debtor with you in respect of goods or services supplied or to be supplied to it as aforesaid.
All dividends compositions and payments received by you from the said debtor whether in liquidation or otherwise shall be taken and applied by you as payments in gross and my/our rights to be subrogated to you in respect thereof shall not arise until you shall have received the full amount of all your claims against it and this guarantee shall be a security to you for the payment of any ultimate balance which may remain due to you in respect of goods or services to be supplied to the said debtor as aforesaid.
You may at any time or times at your absolute discretion and without giving any notice whatsoever to me/us refuse further credit or supplies of goods or services to the said debtor and grant to it or to any drawers acceptors or endorsers of bills of exchange promissory notes or other securities received by you from it or on which it may be liable to you any time or other indulgence and compound with it or them respectively without discharging or impairing my/our liability under this guarantee.
This guarantee shall be enforceable against me/us JOINTLY AND EACH OF US SEPARATELY notwithstanding that any negotiable or other securities referred to herein or to which it shall exceed or be applicable shall at the time of proceedings being taken against us or either of us on this guarantee be outstanding or in circulation. And it is expressly declared that notwithstanding the fact that this instrument of guarantee may be intended or expressed to be executed and given by more than one person the same shall in fact be a valid and effectual instrument of guarantee binding against such person or persons as shall execute the same forthwith upon their execution thereto and shall continue to be binding as against such person or persons notwithstanding the fact that any proposed or contemplated party shall not in fact subsequently execute the same.
In order to give effect to this guarantee I/we declare that you shall be at liberty to act as though I/we were the principal debtor and I/we and each of us hereby waive all and any of my our rights as surety which may at any time be inconsistent with any of the above provisions.
This guarantee shall be revocable at any time as to further transactions by one month’s notice in writing given to you or your duly authorised agent by me/us or in the case of death by me our respective personal representatives.
DATED this………………………………………………….. day of…………………… 20…….
………………………………………………………………….. Witness……………………………
………………………………………………………………….. Witness……………………………
………………………………..Witness ………………………………………………….Guarantors
Often invoices bear open account terms, but it is a secured sale if the seller has a deposit from the customer, or a lien on some asset of the customer such as receivables, inventory or equipment. If the seller has a deposit and the customer fails to pay, the seller applies the deposit toward payment of the account. Likewise, if the seller holds a lien on any asset of the customer, he/she can foreclose if the purchaser does not meet the conditions of the sale.
You may be supplying a customer, but at the same time purchasing from them. It is a contra account when you can offset any portion of an amount owed to you by the customer by an amount you owe to them for their shipments to you. Sales on a contra basis do not at all necessarily imply that the customer is financially weak. Frequently, the supplier is also a natural customer for the buyer. With a weak customer, the practice of the contra account can be used to advantage. If you have extended open account terms, and your customer is unable to pay, you may accept material from them, which can be used, in your own plant to reduce their indebtedness. However, the Bankruptcy Act requires that the creditor did not have notice of the bankruptcy of the debtor when credit was received from or extended to the debtor. If he/she did have such notice, he/she is not entitled to this offset.
As a credit grantor, you can utilise guarantees, security, or contra sales to facilitate selling to a weak customer on open account terms, and at the same time, reduce the possibility of a credit loss. You should also be aware when other suppliers are selling to a customer on this basis. The fact that they find it necessary to lessen that risk, and may be establishing a prior claim on the assets of your customer, will have some bearing on your credit decision. Outside guarantees and security for sales are not always indicated in routine trade clearances.