If you were to go to your banker and ask for a loan, you would expect him to require a completed application for the credit line you are seeking. Certainly, when a potential buyer asks you for credit terms, the ultimate extension of credit is no less a loan than when you seek a loan from your bank. So why do many credit grantors shy away from utilization of a credit application?

I believe the answer is obvious: Fear that requesting completion of the credit application will result in the loss of a sale.

However, a credit application is one of the cornerstones of any credit professional's good, solid, credit extension policy. Used properly, it enables you to extend credit more safely. Moreover, it also enhances your legal position should things go wrong.

Any financially sound buyer with good credit credentials should have no objection to completing an application. Those that object should sound an alarm that something is potentially 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 is probably headed for disaster.

The point to be underscored is that you do need know your buyers. If General Motors, for example, were asking you for credit terms, it would be a different matter. But when it is a totally unknown entity, you must have more information. So, temper your credit application policy with a dose of wisdom. A simple rule of thumb: If you’re not completely sure of the strength of the potential buyer, insist on the completion 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 minor changes, it should also work for international transactions. (Note: You should seek the advice of a qualified attorney in the design of your credit application.)

The one strategically critical element in the sample that must be tailored to the individual seller is the Final & Binding Arbitration clause (see Conditions, second paragraph in the sample application). Credit grantors should make sure this clause reflects their location and language, as well as the name of a competent arbitration authority in their country.

Why include an Arbitration Clause?

Including an arbitration clause in your credit application gives you a tactical advantage over the debtor by forcing the venue for any dispute resolution to your location. The particular clause in this Sample Credit Application is also 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)

Why a Personal Guarantee?

A staggering number of businesses do not survive their first five years of operation. Thus, it should be a rigid credit policy that a Personal Guarantee is required of any business in operation less than five years. Once again, there are always exceptions to any rule, tempered by good, sound judgment. But for the vast majority of credit extensions, this rule should be followed. Again, it is an added protection for you, but understand that the Personal Guarantee is only as good as the financial worthiness of the guarantor.

Consumer Credit Reports in the U.S.A.

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.

In July 2000, the Federal Trade Commission (FTC), which has oversight and enforcement authority for the U.S. Fair Credit Reporting Act (FCRA), issued an opinion memorandum which has a huge impact on a seller’s ability to obtain consumer reports like those provided by Equifax or Experian.

The FCRA requires sellers when selling to consumers to obtain specific written permission from them before obtaining a consumer credit report.

In the commercial sector, sellers have routinely depended upon consumer credit reports when the buyer is a proprietor, partnership or s-corporation as, 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.

At present, it does not appear the FTC will involve itself in enforcement actions for violations of this issue occurring prior to July 2000. However, for events after July 2000, prosecutions can be instituted. So, if you intend to order consumer credit reports on sales involving proprietors, partners, s-corporations, or personal guarantees, you absolutely must insist those individuals specifically grant you authority to obtain a consumer report.

It has been my experience as a collection professional of almost 30 years, that use of a well constructed credit application, like our sample, will vastly improve the collectability of your accounts, decrease your Days Sales Outstanding, and help both you and your buyer to more clearly understand the terms of your business relationship.

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David Greenberg works with an ABC-Amega Inc. team of international commercial collection experts to manage collection cases in more than 200 countries around the world. His collection industry experience spans three decades. He has served on the Panel of Commercial Arbitrators of the American Arbitration Association and is a current member of the Commercial Law League of America and the Association of Executives in Finance, Credit and International Business. Dave has traveled the world, giving educational presentations in the areas of international arbitration, foreign documentation, and credit reporting management.