Receivables management – before you get “on the high seas”

Seemingly, the worsening economic situation (see only here) is already leading to poorer payment morale. For an entrepreneur, however, it helps little to complain about the general “moral decline” (as is done here (in German)). Rather, you should proactively take action well before a possible default in order not to fall victim to the (very German) motto “in court and on the high seas one is in God’s hands” or even to become a candidate for one of the notorious “domino insolvencies” yourself if a large customer falls into insolvency. Over the past twelve months, I indeed noticed an increase of requests to consult on how to react to outstanding payments – right up to being instructed to plan and implement a complete receivables management system. Enough reason to sum-up all the bits and pieces in one post.

In the following first part I will outline the possibilities of proactive receivables management from a practical legal perspective. In a subsequent second part, I will describe the possibilities of proceeding if the “ship” of receivables does end up on the “high seas” – in other words, a contentious enforcement of one’s own claims becomes unavoidable.

Some of the following tips seem obvious and many companies will have taken them to their heart anyway. But all the following advice is based on cases I came accross in the last year, precisely because such “basics” were ignored.

Part 1: Proactively avoiding bad debt losses

Be careful with whom you deal with

“Know Your Customer” (KYC) has become a legally prescribed constant not only for banks when it comes to contracts with new customers. Potential contractual partners are “screened”. In other words, one obtains information about the potential contractual partner before concluding the contract. The effort for the “screening” should of course be in a reasonable relation to the expected return. Still, in my practice I often experience cases in which suppliers do not find out until non-payment that they have concluded their contract, for example, with a company based in Luxembourg – with the ensuing problems for litigation.

In view of increasing economic tensions and trade wars, which lead, for example, to a wide-ranging boycott of goods from Iran, it is also advisable to regularly review business partners with regard to possible sanction lists. Violations of such sanction lists could result in severe penalties for the company. Therefore: “Be careful with whom you deal with”.

Countless service providers are now available for the screening of business partners, but they also want to take their (fair) share. The use of such specialists is not always sensible or necessary. If, however, some thousands of euros could be at stake, one should – in addition to an online search, which is recommended anyway – spare the necessary small change at least for a current excerpt from the commercial register and a business report as basic protection. By the way, such procedure doesn’t hurt for existing customers either…

Profit lies in purchase – sales pays it

Ever since the (in-) famous José Ignacio López joined Volkswagen in the nineties, it has become a commonplace that commercial profit lies in purchasing. Conversely, this means for the seller, especially in the B2B sector, that he is regarded as a potential object of profit maximization for the customer. It is not only lawyers who know of the endless attempts to “foist” their own general terms and conditions (with the better, because closer to their seat, place of jurisdiction) on the respective counterparty. Or, the seller – already in the frenzy of his future bonus – lets himself be “cheered under” a long term of payment-plan. From my practice I can report of a company that pre-financed the construction of complex machinery only then to allow for a payment period of 120 days. I don’t think I have to explain why this company ended up with me.

That’s why the German proverb “Holzauge sei Wachsam” (“wooden eye be watchful” or “be on the qui vive”) is the rule of the day – perhaps even going so far to go through the upcoming contracts with your own purchasing department. It is possible that your purchase manager will still find some profit maximization strategies of the potential customer that your sales representative has missed.

“Without advance, no work” – and what else is possible

I have repeatedly ignored this basic rule of the legal profession in my professional life, and I have just done so again. And almost always I was punished for it, i.e. the client did not pay (in full), so also just again. In other industries and professions than law, however, advance payment is not always common – or at least that’s what they tell you. Perhaps you simply don’t have the market power to demand advance payment. Nevertheless, I would always try to get at least a down payment before I plunge into work.

What can you do alternatively to secure a payment, especially if you have to pre-finance material for an order? For example, you could agree for the customer to provide collateral, such as a guarantee, i.e. the provision of a bank guarantee by the customer (common in German foreign business and known as a “Hermes loan“). Here, too, the higher the sums at stake, the sooner any profit reductions due to the financing of the security can be absorbed.

In contrast, the agreement of a right of retention is often only a sham. In the case of custom-made products, for example, for which there is no general market, the customer can simply let you starve to death to your right of retention in order to obtain a subsequent discount.

The possibilities of securing your own payments are so varied that a more comprehensive description would go beyond the scope of this post. Also because the kind of the security depends on many industry usance, you should constantly try to improve your position.

In the end the gut feeling decides

You have worked through the previous instructions cleanly and – as the advertising often suggests – you are now sitting in front of your tidy desk armed only with the contract and an expensive pen and would simply have to sign.

But, with the risk matrix you set up, you notice that the potential customer was already bankrupt in 2003 and was sold. Your buyer also pointed out a few adjustment screws in the contract (or in the customer’s general terms and conditions) which he would turn on afterwards if he were the customer, in order to get a little more out of it. There was no security either – at the word “aval” the buyer-to-be immediately made it clear that the negotiations were about to fail.

Good advice is now expensive. Or not. Of course you can now ask another consultant and as a lawyer I can probably show you far more potential pitfalls than you would like and would like to know. However, if you have already set up a legally audited contract management independent of the concrete contract and the potential risks are recorded in the matrix – then another consultant will not help you either. Trust your gut feeling. It may sound hackneyed, but in order to be able to say “afterwards one is always smarter”, one must first make a decision, i.e. enter into the contract or not. And if you happen to have read the highly recommendable book “Blink! The Power of the Moment” by Malcolm Gladwell, you know that the infamous gut feeling is nothing more than the concentration of all our experiences in one moment. In other words, the gut feeling is fed by our experiences – not by the advice of a consultant. So, go ahead, make the decision.

In the next part, we’ll look at what you can do if you have gotten smarter afterwards…

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