If you are selling on terms, you are bound to have a customer now and then hit on hard times. Once you have determined a customer is in financial distress, you need to come up with a plan of action fast. You need to protect your interest and also try to salvage a customer relationship because when the customer recovers you don’t want them to take their business elsewhere.

If the customer accounts for a small portion of your sales (and that situation is very unlikely to change), the range of options is simpler, including steps like the following:

  • Reduce or eliminate the credit terms
  • Insist on cash in advance (i.e., COD)
  • Require a letter of credit, a deposit or a Purchase Money Security Interest as a condition of continuing to do business

Any changes you make to the repayment of past invoices should be scrupulously documented and agreed to in writing by all parties. This is no time for handshake deals. Also, make sure to document and convey payment terms for new invoices.

The far greater challenge and potential risk is in responding to a customer in financial distress that is a major long-term customer. If this customer will remain a significant source of business in the near and long term you should carefully study the customer’s financials to see if the difficulties are the result of a temporary cash squeeze or a longer more serious problem.

If your customer’s financial problems are temporary and they are requesting more trade credit along with extended terms, it may well be worth taking concrete steps to help them weather the temporary rough patch in their business. If successful, your company will continue to receive the significant revenue generated by the distressed customer and not have to surrender market share in a still recovering and challenging economy.

If you can implement solutions to help the customer through a difficult time, you also stand to increase customer loyalty over the long term. It might even be beneficial in the long term if you reduce or write off some of the debt. If it is a long term customer, you will make up whatever was written off if you can keep them as a client. While this admittedly high-risk solution might fit very few situations, it effectively drives home the point that working with a long-term, solid customer in temporary trouble can secure customer loyalty in a big way.

Here are some strategies to help deal with distressed customers:

Require Financial Transparency

If a customer is asking for extended terms than you are in effect acting as their bank, and you should insist on receiving the latest financial information from the customer. Also, require a budget for repayment of any past due balance be agreed to. If the customer insists its policy is not to share non-public financial information with vendors, respond with an agreement to sign a non-disclosure agreement. The refusal of a customer to frankly discuss its financial situation is a red flag in and of itself.

The key here is that your company has a right to request added protection and transparency in exchange for shouldering additional risk by extending credit and accepting slower payment. A good tactic is to offer the carrot of discounts for early payment, or in exchange for more business, as part of this approach.

Negotiated Repayment Agreement/Extended Payment Plan

The goal of a long-term payment plan is to allow the distressed customer to pay down its debt to the vendor in smaller portions and over a longer period of time. This allows the customer some breathing room and also ensures you will continue to sell to the customer as long as the payment plan is not in default.

To achieve a successful outcome, an extended payment plan must be viewed as beneficial for both creditor and debtor, allowing the former to maximize revenue and the latter to continue to obtain critical product to run its business. Pull a current credit report on the customer to determine if a payment plan is an appropriate course of action and how to structure the repayment.

A repayment agreement should always be in writing and should include:

  • A waiver of counter claims and disputes;
  • A most favored creditor treatment clause;
  • A stipulated judgment or confession of judgment; and
  • A weekly or monthly payment schedule;
  • A repayment schedule not to exceed one year.

A further possible step, in return for the customer signing such an agreement, is for the vendor to discount the face amount of the past due invoice. As part of the agreement, the customer loses the discount in the event of defaulting.

After executing the agreement, make sure to monitor the plan, issue necessary reminders, and make regular phone calls. If no one makes sure the customer is holding up their part of the agreement then the whole exercise was useless.

Personal or Affiliate Guarantee

If your customer is a small, privately held business then as a sign of its good faith the owner or principals should be willing to provide a personal guarantee in exchange for your company continuing to sell product on easier terms. The personal guarantee should be from the owner of the company, but must not contain the owner’s company title. Such a guarantee creates a contract of secondary liability (i.e., the owner becomes liable for the debt if his or her company defaults).

Promissory Note

Along similar lines, the debtor (customer) to sign a promissory note that contains clauses that will award judgment if a default occurs. A promissory note is a binding legal and financial instrument regulated under Article 3 of the U.S. Uniform Commercial Code (UCC). Under a promissory note, one party (the issuer) promises in writing to pay a determined amount to the other (the payee), either at a fixed or determinable future time (maturity date) or on demand of the payee, under specific terms that typically include the interest rate to be charged. An added inducement is to offer your distressed customer a very low or even no interest rate.

Vendor Composition Agreement

In certain very specific circumstances, in order to help the financially distressed customer avoid filing Chapter 11, you may consider joining other suppliers of the customer in what is known as “vendor composition agreement.”

This is a great alternative to a costly, public and long Chapter 11. Key features are that the trade creditors agree to the following steps:

  • To not pursue involuntary bankruptcy;
  • To work together toward a collective payout plan;
  • To provide trade credit on cash in advance or cash on delivery terms;
  • To negotiate through a single point of contact;
  • To consider consignment arrangements.

To be successful, such a strategy will require the cooperation not only of the distressed customer but also of its banks and other lenders, the ultimate goal being to attract additional capital to restore the company to financial health. While this is a great example of a proactive way to help a distressed customer, it is obviously a huge undertaking and not a viable option for a lot of companies.

As you can see there are many potential strategies and each presents both opportunity and risk. The upside to working with a distressed customer is preserving a key trade relationship and the revenues it brings to your company. The potential downside is increased credit exposure.