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Making promissory notes work.

In the credit and collections game there seems to be a lot of acrimony regarding the use of promissory notes. Credit managers don't like to offer them, customers don't like to sign them and many a CFO view them with such skepticism they force the controller to accrue note balances in the reserve for bad debt. That being said, in these tough times the promissory note can be an excellent instrument for reducing and/or eliminating loss and preserving a good account.

I've often heard hard-boiled credit managers say they don't want to be in the banking business. If the economic conditions were ideal and banks were more flexible, and if business managers made better decisions, it would be best for trade creditors to avoid taking on the role of banker. Simply not considering a promissory note based on an archaic principle of trade credit is short-sighted thinking and indicative of a poor attitude toward customers. A good, pragmatic credit manager will use any tool in his or her arsenal to get paid and or preserve a good account.

As credit professionals, we need to thank the customers that run into difficulty now and then. Consider how valuable you would be to your ownership if all the accounts paid well; you would be viewed as just another expense that could be eliminated to help the bottom line. In fact, your ownership would be remiss in their duties to keep you on board in the absence of marginal accounts. We should be looking at the delinquent customer as our friend because they're keeping us employed. Let's face it; we'd be swimming against the current if we only gave credit to perfect customers.

The delinquent customer, our friend, doesn't like to sign promissory notes for a variety of reasons. We incorporate language in them that make some of the customers think they need to have their legal counsel review the document before they sign. Sometimes--and too often--we hit the customer with unreasonable interest rates. In addition, some of us try to tie personal guaranties and motions for default judgments to the note. All this is too one sided and will usually cause the delinquent customer, your friend, to balk at the note instead of signing it.

We don't need to generate a note that a Harvard Law professor wrote.

"Simplify, simplify, simplify!" said Henry David Thoreau. A simply worded note with the specifications regarding interest and payment is all you need. It sends a psychological signal to the customer that you're trying to help them. When you send a complicated legal document to a customer, it makes them think you don't really trust them and no doubt makes them leery of you.

"Am I jumping out of the frying pan into the fire?" they probably think.

The note is a good instrument for preserving a good customer by giving them a chance to pay the debt in amounts they can afford given current circumstances. That interest rate on your note need not be more than the prevailing rate for the period, If you hard-boiled credit managers don't want to be bankers then don't act like a banker, keep that rate reasonable. Your attempt to motivate them to pay promptly will most likely cost your company its integrity with the customer, subsequently making them seek another vendor when their crisis has abated.

Business is a dynamic process and the financial viability of good companies can sometimes fluctuate. Allowing your customer to sign a note that incorporates a reasonable rate will generally be well received. That customer may even give you priority in their future purchasing decisions based on your willingness to help them weather tough times.

Offering a note to a customer you don't want to continue on with can sometimes be rewarding too. I've had better results collecting using a note agreement than if I'd placed it with an aggressive agency! If you have a delinquent customer who turns down an offer to sign a note and make reasonable payments, it's safe to assume paying you is not high on their list of priorities. Such a customer unwittingly violates the "character" requirement in the five C's of credit and should be referred to legal counsel for litigation. There isn't much to say for the character of a customer who refuses to pay in the face of an offer to pay whatever they reasonably can. Some controllers do want to transfer customers who require promissory notes in their reserve for doubtful accounts, but I believe this is premature if the note is being paid on time. Removing the balance from the accounts receivable to notes receivable also improves the DSO if the balance was delinquent. My experience with the simple note in the manner prescribed in this article has been successful no fewer than five times this year. Will I always have success? Probably not, but I believe the odds are in my favor and it's definitely worth trying to make a note work when it helps you salvage a good account facing short-term problems due to a recession. The note can be a good tool for credit managers if reason and a good attitude toward the customer guide the agreement.

Curtis Spriggs, CCE is corporate credit manager with Electro Mechanical Corp. in Bristol, VA. He can be reached at
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Title Annotation:SELECTED TOPIC
Author:Spriggs, Curtis
Publication:Business Credit
Geographic Code:1USA
Date:Apr 1, 2010
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