TOP 10 CREDIT APPLICATION MISTAKES

BY

RANDALL K. LINDLEY

BELL NUNNALLY & MARTIN LLP

3232 McKinney Avenue, Suite 1400

Dallas, Texas 75204

(214) 740-1400

A SEMINAR PRESENTED TO THE

NACM CFDD Dallas/Fort Worth Chapter

April 17, 2012

Copyright © 2011 by Randall K. Lindley

Bell Nunnally & Martin LLP

3232 McKinney Avenue

Suite 1400

Dallas, Texas 75204

(214) 740-1400

Printed in the United States of America

This publication is for educational purposes only and cannot be relied upon as legal

advice. It has been prepared with the "understanding that the publisher is not

engaged in rendering legal, accounting, or other professional services. Although

prepared by professionals, this publication should not be utilized as a substitute for

professional services in specific situations. If legal advice or other expert assistance

is required, the service of a professional should be sought." From a Declaration of

Principles jointly adopted by a Committee of the American Bar Association and a

Committee of Publishers.

TABLE OF CONTENTS

A. AN OUNCE OF PREVENTION IS WORTH A POUND OF CURE ..........................1

1. The Importance of a Well-Written Credit Application......................................1

2. An Information-Gathering Tool ...........................................................................2

3. The “Contract”.......................................................................................................3

4. The Credit Application as Evidence ...................................................................10

B. TOP 10 CREDIT APPLICATION MISTAKES ...........................................................11

1. Failure to Obtain a Proper Signature from the Debtor ..................................11

2. Failure to Properly Identify the Contracting Parties .......................................12

3. Failure to Clearly Identify Terms and Conditions on E-Contracts ................17

4. Name on Invoice Does Not Match Name on Credit Application .....................18

5. Debtor Signs Credit Application and/or Makes Purchases Without

Authority ...............................................................................................................19

6. Failure to Properly Identify the Guarantor in the Credit Application...........21

7. Guaranty Does Not Link to the Credit Application Debt at Issue ..................24

8. Failure to Include Federal Equal Credit Opportunity Act Language ............24

9. Failure to Include “Change in Status” Provision .............................................26

10. Failing to Update the Credit Application After Creditor Becomes

Aware of Change in Ownership or After Guarantor Leaves ..........................26

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TOP 10 CREDIT APPLICATION MISTAKES

By:

Randall K. Lindley

A. AN OUNCE OF PREVENTION IS WORTH A POUND OF CURE

Every business contract includes a certain degree of risk. The amount of risk is a

function of the likelihood that the other party will fail to perform its obligations. Credit

managers are in the business of evaluating ―risk.‖ Essentially, credit managers weigh the

likelihood that the business will perform the contract (in other words, pay for the product or

service provided), against the likelihood that the business will fail to perform. The threshold

question is always: is this business worthy of an extension of credit?

After the decision is made to extend credit, the ―risk‖ is set. Surprisingly, many creditors

further increase the risk of non-payment by failing to carefully document the business transaction

with the debtor. The ability to enforce a contract turns on the terms of the contract and the

accuracy of the information contained in it. Indeed, the power of documentation is, in a word:

money. The information provided in this outline is intended to provide you with practical advice

from a legal point of view.

1. The Importance of a Well-Written Credit Application

Every new customer seeking to purchase products and/or services on account should be

reviewed for creditworthiness. A well-written credit application will provide information that

will assist with this process. Once signed by the debtor, a credit application will also constitute a

contract that establishes the terms and conditions between the parties for the purchase of goods

and/or services ―on account.‖

2

2. An Information-Gathering Tool

A credit application is a valuable tool to determine creditworthiness. The credit analysis

begins with the quantity and quality of the information gathered. The credit application should

gather at least the following information:

Name of the applicant. The correct legal name of the applicant is essential for

contracting purposes. Often, however, entities will conduct business under an assumed name.1

While a properly registered assumed name can be used to contractually bind an entity,2 complete

research on an entity cannot be conducted unless the application contains the legal name of the

applicant. If the potential customer is a corporation, limited liability company (―LLC‖), limited

partnership (―LP‖) or other registered corporation or association, the legal name can be

researched through the Secretary of State’s office in the state in which the corporation was

incorporated.3 Verification of the name is very important for later collection purposes.

Type of entity. Since a potential customer may be an individual, sole proprietorship,

partnership, LP, corporation, LLC, association or trust, it is important to know the type of entity

so that the proper signatory can be determined.

Address of applicant. The address can be used to conduct a background check and

should be the address used for all notices and billings. Again, it is a good idea to verify the

address with the Secretary of State’s office, where applicable, as well as with the applicant’s

letterhead.

Bank references. The applicant should provide pertinent contact information for its main

banking institutions. Banking references may be used not only to establish the length of the

1 Tex. Bus. & Com. Code § 36.02.

2 Tex. Bus. & Com. Code § 36.11.

3 See http://www.nass.org/sos/sosflags.html for links to all 50 Secretary of State offices.

3

applicant’s relationship with the bank, but also may help in attempting to garnish funds of the

applicant in the event of future default by the applicant.

Trade references. Trade references provide key information on the applicant’s ability to

pay its debts. The history and longevity of these prior relationships will likely determine what

type of debtor the applicant will be in the future.

Social security number or tax identification number. It is absolutely essential that the

applicant provide its social security number or tax identification number, as appropriate. This

information is useful in identifying problem customers. When conducting background checks, it

is good to be cautious about customers that have had frequent address changes or frequent

employment changes.

Own or rent. Determining whether a potential customer owns or rents his or her

residence or place of business can provide valuable information into the financial strengths

and/or weaknesses of the customer.

Additional financial information. Asking such questions as "Have you ever filed for

bankruptcy?" or "Is the project tax exempt?" are helpful to gain information in the evaluation of

the potential customer’s application.

3. The “Contract”

As stated above, a well-written and properly-signed credit application creates a contract

between the parties. To prevent confusion concerning the purpose of the application, it is

recommended that the title be expanded to ―Credit Application and Account Agreement.‖

Among other things, it is important to include certain conditional language to ensure the

agreement is not effective until the company approves the customer for the extension of credit.

4

The terms and conditions included in the credit application will create an effective and binding

contract between the parties.

Payment terms. The customer’s written agreement to pay for the goods or services, as

well as the specific terms of payment, should be set forth in this document. These terms can be

as negotiated by the parties or may be set out in the company’s standard ―terms and conditions,‖

which may be attached and incorporated by reference.

Delivery terms. Clearly setting forth specific delivery terms for material deliveries may

be helpful to resolve future disputes. For example, by including the terms ―FOB Factory,‖ the

parties agree that title transfers to the purchaser at the time the product is picked up by the carrier

at the factory.

Interest rate. A signed credit application can be used to reduce the risk that the customer

will assert a claim for usury while allowing the creditor to charge and collect interest on past due

accounts. When there is no written agreement, the maximum amount of interest that can be

charged by a creditor is significantly lower. For instance, in Texas, when no specific rate of

interest is agreed upon by the parties, an interest rate of 6% is allowed on accounts beginning on

the 30th

day after the date on which the amount is due and payable.4 If the parties have agreed in

writing, interest may be charged up to 18% per annum.5

A sample ―payment terms‖ clause, including the rate of interest, is below:

The purchaser agrees to pay ABC Corp. (―ABC‖) for goods

provided by ABC at ABC’s designated prices. Payment is due net

30-days from the date of invoice, or the date of delivery of the

goods, whichever is sooner. The purchaser agrees to pay interest

on all past due balances, at a rate of 1% per month, beginning with

the first day of the second month following the month products are

delivered, but not to exceed the highest amount allowed by law.

4 TEX. FIN. CODE § 302.002.

5 TEX. FIN. CODE §§ 302.001-009.

5

All payments by Purchaser may be applied against open invoices at

the sole discretion of ABC.

Payment of attorneys’ fees. In some states, attorneys’ fees and costs are not recoverable

absent an agreement between the parties. Therefore, it is advisable to add language to the credit

application that provides that a customer will pay all fees and costs upon collection. A sample

―attorneys’ fees‖ clause is below:

In the event purchaser’s account should be past due, ABC may

engage a collection agency and/or attorneys to collect the amount.

In such event, purchaser agrees to pay ABC for any and all

attorneys’ fees, court costs, litigation expenses and collection

agency fees that ABC incurs for the collection of the account.

Such fees and expenses are separate and apart from its liability for

the account balance and accrued interest. All such fees and costs

will be immediately due and payable to ABC.

Forum/venue selection/choice of law. A credit application can be used to maintain venue

of a subsequent lawsuit for collection in a county of the creditor’s choice. Controlling venue can

save considerable cost and expense should a suit for collection be necessary, since suits without a

venue selection clause would normally be filed in the county where the debtor conducts its

business or resides. Further, the parties can agree that any dispute arising from the agreement

will be governed by a particular state’s set of laws. A sample clause including each of these

provisions is below:

Any legal action or proceeding with respect to purchaser may be

brought in the appropriate state or federal court of Dallas County,

Texas. Purchaser hereby consents to jurisdiction in such courts.

Purchaser further waives any objection to the venue of any action

or proceeding in any such court in Dallas County. This agreement

is made under and shall be governed by the laws of the State of

Texas.

Personal guaranty. In most instances, some type of business entity will complete the

application for credit. Many credit applications include a personal guaranty. Obtaining the

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signature of an additional individual will increase the number of persons responsible for payment

of the account.

Change of status. A ―change in status‖ provision requires that the debtor notify the

creditor of any and all changes to the ownership or structure of the debtor’s business. For a more

detailed discussion of ―change of status‖ clauses and related issues, see Top 10 Mistake Numbers

9 and 10 on page 26 of this outline. A sample ―change of status‖ clause is below:

The purchaser shall promptly notify ABC, by certified mail, of any

change of ownership of the purchaser.

Right to terminate credit. A creditor may want the flexibility to terminate a relationship

with a debtor at its sole discretion. By including a clause that permits termination of credit at

any time, subject to the creditor’s sole discretion, a creditor may avoid remaining in a

relationship that is no longer mutually beneficial. A sample ―right to terminate credit‖ clause is

below:

The extension by ABC of credit availability to the purchaser and

the amount and the terms of such credit availability are in the sole,

absolute and exclusive discretion of ABC. ABC reserves the right

to terminate the extension of credit availability to the purchaser at

any time with or without notice and to change any of the terms and

conditions thereof upon notice to the purchaser.

Right to investigate accuracy of data and credit information. If a creditor seeks to

purchase or acquire a "consumer report" that deals with personal, family or household credit

issues, many state laws require a written consent by the person whose credit is being checked, as

well as a statement to the consumer reporting agency that the report is being obtained for a

permissible purpose.

Warranties. If a creditor provides goods and services, it is important to only provide the

necessary and appropriate warranties. By including a clause that explains the warranties

7

provided under the agreement, a creditor may extend the intended warranty, yet limit its liability.

A sample ―warranties‖ clause is below:

ABC warrants title to the goods and, except as noted below with

respect to items not of ABC’s manufacture, also warrants the

goods on date of shipment to purchaser, to be of the kind and

quality described herein, merchantable, and free of defects in

workmanship and material. THIS WARRANTY IS IN LIEU OF

ALL OTHER WARRANTIES, EXPRESS OR IMPLIED,

INCLUDING BUT NOT LIMITED TO THOSE OF

MERCHANTABILITY AND FITNESS FOR A SPECIFIC

PURPOSE – WHICH ARE SPECIFICALLY DISCLAIMED,

AND CONSTITUTES THE ONLY WARRANTY OF ABC

WITH RESPECT TO THE GOODS.

Please note this provision may require capitalization to be conspicuous, as required by law.

Limitation of liability. Creditors should always limit their liability under the agreement

to ensure they are not liable for more money than the total amount they have been paid under the

agreement. A sample ―limited liability‖ clause is below:

NOTWITHSTANDING ANY OTHER PROVISION OF THIS

AGREEMENT, THE TOTAL LIABILITY, IN THE

AGGREGATE, OF ABC TO PURCHASER AND ANYONE

CLAIMING BY OR THROUGH PURCHASER, FOR ANY AND

ALL CLAIMS, LOSSES, COSTS, ATTORNEYS’ FEES OR

DAMAGES (OF ANY FORM, INCLUDING CONSEQUENTIAL

DAMAGES), RESULTING FROM OR IN ANY WAY

RELATED TO THE ACCOUNT OR THIS AGREEMENT

FROM ANY CAUSE OR CAUSES SHALL NOT EXCEED THE

TOTAL AMOUNTS PAID TO ABC FOR THE GOODS. IT IS

INTENDED THAT THIS LIMITATION APPLY TO ANY AND

ALL LIABILITY OR CAUSE OF ACTION HOWEVER

ALLEGED OR ARISING, UNLESS OTHERWISE

PROHIBITED BY LAW.

Please note this provision may require capitalization to be conspicuous, as required by law.

Prices subject to change. The agreement should state that all prices under the agreement

are subject to change without notice to the debtor.

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Alternative dispute resolution. The creditor may believe it is desirable to avoid a court

proceeding if the debtor fails to pay under the credit agreement. An alternative dispute

resolution provision may be added to the agreement. The provision allows the parties to choose

arbitration instead of litigation. In most states, if the parties agree to be bound to an alternative

dispute resolution procedure, such agreement must be in writing.

Periodic financial statement disclosure. This clause authorizes a creditor to request

periodic disclosures of the financial statements of the debtor. This clause can be helpful,

particularly for large accounts. A sample ―disclosure‖ clause is below:

Purchaser agrees to provide updated financial statements to ABC

annually.

Federal Equal Credit Opportunity Act. The Federal Equal Credit Opportunity Act

(―ECOA‖) prohibits creditors from discriminating against credit applicants. It also prohibits

creditors from considering whether all or part of the credit applicant’s income derives from any

public assistance programs and/or because the applicant has exercised rights under the Consumer

Credit Protection Act. It is prudent to include in each credit application a disclaimer and

explanation of the Act and provide the applicant notice of its rights under the Act. For a more

detailed discussion of the ECOA, see Top 10 Mistake Number 8 on pages 24 through 26 of the

outline. Sample disclosure language regarding the ECOA is below:

Right to Request Specific Reasons for Credit Denial: If your

application for credit is denied, you have the right to a written

statement of the specific reasons for the denial. To obtain such

statement, please contact ABC’s credit manager at the above-

identified address within 60 days of the date you are notified of its

decision. ABC will send a written statement of the reason(s) for

the denial within 30 days of receiving your request for such

statement.

Notice: The Federal Equal Credit Opportunity Act prohibits

creditors from discriminating against credit applicants on the basis

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of race, color, religion, national origin, sex, marital status, age

(provided the applicant has the capacity to contract); because all or

part of the applicant’s income derives from any public assistance

program; or because the applicant has in good faith exercised any

right under the Consumer Credit Protection Act. The federal

agency that administers compliance with this law concerning this

creditor is the Federal Trade Commission, Equal Credit

Opportunity.

Merger. A merger clause provides that the agreement at hand is the only agreement

between the parties, should a dispute ever arise. The clause is helpful in eliminating ―parol

evidence‖ – that is, evidence of an agreement outside the four corners of the document. A

sample ―merger‖ clause is below:

This agreement embodies the final, entire agreement of ABC and

purchaser and supersedes any and all prior commitments,

agreements, representations, and understandings, whether written

or oral, relating to the subject matter hereof and may not be

contradicted or varied by evidence of prior, contemporaneous, or

subsequent oral agreements or discussions of ABC and purchaser.

There are no oral agreements between ABC and purchaser.

Authorization of undersigned. If the applicant is an entity, the creditor should receive

express authorization from the entity that the individual signing the application is authorized to

apply for credit on behalf of the entity. Further, the clause should bind the entity to the

agreement based on the individual’s signature. A sample ―authorization‖ clause is below:

If applicant is a corporation, partnership, LLC or other business

entity, the undersigned affirmatively states that he is authorized to

make application on behalf of said corporation and to obligate

same for any credit extended thereto as a result of this application;

and further, that the corporation on whose behalf application is

hereby made will continue to be bound and obligated for any credit

advanced thereto until such notice to the contrary is given in

writing to ABC.

Consistent Terms on Invoice. Please note that all of the terms and conditions that can be

included on the credit application can also be included on an invoice or in accordance with the

10

approval or acknowledgement of any order. In any event, the terms and conditions should be

uniform and included on the document(s) that work best for the company.

4. The Credit Application as Evidence

In addition to information gathering, a credit application can serve as evidence of

business practices when a claim of discrimination (economic or otherwise) is made as a result of

a failure to extend credit. Additionally, a signed credit application and account agreement that

establishes the terms and conditions between the parties will prevent unfavorable terms from

arising through a traditional ―battle of the forms.‖ Further, if the debtor signs the credit

application and has provided false information, and the creditor relies on this information in its

decision to extend credit, then the creditor may have a claim of fraud or misrepresentation

against the individual that made the representation or signed the application. In addition, if this

debtor files bankruptcy, such facts might form the basis of an objection to the discharge of the

debt.6

In Colorado v. Ferrell, a Colorado court considered the significance of false information

being provided on a credit application.7 The relevant facts of Ferrell are as follows:

Debtor opened a credit account on which he purchased three jackets and some shirts,

and the account was not paid;

The debtor was not prosecuted criminally for obtaining goods of value by deception

in violation of a Colorado statute;

The evidence shows that Mr. Ferrell gave an incorrect name as well as an incorrect

address on his credit application.

The court determined that the debtor failed to show that anyone at the department store relied

upon the correctness of the name or address of the debtor and thus, there had been no deception

and no theft. In Colorado, to prosecute a debtor for theft by deception requires proof that the

misrepresentation caused the victim to part with something of value and that the victim relied

6 11 U.S.C.A. § 523(a)(2)(A) (West 2011).

7 591 P.2d 1038 (Colo. 1979).

11

upon the misrepresentation. There can be no deception if the victim is not deceived. In this

case, the department store did not utilize the information to conduct a creditworthiness

investigation. Therefore, the court held there was no deception resulting from the false

information.

B. TOP 10 CREDIT APPLICATION MISTAKES

1. Failure to Properly Identify the Contracting Parties

The party liable under a contract depends upon the type of entity involved in the

transaction. Whether acting as a corporation, partnership, sole proprietorship or something in

between, the debtor’s capacity as an entity is important to understand for collection purposes.

Texas law holds the following persons liable for the debt of an entity based on a contract:

Party Persons Liable

Corporation Corporation

Limited Liability Company Limited Liability Company

General Partnership Partnership and All Partners

Limited Partnership Partnership and the General Partner(s)

Limited Liability Partnership Limited Liability Partnership

Sole Proprietorship Individual

Sole Proprietor doing business with a Trade Name Individual

It is also important to keep in mind that a debtor who commits a tort, such as fraud, may be

personally liable for his or her actions.

Perhaps the largest pitfall for a creditor is failing to identify the party with which it

contracted. Misidentification of the debtor may include:

failing to include the full name of the entity;

relying solely on a trade name (without the full legal name);

failing to include a trade name;

failing to identify the proper type of entity (e.g. partnership or corporation); or

failing to check with the Secretary of State to determine if an entity is in good

standing.

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Additionally, properly identifying the entity to an agreement is extremely important. The credit

manager can go online with the Texas Secretary of State and verify certain information about the

following entities:

Corporations;

Limited Liability Companies (LLCs); and

Limited Partnerships (LPs).

It is possible that the applicant listed is no longer in business (e.g., the corporate debtor

has been forfeited), or the applicant listed is simply not an existing business. Legally speaking,

if the creditor contracts with no one, then there is no debt to collect. The practical side of this

issue is that the creditor usually delivers the goods or services to the debtor before this problem

arises.

If a business operates as a sole proprietorship or a general partnership, it is important to

obtain the full name of the proprietor and/or the partners. If that applicant has declared in

writing on the credit application that the applicant is a sole proprietorship or the partners declare

in writing that the applicant is a general partnership, then the individual(s) will be personally

liable for the debt.

2. Failure to Obtain a Proper Signature from the Debtor

In today’s complex business world, it is simply not enough to merely obtain a signature.

A diligent creditor will not only identify the person signing the document, but will inquire into

whether or not that person has the authority to sign and whether that person was the actual

signer. A number of mistakes appear regarding the debtor’s signature on a credit application.

Consider the following common mistakes that may occur:

The credit application is not signed;

The included signature is illegible without the name printed below; or

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For a corporate applicant, the individual signing the credit application did not include

his or her title.

A brief discussion of each of these mistakes may be found below.

a. Unsigned Credit Application -- Enforcement Problem

An unsigned credit application may be difficult to enforce against a debtor. To form a

valid contract, both parties must agree to its terms. A signature of each party is the most

common way to prove that both parties agree. Without the debtor’s signature, the creditor may

not prove that a valid contract was formed and thus, will not be able to enforce the contract

against the debtor should a dispute arise.

b. Unsigned Credit Application -- Charging Interest at 18%

Creditors may recover interest as damages based on an agreement in a number of ways.

First, the creditor may assert a claim for interest at the rate identified in the agreement. Second,

if an interest rate is not specified in the agreement, or if there is no written agreement, then the

rate of interest on the ―open account‖ is based on the statutory rate.

i. Contract

Generally, the maximum allowable interest rate is 10% per year where parties to a

contract have agreed that interest will be charged.8 However, parties to a written agreement may

contract for interest rates higher than 10% per year and up to 18% per year.9

ii. “Open Account”

Where parties to an agreement fail to agree that any interest will be charged, the

maximum allowable interest rate is 6% per year.10

The default rate of 6% per year applies to the

8 Tex. Fin. Code § 302.001.

9 Id. at §§ 303.001-009.

10 Id. at § 302.002.

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―principal amount of credit extended beginning on the 30th

day after the date on which the

amount is due.‖11

c. Credit Application Contains Illegible Signature

An illegible signature of the debtor on a credit application may create an evidence

problem. Indeed, establishing that a contract was signed is an important proof element required

in a breach of contract case. Therefore, a prudent creditor will always require the signer’s

printed name below his or her signature on the application.

d. The Importance of Signature Blocks

If the applicant to whom credit is being extended is a corporation, then the person signing

should sign in his or her corporate capacity and state his or her title. The corporate signature

block should also identify the complete legal name followed by the d/b/a or trade name, if any.

A sample signature block to include in any credit application in which the debtor is a corporation

is below:

WESCO CORPORATION

By: __________________

Janis Rowe, President

Here, only the corporation, WESCO, is liable on the contract and not the President, Janis Rowe.

However, contrast the above signature block to one found in Lachmann v. Houston

Chronicle.12

In Lachmann, the signature block appeared as follows:

ARTCRAFT MATTRESS COMPANY

By: ____________________________

Arno Lachmann, its President

11

Id. 12

375 S.W.2d 783 (Tex. Civ. App.–Austin 1964, writ ref'd n.r.e.).

15

Here, Artcraft Mattress Company was a trade name for the true entity that intended to enter into

the contract – Household Manufacturing Company. The court held that an individual is liable if

he contracts in his own name without disclosing the name of his principal. Thus, Arno

Lachmann was individually liable.

e. Signed Credit Application and Unsigned Security Agreement

When both the credit application and security agreement are contained in one document,

it is important to ensure both sections of the document are signed by the debtor. In re Nedeau13

sets forth this rule. The relevant facts of Nedeau are as follows:

Sears, as the creditor, received a security interest in an air conditioner it sold to a

customer on credit;

Before purchasing the unit, the customer filled out a credit application, which

included a security agreement on its back side;

The credit application indicated that the applicant see the reverse side for ―important

information.‖

The court held that although the security agreement was on the back side of the signed credit

application, the security agreement contained no signature and thus, was not enforceable. The

court noted that even if the debtor read the security agreement, it was not sufficient – a specific

signature for the security agreement was required. The court stated that the debtor must clearly

agree to the terms and a signature is the least a creditor can do to prove such agreement.

f. A New Millennium: E-signatures

A signature is the most well recognized way to identify the author or sender of a

document. It is also used to confirm the statements made in a document and to manifest an

intention to be legally bound. The purpose of a signature is twofold: identification and proof.

Mistaken identity is a real problem with e-signatures since witnessing the signature, in the

traditional sense, is not possible. For obvious reasons, contracting electronically includes an

13

24 B.R. 1 (Bankr. S.D. Fla. 1982).

16

increased risk of fraud. Unlike a traditional John Hancock, however, electronic signatures can

range in form from a simple encryption embedded in your computer to more complicated

technology such as encrypted ―smart cards,‖ stylus pads, and fingerprint or retinal scanners.

Electronic signatures, or ―e-signatures,‖ are simply digital versions of regular ink-and-paper

signatures. A typed signature or a scanned image of a signature can identify the signatory, but

these methods of signing are often subject to the risk of forgery. As the marketplace becomes

increasingly connected through the Internet, understanding the effectiveness of and requirements

for valid e-signatures is becoming increasingly important.

Laws such as E-SIGN14

have helped solidify the use of electronic signatures in business

transactions. Additionally, the Uniform Electronic Transactions Act (―UETA‖), makes the

E-SIGN rules applicable to e-signatures and e-contracts governed by state law. E-SIGN requires

that the party have the ―intent to sign‖ in order for the electronic signature to be valid and

enforceable. This law provides that electronic records and signatures may not be denied legal

effect or enforceability solely because they are in electronic form. They also state that contracts

may not be denied legal effect or enforceability solely because electronic records are used in

their formation. For example, the formation of an enforceable contract under this section would

exist where an individual (or his or her employee) types the individual’s name as part of an

e-mail purchase order.

From a legal standpoint, creditors need to consider whether or not the means of

transmitting this form of a signature will be considered enforceable in court to prove the

authenticity of various documents. Common problems involve signatures received via e-mail or

14

On June 30, 2000, Congress enacted the Electronic Signatures in Globl and National Commerce Act (―E-SIGN‖)

to ensure the legality of electronic contracts and signatures. See generally 15 U.S.C.A. § 7001, et seq. (2004).

17

fax. Below are two cases that help answer the question of whether these forms of

communication meet the standard for authenticity.

i. E-mails

A 2005 decision from a U.S. Federal Court definitively held that, under California law, a

typewritten signature on an e-mail will satisfy the statute of frauds prerequisite.15

The court was

asked to determine whether an employee’s name on an e-mail was a valid writing and signature

to satisfy California’s statute of frauds. In support for its holding, the court cited UETA, which

states that a ―record or signature may not be denied legal effect or enforceability solely because it

is in electronic form.‖16

Based on the language from the UETA, the court explicitly ruled that

the signature found within the e-mail was enforceable in its electronic form.

ii. Faxes

In 1998, a U.S. Federal Court articulated that a fax satisfies the statute of frauds signature

requirement under the Texas Business and Commerce Code.17

The court had to consider

whether a series of faxes constituted a ―writing…signed by… (an) authorized agent or broker‖ in

a breach of contract dispute. The court clearly explained that the faxes were valid letters of

confirmation and as such that the signatures contained within were valid and satisfied the statute

of frauds guidelines.

3. Failure to Clearly Identify Terms and Conditions on E-Contracts

As technology progresses, e-contracts will become more and more commonplace in

ordinary business transactions. Today, a company may post a credit application to its website,

and the customer may then complete the credit application and e-mail it back to the company,

forming a formal, binding contract. The law provides that a valid contract has been formed, as

15

Lamle v. Mattel, Inc., 394 F.3d 1355 (Fed. Cir. 2005). 16

See Cal. Civ. Code § 1633.7 (2004). 17

Den Norske Stats Oljeselskap, A.S. v. Hydrocarbon Processing, Inc., 992 F.Supp. 913, 915-16 (S.D. Tex. 1998).

18

long as the general rules of forming a contract have been followed. To be careful, a credit

professional should draft the e-credit application and e-credit sale with concise terms and

conditions that are clearly identified on the website. The customer must have notice of all the

terms and conditions that apply for the e-contract to be enforceable. Thus, the terms and

conditions must be clearly identified. It is most prudent to include a ―link‖ to the credit

application and account agreement that includes all of the terms and conditions, and require that

the customer ―click‖ that he or she accepts the terms and conditions within such a document. A

sample e-signature block with included ―acceptance‖ language is below:

By selecting ―Accept‖ below, I am attaching my electronic

signature to, and our business agrees to, the [vendor’s] terms and

conditions contained in the above document. Furthermore, I am

authorized to sign this document on behalf of our business.

_____ Accept _____ Do Not Accept

Based on current case law, it is advisable that the ―acceptance block‖ be located at the bottom of

the electronic document so the person reviewing it is required to scroll down over the terms of

the document.

4. Name on Invoice Does Not Match Name on Credit Application

Invoices are usually sent at the time of delivery of the product or performance of the

labor that is the subject of the contract. A typical invoice contains:

an invoice number;

the invoice date;

the name and address of the seller;

the name and address of the buyer;

the date that the product was sent or delivered;

the related purchase order number;

a description of the product(s);

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the unit price(s) of the product(s);

the total amount charged; and

the payment terms (including the method of payment and the date payment is

due).

Invoices are important because they provide evidence of the performance of the contract and the

amount of the alleged debt. The accuracy of the information reflected on an invoice is crucial to

the presentation of the claim in court. Invoices that fail to correctly name the debtor (in a name

other than that reflected on the credit application) pose a common problem for creditors.

Creditors frequently code the name of debtors into a computer system to generate invoices for

materials or services provided. When the name keyed into the business’ computer system for the

debtor is different from the name reflected on the credit application, then invoices are generated

with an incorrect name. This may lead to serious problems in the creditor’s ability to recover

from the debtor in an event of default.

5. Debtor Signs Credit Application and/or Makes Purchases Without Authority

Whether a person signing a contract or authorizing a purchase of products or services has

authority to do so, it is very important for enforcement purposes.

a. The Person Signing the Credit Application Should Have Authority to

Sign

To the extent possible, a prudent creditor will verify that the person signing the credit

application is authorized by the entity to sign.

b. No List of Persons Authorized to Purchase on Behalf of Company

All creditors should request a written list of persons authorized to purchase on an account

created with a debtor to prevent unauthorized purchases. Consider the following scenario,

indicating the importance of this concept:

Build Co. is an established customer of Supply Inc.

Build Co.’s credit application lists a designated contact person.

20

Barry Badguy submits a purchase order to Supply Inc. on ―Build Co.‖ letterhead.

Supply Inc. calls the designated contact person for Build Co. who tells Supply Inc.

that ―Yes, Barry Badguy does work for us.‖

Supply Co. fills the order.

Build Co. refuses to pay.

Supply Inc. sues Build Co. and Barry Badguy.

Build Co. claims that its designated contact had no authority to validate any purchases

made by Barry Badguy.

Build Co. also claims Barry Badguy was using Build Co.’s name and letterhead

without permission.

Of course, Barry Badguy has no assets.

The list of persons authorized to purchase on the account is vital to a creditor ensuring it can

establish liability for the materials and services that are provided for, but which remain unpaid.

The ―list of authorized persons‖ should be listed on the credit application or be obtained from the

person who signs it, such as an officer of the business entity. The ―list‖ should be updated

annually. Before allowing anyone not listed on the credit application to place an order on the

account, the credit manager should request written authorization.

c. Apparent Authority

Even if the credit application does not specifically provide a list of authorized persons, a

creditor may still rely upon the doctrine of ―apparent authority‖ to bind the entity to the

agreement entered into by an alleged unauthorized person. Apparent authority involves three

key persons: the principal, the agent and the third party. An illustrative case of these

relationships can be found in Funderburg v. Southwestern Drug Corp.18

The relevant facts of

Funderburg are as follows:

The manufacturer of ―Golly Suds‖ soap hired an agent to distribute or sell the soap

around the state;

The manufacturer only gave the agent ―limited authority‖ to make sales of the soap;

The agent contacted a soap wholesaler to consider purchasing Golly Suds soap;

18

210 S.W.2d 607 (Tex. Civ. App.–Fort Worth 1948, no writ).

21

The agent presented a type-written Sales Agreement Contract allegedly furnished by

the manufacturer providing him authority to sell the soap;

The wholesaler purchased a certain amount of Golly Suds from the agent;

Apparently unhappy with the soap upon receiving it, the wholesaler returned the soap

to the manufacturer and requested a credit;

The manufacturer claimed the agent had no authority to enter into the contract.

The court held that the type of authority given to the agent by the manufacturer was irrelevant

since the wholesaler, as a third party, had no knowledge of any limitation on the agent’s

authority. The court explained that when a principal provides an agent private instructions on his

or her authority or limits the authority in some way, without the third party knowing of such

instructions, the principal is bound by any acts of the agent, who is cloaked in ―apparent

authority.‖ Thus, there exists a duty of principals to inform third parties of limited authority of

all agents entering contracts on the principal’s behalf.

In a credit application scenario, the principal is the entity seeking credit, the agent is the

individual signing the credit application on behalf of the entity, and the third party is the creditor.

If an entity provides an employee with general authority to act on its behalf, a creditor may rely

on that employee’s authority to enter into agreements unless told by the entity that the employee

has a limited ability to enter into agreements.

6. Failure to Properly Identify the Guarantor in the Credit Application

a. Overview of Guaranty

First and foremost, a guaranty is an agreement where one party consents to act as a surety

for another. Basically, the guaranty provides the creditor with another source of recovery in the

event the debtor fails to make his payment(s). The document itself creates a contractual

relationship between the creditor and the surety by defining the specific nature of the surety’s

obligation. In order to be enforceable, the guaranty must be in writing and create a contractual

22

relationship through an offer and acceptance.19

Additionally, it is important to be aware that

some states require that the guaranty provide a description of the underlying consideration.20

For

example, the recited consideration might include the creditor’s decision to extend credit to the

business based on the guaranty. A guaranty may also be included within the ―four corners‖ of

the credit application. In other words, the guaranty may be a part of the credit application. To

succeed on a breach of guaranty claim, a plaintiff must show three things: (1) the terms of the

underlying contract; (2) the occurrence of the conditions upon which liability is based; and

(3) the failure or refusal to perform by the guarantor.21

b. Misnaming the Guarantor

Guaranties are a useful tool for creditors because they provide additional security that the

debt will be paid. Practically speaking, there are several problems that creditors encounter when

attempting to enforce a guaranty. The biggest and most frequent problem found in guaranties is

the failure of the credit application to accurately identify the guarantor. The guarantor may not

be accurately identified for a number of reasons including the following:

failing to print the guarantor’s name combined with an illegible signature;

failing to include the guarantor’s address; or

there was no middle initial given.

It is imperative for creditors to succeed in naming the guarantor because if the creditor fails to

properly identify the guarantor or obtain a legible signature, the guaranty may be unenforceable.

c. Incorrect Signature of Guarantor

One may only be held liable to a contract that he or she signs. Therefore, if the guarantor

is misnamed, he or she cannot be held liable on the contract.

19

Material Partnerships, Inc. v. Ventura, 102 S.W.3d 252 (Tex. Civ. App.–Houston [14th Dist.] 2003, pet. denied). 20

See, e.g., Colo. Civ. Code Ann. § 2793; Spittler v. Nicola, 479 N.W.2d 803 (Neb. 1992). 21

Wiman v. Tomaszewicz, 877 S.W.2d 1, 8 (Tex. App.—Dallas 1994, no writ).

23

d. Guarantor’s Signature in Corporate Capacity

Frequently, a guarantor will sign in his or her name followed by his or her corporate

capacity, believing this excludes personal liability. While true in many instances, signing in

one’s corporate capacity does not always insulate one from liability. An example may be found

in Taylor-Made Hose, Inc. v. Wilkerson.22

The relevant facts of Taylor-Made are as follows:

Guarantor signed a credit application (that included a personal guaranty) on behalf of

her company in her capacity as Vice President;

The company filed for bankruptcy;

The guarantor was sued personally for over $22,000;

The guarantor claimed she was not personally liable for the debt because she signed

in her corporate capacity.

The court ultimately held that the guarantor was personally liable for the debt because the

language of the guaranty clearly stated that, by signing below, the guarantor agreed to be held

personally liable. The court explained that the agreement was completely clear: the guarantor

made herself personally liable by signing the guaranty, regardless of whether she signed in her

corporate capacity.

This concept is reiterated in Austin Hardwoods, Inc. v. Vanden Berghe.23

The relevant

facts of Austin Hardwoods are as follows:

Guarantor signed a credit application (that included a personal guaranty) on behalf of

his company in his capacity as Vice President;

The company filed for bankruptcy;

The guarantor was sued personally;

The guarantor claimed he was not a guarantor of the agreement but merely filled out

the agreement on behalf of his company.

As was the case in Taylor-Made, the agreement in question clearly stated that the undersigned

personally guaranteed the payment of the account pursuant to the signed agreement. The court

22

21 S.W.3d 484 (Tex. Civ. App.–San Antonio 2000, pet denied). 23

917 S.W.2d 320 (Tex. Civ. App.–El Paso 1995, writ denied).

24

explained that the agreement was susceptible to one meaning: the Vice President was a guarantor

and personally guaranteed payment.

Both of these cases indicate that whether or not one signs in his or her corporate capacity

is not the end-all, be-all to personal liability. However, the problem is not whether these

agreements were enforceable against the individual; the true problem creditors face in cases such

as these is the time and expense it takes to litigate the case and receive such a ruling from a

court. Because the guarantors signed in a corporate capacity, the debtor in both cases found a

legitimate basis to defend the creditor’s claim. Rather than defeat the debtor pre-trial, these

creditors were forced to trial and most likely, incurred significant legal fees in doing so. Thus, to

save time and expense in the future, it is imperative for the creditor to make sure the guarantor

did not sign in any type of corporate capacity.

7. Guaranty Does Not Link to the Credit Application Debt at Issue

Many guarantees that are attached to a credit application or even included in the body of

the credit application include a blank space where the guarantor will fill in the name of the entity

whose debt is being guaranteed. Failing to complete this blank space that identifies the business

debt is problematic.

8. Failure to Include Federal Equal Credit Opportunity Act Language

The Federal Equal Credit Opportunity Act (―ECOA‖)24

prohibits creditors from

discriminating against credit applicants based on race, color, religion, national origin, sex,

marital status and age. It also prohibits creditors from considering whether all or part of the

credit applicant’s income derives from any public assistance programs and/or because the

applicant has exercised rights under the Consumer Credit Protection Act. The ECOA applies to

all credit – commercial as well as personal – without regarding to the type of credit or the

24

See generally 15 U.S.C.A. §§ 1691-1691f (West 2011).

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creditor. The ECOA requires creditors to comply with certain notice provisions when an

―adverse action‖ is taken on a credit application or an existing account. ―Adverse action‖ is

defined broadly and includes, among other things:

denial and/or revocation of credit,

change in the terms of credit, or

refusal to grant credit in substantially the amount or on substantially the terms

requested.

Further, the ECOA requires creditors to notify applicants:

whether the application was accepted or rejected within 30 days of receipt of a

completed application,

within 30 days of an adverse action on an incomplete application, or

within 30 days of taking an adverse action on an existing account.

If an adverse action is taken, the notice must be in writing and must contain:

a statement of the action taken;

the name and address of the creditor;

a statement of the provisions of section 701(a) of the Act;25

the name and address of the federal agency administering compliance; and

either of the following:

o a statement of the specific reasons for the adverse action; or

o notice of the applicant’s right to a written statement within 60 days of the

creditor’s notification.

Finally, a civil action under the ECOA may be brought in any United States district court

without regard to the amount in controversy within two years from any violation of the Act. The

Act provides for actual and punitive damages in individual or class actions. Punitive damages

are limited to $10,000 in individual actions and the lesser of $500,000 or 1 percent of the

creditor’s net worth in class actions. The ECOA also authorizes attorneys’ fees and costs to

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A 701(a) notice should provide as follows:

The Federal Equal Credit Opportunity Act prohibits creditors from discriminating against credit

applicants on the basis of race, color, religion, national origin, sex, marital status, age (provided

the applicant has the capacity to contract); because all or part of the applicant’s income derives

from any public assistance program; or because the applicant has in good faith exercised any right

under the Consumer Credit Protection Act. The federal agency that administers compliance with

this law concerning this creditor is the Federal Trade Commission, Equal Credit Opportunity,

Washington, D.C. 20580.

26

successful plaintiffs. However, failure to comply with certain provisions of the Act, including

but not limited to the notice provisions, will be excused if the failure results from an ―inadvertent

error.‖ To qualify for the defense, the creditor must correct the violation as soon as possible.

9. Failure to Include “Change in Status” Provision

A ―change in status‖ provision requires that the debtor notify the creditor of any and all

changes to the business nature of the debtor, including changes to the following areas:

ownership of the business,

corporate structure,

state of incorporation,

principal place of business,

corporate shareholders, and

principals and/or owners.

This provision may also include language that any change to the corporate structure of the debtor

will have no effect upon the rights and remedies of the creditor with respect to the agreement

unless the creditor expressly agrees to such an effect.

10. Failing to Update the Credit Application After Creditor Becomes Aware of

Change in Ownership or After a Guarantor Retires or Leaves the Business

A change in ownership of the debtor often includes a change of entity. This can make the

credit application an unenforceable document unless the new entity specifically assumes the

liability of the credit application contract. The creditor can address this problem in several ways,

as follows:

obtain written authorization from the new entity to assume the old credit application,

and/or

require a new credit application be signed.

Similarly, if a guarantor retires or leaves the business, the guarantor may provide written notice

of revocation of the guaranty. If the creditor receives such a notice, then the creditor must decide

whether to continue to extend credit to the business after the date of this letter.

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