In what situations is it a good idea to use debt security?
Collateral is worth using whenever you sell goods or services. Remember, however, that its type is worth adjusting to the nature of the transaction, its value, and the relationship you have with your counterparty.
To secure a claim, appropriate provisions should be included in the contract drawn up with the contractor. These should include the type of security and the circumstances and conditions under which it will be triggered.
Securing receivables is a preventive measure. Its function is to reduce the likelihood of problems with timely payment for goods or services. If you think about collateral early enough and put it in the contract, you will be able to significantly reduce the losses that a delay or non-payment would generate.
Important!
Theoretically, the collateral does not have to be specified at the stage of signing the contract, but it is in all respects a – nomen omen – safer solution. By including the collateral in the contract right away, you will start from a better negotiating position – the rejection of the collateral by the counterparty may then end in the termination of cooperation.
However, if you do not take care of the appropriate security when signing the contract, you can – admittedly – try to add it later, but such a move will require an addendum to the contract and, therefore, the consent of the counterparty. In the vast majority of cases, the latter will have nothing to gain by signing the annex. So to get him to agree to the new terms, it will be necessary to offer him something in return.
Types of collateral for receivables
Wanting to take care of your business, you can use many types of security. They are usually divided into two main categories:
- personal securities allow recovery from the debtor’s assets. This group includes:
- civil sureties,
- bills of exchange,
- Bank and insurance guarantees,
- assignment of receivables as collateral,
- Voluntary submission to enforcement of the debt.
- In-kind coll aterals work somewhat differently. Under them, specific assets of the debtor are secured. These can be used to satisfy the creditor, even if their ownership changes in the meantime. In this category we find:
- transfer of security,
- pledge,
- registered pledge,
- mortgage.
In the following text we will discuss a selection of them.
What is surety bonding?
The surety establishes a backup debtor, or guarantor. This is a third party who declares to repay the debt in case the debtor fails to do so. The guarantor must declare that he or she agrees to these conditions by signing (in his or her own hand or electronically) the surety agreement.
In the context of suretyship, four issues are primarily relevant:
Between the debtor and guarantor there is a principle of solidarity. This means that you can expect repayment of the debt from both the debtor and the guarantor, but also from one of them.
The guarantor is liable for the debtor’s obligation as it was at the time the contract was drawn up. This means that if you draw up another agreement with the debtor at a later date (and his debt increases), the guarantor’s obligation will not change.
A guarantor may be liable for part of the debtor’ s debt, but cannot be held liable for more than the original obligation.
The guarantor is liable for the obligation with all his assets.
Important!
If the debtor has not paid on time, it is the duty of the creditor to immediately inform the guarantor.
How to secure a claim with a bank guarantee?
The debtor can, at the request of the creditor, enter into a guarantee agreement with the bank. It will allow the creditor to demand payment from the bank after certain conditions are met – so the creditor is the beneficiary of the guarantee.
The bank does not provide the guarantee free of charge. This is an additional service that the debtor will have to pay for. In addition, additional criteria are usually required – for example, achieving a certain creditworthiness.
Bank guarantees come in conditional and unconditional forms.
- A conditional guarantee means that the creditor also has to meet certain conditions in order to demand payment from the bank. Once these conditions are met, it is usually necessary to provide the bank with documents that prove this.
- An unconditional guarantee only requires the creditor to make a demand for payment.
Bill of exchange as collateral for receivables
A promissory note is one of the most popular and simplest forms of security. It requires no court process, no notarization – it doesn’t even have a specific, fixed form.
A bill of exchange is a financial instrument under which a debtor agrees to pay a creditor unconditionally a certain amount of money. There are several types of bills of exchange in circulation – for the creditor, the most favorable is the following blank bill of exchange , i.e. one on which no amount is written – it is written only at a later stage, when it is already known what sum of money is needed for repayment.
Important!
A promissory note, while an important form of debt security, will not work if the debtor turns out to be insolvent.
Voluntary submission to debt enforcement
Wanting to recover a debt, you can take legal action. Submitting the case to a bailiff will not work without first obtaining a writ of
Voluntary submission to execution of a debt is a security in which the debtor agrees to pay a certain amount in case he fails to make payments on time. It replaces a writ of execution and takes the form of a notarial deed.
For details on this form of security, see Art. 777 of the Code of Civil Procedure.
How does a security transfer work?
Under a security transfer, the debtor transfers ownership of the thing specified in the contract to the creditor. Thus, the collateral can be a car, a machine or computer equipment.
An important feature of the transfer of ownership is that the ownership right reverts to the original holder of the thing (the debtor) as soon as the debtor settles the obligation.
Typically, a transfer of title does not involve the creditor physically taking the thing from the debtor. The latter still retains the right to own and use the item (that is, he can still drive a car or use a computer that is collateral). However, the owner of the item remains the creditor, and as soon as the debtor has trouble paying the obligation, the creditor will not fail to take advantage of this fact.
What is a pledge and what are the types of pledges?
The pledge comes in two forms: ordinary and registered.
Ordinary pledge
It occurs only in the context of movable property. The pledged item is transferred to the creditor, and the creditor can claim satisfaction from the pledge even if the owner of the item changes. Moreover, the creditor secured by the pledge has priority in claiming satisfaction over any personal creditors of the owner of the pledged item.
In the case of a simple pledge, however, it is difficult to avoid litigation – it is through this avenue that the creditor must assert his claims.
The object of the pledge may be movable property, a property right or a share in the debtor’s property right.
Registered pledge
A registered pledge is a special type of pledge. It can apply to an indefinite debt. This means that an obligation with a variable value (such as trade credit) can be secured in this way.
Of particular importance, a registered pledge requires a written form (pledge agreement) and registration in the pledge register. This agreement should include:
- date of conclusion,
- The names, surnames (or names), places of residence (registered offices) and addresses of the pledgee, the pledgee, as well as the debtor (in a situation where the pledgee is someone else),
- Identification of the subject of the pledge,
- identification of the claim secured by the pledge, along with the highest amount of collateral.
What else is worth knowing about a registered pledge?
- In the pledge agreement, the pledgee may undertake not to dispose of or encumber the pledged property.
- Things pledged with a registered pledge may remain in the possession of the pledgee.
- Satisfaction of the pledgee can be achieved by taking ownership of the pledged object or selling it through a public auction.
Securing a claim with a mortgage
A mortgage in the context of collateral works similarly to a pledge, but the subject of a mortgage is always real estate. In a situation where the debtor fails to pay the obligation on time, the creditor can demand payment of the debt from the real estate.
In this scenario, the property should be sold, and the funds from the sale should be used to repay the debt. If the mortgaged property is sold during the term of the contract, the new owner is responsible for repaying the debt.
To establish a mortgage, a mortgage security agreement must be entered into. It must take the form of a notary public. The parties to the agreement are the creditor and the owner of the property (debtor). In order for this agreement to remain valid, it is necessary to apply for the mortgage to be registered in the real estate registry at the land and mortgage court.
What can you do if there are late payments?
It’s obvious that it’s better to secure the claim than to go to the trouble of recovering the debt in the absence of collateral. But what if the contract has already been concluded, and the customer does not want to agree to sign an addendum that includes the collateral? If your counterparty does not pay the invoice on time, you still have – as a creditor – several options.
Monit
The first step is usually to issue a reminder – a note reminding of the expiration of the payment deadline. It is worthwhile – if there are grounds for it – to assume that the delay is not due to the counterparty’s ill-will, but only an oversight.
Call for payment
The next step in the so-called soft debt collection is to send the counterparty a demand for payment. It is a good idea to send this letter by registered mail, so that the addressee has to confirm receipt.
The demand for payment should contain key elements, such as creditor and debtor data, the title “demand for payment,” a description of the circumstances to which the demand relates, the deadline for payment, and details for transferring the amount due.
Interest
If a contractor has not paid an invoice on time, you have the right to charge statutory interest. Their amount depends on who the debtor is and the reference rate of the National Bank of Poland (check the current value of the reference rate here).
If a public entity that is a medical entity is in arrears with payment, interest shall be applied at a rate equal to the sum of the NBP reference rate and 8 pp. If the debtor is any other entity, interest is equal to the sum of the NBP reference rate and 10 pp.
Read more about debt collection methods – both amicable and hard.
Summary
If debt collection is a way to patch up the hole created by unpaid invoices, securing receivables is prevention. The phrase “prevention is better than cure” also fits finances, so it is always better to secure receivables prematurely than to hope that everything will somehow work out.
With proper debt prevention, you will avoid grueling, stressful and protracted litigation. You’ll recover the money owed to your company much faster, and on top of that, you’ll significantly reduce the risk of damaging relationships with contractors – three pluses and no minuses.
