In a competitive business market and especially at the outset of a new commercial relationship where a credit line is to be given, there are a number of key considerations which businesses should attend to when signing contracts with customers and also when bringing clients onboard. Taking the time to assess potential customers and put appropriate safeguards in place can help businesses reduce financial and contractual risks from the outset. These are as follows:
1. Due Diligence
Whilst a comprehensive due diligence exercise can be costly and time consuming and may not always be a feasible option for many sole traders or small businesses at the outset, it is extremely important to understand the party you are dealing with, especially if later on you need to consider taking legal action against them or conversely if you need to defend yourself against a claim which you believe to be unsubstantiated. A proportionate customer due diligence process can help identify potential financial, ownership and reputational risks before a business enters into a commercial relationship.
Some ways of undertaking due diligence are as follows:
- Checking the source and origin of your customers’ funds;
- Requesting financial statements;
- Being aware of suspicious financial activity – if there is any real cause for suspicion then this should be reported to the Financial Intelligence Unit (FIU) of the Central Bank of the UAE.
- Checking publicly available information about the customer and its business activities;
- Verifying the identity of the individuals authorised to act on behalf of the company.
The type of information that a business should be looking to obtain when undertaking a due diligence exercise would be the details and documents of the customer’s business. This could include the following:
- Trade licence;
- Company’s Memorandum and Articles of Association;
- Details of shareholders or ultimate beneficial owners, parent company, subsidiaries as well as details of the relationships between signatories and any ultimate beneficial owners;
- Evidence of good financial standing/ information on assets held by the customer.
The level of due diligence required will depend on the nature and value of the proposed relationship and the level of risk involved.
You need to keep up-to-date information on your customers so that you can:
- Amend your risk assessment of a particular customer if their circumstances change; and
- Carry out further due diligence measures if necessary.
Changes of circumstance may include:
- A substantial change in the level or type of business activity;
- A change in the ownership structure of a business.
- A significant change in the customer’s financial position or business activities.
2. Onboarding
Onboarding is the process of welcoming new clients, getting them up to speed with your procedures and policies and making them feel comfortable so that you can work together effectively. It is also about getting all of the information you need, thus setting the tone for a successful and productive relationship. A clear onboarding process is proven to increase confidence and satisfaction, improves performance, and reduces confusion. It can also help ensure that the necessary customer information, contractual documents and payment terms are established before work begins. Some of the methods and processes used for onboarding include face to face meetings, calls, videos, printed materials, digital communications, training documentation and questionnaires.
For businesses providing goods or services on credit, a well-structured onboarding process can also be an important part of managing credit risk and setting clear expectations from the beginning of the relationship.
3. Requesting Trade References
Trade references are generally used to increase a company’s creditworthiness in front of a third party and is commonly a kind of judgement about another company’s ability to fulfill a commitment. When businesses request trade references they are looking for a stable history of on-time payments and although it is impossible to foresee if a company will pay a debt within the expected terms, information about past behaviour is often used as a good predictor. Trade references can therefore provide businesses with additional insight when assessing the creditworthiness of a prospective customer.
The reference itself can be as simple as a name with its contact information. However in other cases, there may be a requirement to produce a letter with an opinion and precise data about the past or present credit along with complete contact details should further information be required. Where appropriate, businesses may wish to ask about the customer’s payment history, typical credit terms and whether payments were made within the agreed timeframe.
4. Obtaining Credit Risk Reports
When a company does not ask for payment before delivering products or providing services, its credit risk increases. Many business transactions are conducted on credit; however it is important (for small businesses especially) to investigate more than just the information that is provided in company financial statements. Ultimately a business would need to know whether a potential customer is a good or bad credit risk and this is where credit risk reports come into use. They help to determine a company’s profitability, financial stability and payment performance and can allow a business to:
- reduce the risk of payment defaults by assessing a company’s payment history before doing business;
- assess a company’s credit with risk indicators and explanations;
- determine the amount of credit to extend; and
- mitigate potential business risks by accessing a company’s bankruptcies and liens.
5. Requesting Security
If a business is entering into a contract (particularly one of high value), it is recommended that some form of security is obtained for certain types of transactions or business relationships so that the business is protected should a dispute occur. Security can be requested in a number of ways including by way of signed and post-dated cheques, letters of credit, personal & bank guarantees and parent company guarantees. The most appropriate form of security will depend on the nature of the transaction and the parties involved, so businesses should consider obtaining legal advice before agreeing to specific security arrangements.
In conclusion, requesting information upfront is not only commercially prudent, but from a litigation standpoint, is invaluable. Once a relationship sours, such information is almost always very difficult to obtain and can often lead businesses down the route of expensive and time consuming litigation.
Taking these steps at the client onboarding stage can help businesses identify potential risks, make informed decisions about extending credit and strengthen their position if a commercial dispute later arises.
If you require legal advice on commercial contracts, customer due diligence, credit risk or business disputes in the UAE, contact James Berry & Associates Legal Consultants at [email protected]. Our commercial lawyers can advise you on protecting your business interests and managing contractual risks from the outset.
This article does not constitute legal advice and should not be relied upon as such.
