It is often easy to so focus on the technical provisions of a particular contract (e.g. a lease, a service contract, a purchase agreement, or a partnership agreement) that we lose sight of the importance of the credit-worthiness of the party with whom we are contracting. Too many times a company spends thousands of dollars in legal fees in drafting the perfect contract, only to find out the hard way that the contract is not worth the paper on which it is written.
A contract is meaningless when the party on the other side of the contract is judgment proof (ie. has no resources). However, this does not necessarily limit the landlord, seller, service provider or other company to doing business with only the wealthy. The following are methods to hedge against the financial instability of the party with whom you are contracting:
· Require the other party to a contract to obtain a written guaranty of its obligations under the contract from a third party that has a proven credit record.
· Require the other party to deliver a letter of credit from a financial institution.
· Obtain a security interest in, lien against or pledge of the assets or real estate of the other party to secure its payment obligations under the contract.
· Require a money deposit or an advance payment of the obligations under the contract.
Obviously, before determining whether any of the above are necessary, perform a legal credit check on another party to a contract before entering into any agreement pursuant to which your company is entitled to any material monetary payment. If the other party’s financial wherewithal is not commensurate with its obligations under the agreement, have competent legal counsel incorporate one or more of the above (or other) financial protections.
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