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When Love Triangles Go Bad

In my experience one of the most difficult credit decisions involves situations where the client’s customer may not have sufficient credit to support a sale but the end user of the product, the customer’s customer, does.   In such situations the temptation is to look to the end user for credit support under the assumption that the payment will be made and passed on through the chain.  Is this is a good assumption?  Quick answer-not always.

I use two real examples for illustration.  In the first, we factored AR for a supplier of roofing material that was used to upgrade gas stations operated by a major oil company.  Our client was selling to the company that performed the upgrades.  The customer had signed a notification letter and was making payments directly to us but we knew their ability to pay was tied to their receipt of end user payments.  In this case things worked as expected and we successfully supported our client. 

In another case, our client supplied a cosmetic product which it sold to a distributor.  The distributor had a direct relationship with its customer, a major cosmetics retailer. The distributor did not have sufficient credit to support the sale but its customer did.  The distributor agreed to make payment to us when they had received the payment from the retailer.  The product was delivered to the retailer, accepted by them, with full payment for the product then made to the distributor.   The distributor then refused to make payment to us, or to anyone else, despite the signed agreement.

In reflection, the same option would have worked well for us in each case.  We should have put an agreement in place whereby the end user agrees to pay us directly thus bypassing our client and its customer entirely.   Clearly all parties (lender, client, customer and the end user) will need to agree to this arrangement.  When in place it would then shift the assessment of credit risk to the appropriate party.   The one with the money.

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