Who’s who?: Know your customer

As a credit professional, a large part of your job involves engaging with customers–whether they’re next door or overseas. However, the task of properly identifying a customer can be challenging when businesses operate under similar names, use DBAs (Doing Business As) or are part of a parent-subsidiary structure.

Why it matters: With each new customer, it’s essential to not only understand their business but also confirm their legal identity as a formal entity in a process called, “Know Your Customer”(KYC). Knowing who your customer is from the start is paramount in assessing risk, protecting your legal rights and ensuring the enforceability of contracts.

In this article, we’ll focus on the importance of knowing your customer in credit management and explore how to properly identify them.

What is Know Your Customer?

Know Your Customer (KYC) is a fundamental practice in credit transactions that involves a set of procedures to verify a customer’s identity and assess potential risks. To effectively know your customer, you need to answer four key questions:

1. Who are you selling to?
2. What are you selling to them?
3. When are you shipping the product?
4. Where are you shipping it?

Identifying your customer by their correct legal entity name ensures that credit is extended to the correct business and decisions are based on accurate data. “If a creditor is deciding whether to extend credit to a prospective customer and the creditor is using an incorrect legal name, the creditor risks not finding negative information about that customer, such as a tax lien or UCC financing statements filed against the customer, that may justify a refusal to extend credit to that customer,” said Bruce Nathan, Esq., partner at Lowenstein Sandler LLP (New York, NY). 

Verifying the exact legal entity name can also prevent against fraudulent financial activity such as money laundering or terrorism financing. “One of the biggest risks of failing to properly verify your customer is the potential to unknowingly sell to a denied party or a person or entity in an embargoed nation,” said Edwin Bell, DBA, CBA, ICCE, former senior manager of credit administration for W. W. Grainger Inc. “This can expose you to significant legal consequences—not just for your company, but for you personally as well.”

The Customer Identification Program (CIP) under the USA PATRIOT Act requires that financial institutions verify customer identities in an effort to prevent money laundering and terrorism financing. Under this act, banks must develop a written CIP that is appropriate for the size and type of business. The CIP includes procedures for identity verification, recordkeeping and notifying customers. It requires that banks compare customer information with certain terrorist lists kept by the federal government.

Non-compliance with CIP regulations can lead to serious consequences, including criminal penalties of up to $1 million per incident, as well as civil fines of $250,000. Executives may also face fines or even imprisonment depending on the violation’s severity.

Protecting your legal rights

If a potential customer enters a business name incorrectly on a credit application, you may face disputes about debt responsibility. While most customers strive to do the right thing, financial strain can sometimes lead to attempts to take advantage of minor mistakes, avoiding payment or paying less than owed.

A creditor may face challenges collecting or securing payment of an outstanding claim if the creditor fails to identify its customer by its correct legal name. “Knowing your customer and specifically its correct legal name helps you to enforce your legal rights if the customer defaults and you need to take legal action,” said Nathan.

Contract enforceability

Without proof that the correct entity placed the order or received the goods, your ability to collect payment is considerably weaker. This lack of clarity can lead to liability disputes and further complications. For example, a minor discrepancy in the legal entity’s name on a credit application can lead to filing a lien against the wrong entity, which can invalidate your lien and expose your organization to unnecessary liabilities. “Mechanic’s liens are filed against a physical property, not your customer,” said Sam Smith, senior corporate and collections manager at Crescent Electric Supply Company (Hazel Green, WI). “If you can’t prove that the correct entity placed the order or received the materials, your chances of successful collection drop significantly.”

Tips to properly identify your customer

• Verify the legal name with the Secretary of State and at the beginning of the creditor-customer relationship: Most states provide online business registries where you can confirm the legal entity name of a business. “The primary source of accurately identifying a customer would be the Secretary of State’s website in the state of formation for that customer,” said Michael Papandrea, from Lowenstein Sandler LLP (Roseland, NJ). “The customer should also provide their actual legal entity name when filling out a credit application.”
• Refer to the OFAC SDN List: Before onboarding a customer, check the Office of Foreign Assets Control (OFAC) Specially Designated Nationals and Blocked Persons List (SDN List) to see if the company is owned or controlled by, or acting for or on behalf of, targeted countries. The SDN lists individuals, groups and entities, such as terrorists and narcotics traffickers designated under programs that are not country-specific. Their assets are blocked, and U.S. persons are generally prohibited from dealing with them.
• Use credit reports and public records: “A parent company may have strong credit, but the subsidiary you are dealing with may not—better to discover this upfront rather than too late,” Smith said. It helps to check business credit reports from D&B, Experian, Equifax and NACM to verify the entity’s financial health and legitimacy.
• Shifting (some of) the burden to the customer: “Creditors may consider including a requirement in their terms and conditions that if the customer changes its business form or name through an M&A transaction or otherwise, they have an affirmative duty to notify the creditor of the name change within X number of days,” Papandrea said. “Having an affirmative duty on the customer’s end lessens the burden on the creditor—but creditors must still be diligent and periodically check in to ensure no changes are going unnoticed.”
  • An affirmative obligation (or duty) in a contract requires a party to perform a specific action. It requires active engagement, emphasizing the importance of responsibility and action in contractual performance.
• Understand parent/subsidiary relationships: If you are dealing with a division or subsidiary, determine whether they are responsible for the debt or if a corporate guarantee should be required. 
• Conduct a physical verification: If possible, visit the business location to ensure legitimacy. If remote, use tools like Google Earth to check the listed address. 
• Educate the sales team: Ensuring that the sales team understands the importance of KYC and practices proper customer identification will prevent problems down the line. “If your sales team understands the what and why, your efficiency, customer satisfaction and bad debt should all improve,” Smith said.
• Standardize and document internal processes: “It helps having a clearly documented process for verifying customers, especially in larger organizations with multiple credit managers,” Smith said. “This is important for keeping things running smoothly, even when team members come and go.”
• Review accounts closely: Take the necessary time to review accounts before extending credit.
• Ask questions: Don’t hesitate to ask questions. “If something seems off, verify with someone who has the authority and knowledge to provide accurate information,” Smith said.

The bottom line: Taking the time to properly identify customers upfront helps mitigate risk, prevent fraud and strengthen collection efforts. It also makes contracts more enforceable while protecting legal rights in the case of litigation. “In construction, where lien rights and contractual enforceability are critical, accuracy is not optional—it is essential,” Smith said. “Taking a few extra steps at the start of the credit process can protect your business from costly mistakes and safeguard against financial losses down the line.”

Learn more about Know Your Customer (KYC) from an international standpoint in NACM and FCIB’s upcoming webinar, Going Global – Know Your Customer, hosted by Bell.