There is a common misconception that most business owners seem to have regarding the collection of customer owed debts. Many times a business owner has come to me because their business is owed a couple of thousand dollars from a customer or two or more and they want to sue those customers in order to recover the money. The owner either cannot afford or is unwilling to write off the bad debt. Maybe they had to borrow money in order to meet their obligations under the contract; or perhaps, since the debtor has not paid, the business owner had to borrow money to cover expenses that would otherwise have been covered.
Sometimes there is no contract or after reviewing the contract, I have bad news for my client. Yes, the business owner has a good case. But that several thousand dollar debt will likely take several months or longer and may cost several thousand dollars in attorney fees to resolve in court – and that does not even take into account collecting on the judgment. The client is also not entitled to interest on the outstanding debt until a judgment is received. Lastly, the Court will not order the debtor pay the costs associated with the litigation.
Not surprising, we follow the American rule wherein each party pays its own costs associated with the lawsuit. Obviously, no business owner wants to hear that client is also not entitled to interest on the outstanding debt until a judgment is received. Lastly, the Court will not order the debtor pay the costs associated with the litigation.
Not surprising, we follow the American rule wherein each party pays its own costs associated with the lawsuit. Obviously, no business owner wants to hear that pursuing the debt may cost more money and that, in the end, the money collected will be reduced by attorney fees and costs. The delinquent customer may even cost the business owner more money in the form of interest they had to pay to borrow money to keep their own vendors happy and their business afloat. In essence, these interest payments reduce that judgment even more. Even if the business owner did not have to borrow money, at the very least, they would be unable get the use of the money owed until it is paid by the debtor. So while they may have won the case, at the end of the day you must really ask did they really win?
If you knew all of the above before you signed the contract, what could you have done differently? In the ideal world, you would have gotten paid up front but, as we all know, we don’t live in an ideal world, so what is the backup plan? In the real world, we must insist that all business relationships be made and conducted in writing. If you can’t afford not to get paid, make sure that the transaction is committed in writing – i.e., a contract.
Now, how can a contract be prepared that will protect you in case your customer does not fulfill their obligations? Along with the many concepts that need to be addressed in a contract, there are two that should be included to ensure that the scenario described above doesn’t happen. First, the contract should provide that, if the customer does not fulfill their obligations and you have to sue them, they must pay the costs of your attorney as part of your damages. Second, if payment is not received by you on the due date (and maybe any grace period) the outstanding debt will begin to accrue interest.
These are just two very common concepts that you should consider in any contract you enter into. There are many more concepts that should be addressed in your contracts. Which concepts and how they should be addressed are dependent upon what you are selling/buying, relative strength in negotiations between the parties, and the nature of your business. If you are unwilling or unable to write off the bad debt from a transaction, it is a transaction that is important enough to warrant consulting with an attorney so that you will be protected in the event of a disagreement or the other side’s failure to perform. To borrow from the old adage, an ounce of prevention may save you thousands of dollars later.
A little bit of forethought on constructing the appropriate contracts for your business can save you a lot of regret in hindsight.
The article above is a reprint from my first newsletter from July 2006, but a conversation over the weekend made me think it would be useful to post it in the blog.