If a company offers credit terms, sooner or later it will encounter a customer or client who refuses to pay for the products and services it received.
In the four years that I’ve been in business as an outsourced CFO, I’ve helped many companies deal with the hassles and details of extending credit. Throughout that time, I’ve been fortunate to have wonderful clients who always hold up their end of the mutual relationship. I guess it was just a matter of time until I came upon one who didn’t. In order to help my clients and readers, I thought I would document this frustrating experience. Here is what happened.
In November of 2010, I was contracted by a start-up company to complete a 3-year financial projection for the purposes of obtaining investor money. After expediting the project and completing it in just two days, the client was so pleased with the work that he gave Consult Your CFO a resounding video testimonial. Unfortunately, this great testimonial is now worthless, because of events that followed the engagement.
After the work was completed and delivered, and the client expressed his gratitude and appreciation for a job well done, obtaining payment for the work became a second job. After repeated calls and e-mails to the client, the client responded that the check had been mailed. It became quickly apparent, after the 2nd time of hearing the check had been mailed, that the client was playing games and did not want to – or was simply unable to – pay for the services rendered. After a month of dealing with this frustration, I decided to take him to small claims court.
At that time I figured the judicial process would easily remedy the situation, because I had so much supporting documentation, including:
- a signed contract,
- supporting detailed invoices,
- e-mails from the client acknowledging that he owed me the money, and
- a video testimonial extolling my company’s services.
Figuring this was a no-brainer, I looked into filing a Warrant in Debt claim against the client, after a letter from my lawyer to the client for non-payment garnered no response. For a small business, spending money on legal services is warranted only when true needs arise, i.e. contract terms or suits. Therefore, I filed the Warrant in Debt at the County District Court on my own. The court asks the plaintiff to fill out all sorts of documents. They even asked me if the client that I was suing was in the military. In addition, they asked me to contact the State Corporation department to determine the name of the registered agent of the company. Little did I expect that the company was never actually established because the client’s check did not clear due to lack of funds. Therefore, I was told I would have to sue him personally. As I learned, the onus and upfront costs are squarely placed on the plaintiff.
While my trial date was, in my opinion, very reasonable (1 month from filing), I was never informed that I would need a lawyer present at the hearing, because of the amount owed and because Consult Your CFO is a corporation. Therefore, during judgment a month later, I had to ask for a continuance until I could have an attorney present, even though the defendant (“Client”) did not argue the summons or show up for the hearing. For a small business to spend an estimated $1,000 for legal representation on top of the time and cost to file and time and energy to get paid before this point is ridiculous. Additionally, even if you win and obtain judgment, you’re not done. You still have to hire a lawyer to complete a derogatory with the defendant (“Client”) which incurs additional, unrecoverable legal costs.
Once the derogatory is complete, even if the client or defendant had the money, they could go to the bank and immediately close the bank account and move it, thereby extending the process indefinitely, unless you could prove that he/she was doing it purposely to avoid paying the judgment. Therefore, the small business could be out all the legal costs as well. So where is the Justice? Why file a small claims case at all if all you are doing is wasting money on legal fees and court costs with little chance of recovering even the original amount earned? Why does the judicial system not create a framework to resolve the disagreement simply and economically for both parties, instead of putting all the onus on the plaintiff and no accountability on the defendant to make them responsible for what they owe?
So was my situation unique?
It is amazing what people will tell you when you are standing in line and are willing to ask. I talked to four individuals during this judicial process. Two were lawyers acting on a company’s behalf, one was being sued and one was suing another like me. This process has unfortunately showed me how broken the Judicial process is in handling small claims.
The person being sued told me that he owed the money to a sub-contractor, but being a small business himself was waiting to be paid by his Client. Therefore, if he had been paid timely by the Client in the 1st place, than the sub-contractor would have been paid timely as well, which would avoided the waste of time and energy of all parties, including the courts.
The other person suing said that the key is to file a claim as soon as the client misses a payment. He told me that obtaining payment even with a court judgment does not mean you will obtain payment. He has clients he has never collected on.
Both of the lawyers complained that they had a drawer full of files of approved judgments that they will never get paid on. In addition, they told me that while each county handles small claims differently, they both agree that obtaining payment is very difficult and that it is stacked against the service or product provider. They both recommended that service providers obtain a retainer up front and make sure the check clears before starting work for a new client. This will alleviate the back-end process of attempting to collect. The vast majority of people are trustworthy and engage in honest, fair business practices. But considering the few bad apples out there who take advantage of the system, it behooves you to be extra careful until the relationship can be well established.
These are the key takeaways from this experience:
- Courts have a multitude of layers and thresholds that have to be navigated in collecting payment. In my opinion, these legal steps create undue burdens on the small business owner trying to obtain a fair remedy for work provided. Therefore, do everything you can to avoid the judicial process.
- Obtain a retainer upfront and work off the retainer. Stop work until the retainer is replenished.
- Fallback position: if a retainer cannot be procured, make sure you obtain personal guarantees in writing.
- Only after the client has established his credit worthiness with you should you extend credit. This is particularly true for professional services providers, because there is no way to get those hours back once expended. A car dealer can repossess a car, but a consultant can’t take his opinions back.
- Be particularly careful with clients that have startup businesses. You have much less risk in extending credit to a well-established company.