How Businesses Should Handle Unpaid Bills from Clients [e282]

Full Podcast Transcript

NASIR: Welcome to Legally Sound Smart Business.
My name is Nasir Pasha.

MATT: And I’m Matt Staub.
We’re both attorneys here with Pasha Law PC, currently practicing with offices in California, Illinois, New York, and Texas.

NASIR: Welcome to the podcast where we discuss current business news with our legal twist.
Today, we are discussing what to do when your client refuses to pay.

MATT: Correct.
You know, we decided to change things up a little bit. I don’t think this is necessary for any one particular current event that’s going on but it’s an ongoing issue. Maybe in the news people have seen some real estate tycoons who have, over the past few decades, hired contractors and small business owners for jobs, let them perform the service, perform the work. When they’ve completed them, companies haven’t held up their end of the deal. So, what we’re going to discuss today is, as a business owner, what can you do to protect yourself from being blindsided as well as what you can do once it’s happened.

NASIR: And this is a problem that pretty much every business has. I mean, it’s hard to think of any business that really doesn’t have some consideration of how to collect money from your customers or clients, right?
For other businesses, there’s less risk. For others, there’s more. It’s just kind of depending upon what industry you’re in. Obviously, we represent a lot of small and medium-sized businesses across the country. But this could be very frustrating and sometimes crippling challenge to some business owners, especially in high-risk industries. We’re talking about everything from a lot of service-based industries – construction is one of those things where, a lot of times, there’s non-payment – and then, also, if you’re working with the type of clientele that tends to, you know, you have certain fees that maybe they can’t afford and they’re already in a position where they’re disadvantaged in relationship to what they’re being provided. I’m starting to think about, like, credit repair services. I know a lot of bankruptcy attorneys, for example, they have to make sure that they get paid their money because their clients are filing for bankruptcy.
There’s a very wide range of types of businesses but pretty much every business has to deal with this issue on some level.

MATT: Yeah. Like you said, it’s going to vary greatly, depending on the nature of the work and the industry. If it’s a business where you’re going to require 100 percent payment upfront, obviously, you’re going to have less issues. I mean, you could still have chargebacks, things like that, or bounced checks. I think your bankruptcy example is a really good one. If you’re going to get paid at the end, especially with a client who’s having presumably some sort of money issues, it’s going to be a lot harder to collect. Really, to me, it’s a two-part analysis. It’s the front-end and the back-end. You can be proactive about it and that’s, of course, making sure you have all the safety precautions in place – obviously, we’re two lawyers here, we’re going to talk about what agreement and the terms you would have in that. On the flip side is the reactionary aspect of it and what you do after this happens. That can even be in situations – and many times it is – where you have a contract and the client just has refused to pay or can’t pay or whatever reason they might give.

NASIR: Yeah. In fact, whenever we come across a client, they want to go after a customer or a client that hasn’t paid and so forth, I mean, our first thought is, “Yeah, we need to address the apparent issue that the client is bringing to us.” But, in the back of our minds, “Okay, what can we do to assess to make sure that this doesn’t happen in the future?” Because most businesses can’t survive having to hire an attorney or even a collection agency or even doing an in-house to collect.
Like you said, it is a two-part question. But let’s start with the pressing need.
Okay, you have somebody that does not pay your invoice. What do you do?

MATT: Give up.

NASIR: That’s usually the first answer. Some people just don’t give up, though, do they?

MATT: Well, no, some do.
I guess, for me, the first thing you do is you’ve got to look at why this has happened. I just kind of touched on this briefly before but, you know, it could be a variety of reasons. You know, we might dive into them a little bit here but, you know, the main reasons that you’re going to get are one’s inability to pay and that could be intentional or it could have been nonintentional at all and just something kind of happened and it fell through and caused that. You have issues where the customer might be dissatisfied with the work or the product that they received. You know, you just have those customers that are just difficult to deal with or I guess worst case we’re talking just flat out malicious and had no intent to pay from the beginning and that’s obviously going to take it up a notch and we’ll get to the actions you can take a business owner but, to me, those three general areas are what you’re going to encounter or business owners are going to encounter most frequently when they have a client or customer who hasn’t paid.

NASIR: I would add one fourth category that – I’m sorry, Matt – we didn’t discuss. It’s kind of in-between some of these. There’s always these types of customers that intend to pay and it’s not like they’re completely unable to pay but because they’re waiting for some money to come in that they expected to come in earlier or they need to prioritize another bill over yours, they’re just procrastinating or routinely late in payment. Sometimes, even big businesses do that until you start bothering them and we’re going to talk about some of the ways to get your money back. They’re just going to not pay you until they get bugged enough to pay your bill.

MATT: I think, if we’re looking at this – and I don’t know what this is called – the Venn diagram is two overlapping circles. What’s three? You know what I’m talking about?

NASIR: That’s still a Venn diagram.

MATT: It’s still a Venn diagram.

NASIR: Yeah.

MATT: I think that your example that you just outlined there is the overlapping component of the inability to pay and just a difficult customer.

NASIR: Yeah.

MATT: Well, I guess that’s wrong. They don’t quite have the inability to pay but I don’t know. You see what I’m saying there? But I agree that is a different subset, for sure – that type of person who’s just a prioritizing customer, I’ll say.

NASIR: Yeah.
So, let’s start with what I think is the most difficult situation to deal with as an attorney. That is when the customer feels dissatisfied. The problem with that, as an attorney, from a legal perspective is that, well, we can’t really fix the fact that they feel like they didn’t get the value for the services that you’re billing them for. If they’re dissatisfied, from a legal perspective, it’s really hard for us to deal with that because we can say all day long, “Hey, you owe this money already,” but then, to balance that with the reputation of the business and so forth, it doesn’t feel great to get paid reluctantly. I don’t care what business you’re in.
If that’s the issue – and, really, you need to find out if that’s the case – then you need to do some kind of soul-searching to make sure that, “Hey, are you providing a quality product or service for what you’re charging your clients and customers?” If not, then even attorneys are going to have trouble collecting in that sense.

MATT: In my experience, the types of businesses that have the most trouble with this are going to be the ones that are a little bit more subjective. I would say kind of the arts – maybe a photographer, for example, or somebody that does web design – any sort of artistic-related field just because it’s so dependent on the individual.

NASIR: Yeah, if you throw a wedding.

MATT: Yeah, well, I guess weddings are going to be in a different situation because, at least with web design, you can technically go back and make the change. You’re not going to restage your wedding.
Do you remember reading, well, I don’t know if you did but I remember we read about a case in law school – whenever how long ago that was – where it was in our contracts class with the wedding photographer who I guess ended up screwing up. It wouldn’t happen today because it’s digital but he screwed up all their photos and it was all ruined and they were suing. I forget all the details but…

NASIR: I remember that because it was how to calculate damages in that sense, right?

MATT: Yeah, exactly.

NASIR: And I don’t remember the answer but now I remember it definitely being an issue.

MATT: Yeah, if the dissatisfied customer.
To me, you kind of have to make a decision on how you want to approach it; you want to be a good cop, you want to be a bad cop, you want to be some sort of mix in-between. I mean, you would supposedly have an idea of what your customers like and maybe you just have to feel them out and get an idea what’s the best approach to take.

NASIR: Yeah, if this is a very unusual case, your customers usually pay but this customer maybe had a bad experience, even if you believe that’s not correct, you know, from a business decision, it may be best not to escalate it to another level or at least obtain the feedback to find out what’s wrong and see what it’s going to take to satisfy them and possibly get paid. But, of course, I think this is the easiest for a business to deal with on their own versus an attorney.

MATT: Yeah. Like you said, is this an isolated incident or is this an ongoing thing?
Oftentimes, we obviously deal with this with the businesses that we work with and I think what we tell our clients sometimes is, “Look, I mean, we have legal avenues we can take,” but this, there’s not a legal solution necessarily to this.

NASIR: Yeah.

MATT: Or I shouldn’t say that. Legal approach per se. And so, it’s exactly what you just said. For a business owner, probably the easiest for them to handle without pulling any sort of attorney to get involved, but that’s obviously very case-by-case.
We touched on that. Let’s get into something that’s maybe the next level of having an attorney get involved perhaps is inability to pay. Again, this is going to be very dependent on the situation but you presumably would know your customer and – I think I touched on this earlier – it could be they had no intent from the beginning. They knew they had the inability to pay from the beginning. Conversely, for a business, if something happens and they just don’t have the ability to pay right now, then try to work something out whether that be payment thirty days from now, worst case scenario maybe say, “Well, if you can’t pay me 100 percent of it right now, can you pay me 75 percent of it in fifteen days?” I’m not advocating that route but that’s an option that’s out there.

NASIR: Yeah. Very rarely is there true inability to pay in the sense that it’s more likely it’s just that, out of all the things that they have to pay for, you’re not a priority. It doesn’t mean that they can’t pay anything. Also, it’s somewhat rare that people have not enough money to pay you or anything in a sense that they’re on the brink of bankruptcy. That’s also rare. There’s a lot of bankruptcies in the country at any given time but that’s not a common thing – unless you’re in a specific industry.
My point being is that, just because they say they have the inability to pay doesn’t mean that they can’t pay something and, like you said, over time. And so, this can be difficult for a business to deal with because, here, there is trouble kind of going after a client or a customer that wants to pay you but is unable to and so you really have to find creative solutions. But the worst case scenario is that they say that they’re unable to pay – and this is kind of going into our third category a little bit – they say that they’re unable to pay but they actually can or actually do have the means but they’re just choosing not to prioritize you. It makes to escalate it a little bit and there’s little things that you can do that are economical, depending upon how much you’re trying to collect and that could be a little bit more aggressive letter from the business or, if the amount makes sense, from an attorney which is much more effective and then even escalating there, there’s so many options short of full-fledged litigation if the amount in controversy is a smaller amount, depending upon the state – $5,000 or less or in other states it’s a little more – then you can go to small claims court which you don’t really need an attorney to do so. I mean, an attorney can help kind of guide you through the process but you don’t need that kind of representation.

MATT: Yeah. I mean, you don’t need it – not only do you not need it, I mean, sometimes, you can’t even have one.

NASIR: That’s right.

MATT: But, yeah, I think you described it perfectly. It’s a risk versus reward situation. You’ve got to look at whether you think you’ll be able to collect something from them for the lawsuit route, whether you think you’ll be able to collect something from them, how much is owed, is it going to be worth it financially to pursue that route. Small claims court is obviously going to be much cheaper – the cheapest legal option – presumably because you might not have to pay anything other than your time. But, yeah, like you said, escalate to a demand letter or a full-fledged lawsuit, I’m thinking, for most of these small and medium-sized businesses, for the most part, a lawsuit in civil court is probably not going to be cost-effective.

NASIR: Yeah, especially if your clients are consumers.
Now, if you’re B2B, it’s a whole different picture.

MATT: Right.

NASIR: Often, if you’re dealing with a business that all of us, especially that they’ve been paying before but then, all of a sudden, can’t pay, then your strategy is much different because keep in mind that you’re probably not the only vendor that’s not being paid. So, in theory, assuming everyone is telling the truth – that they are, in fact, unable to pay – there’s only a select pot of funds to go around. The question is how are they going to use that fund. Are they going to use that fund to pay the vendors that don’t bother them? Or are they going to use the funds from the vendors that are pressuring them legally – whether it’s a demand letter or lawsuit – to actually pay them? The answer is obvious but, of course, it’s a delicate strategy because, if your bill is hefty enough, you don’t want to put them out of business either. You need to put enough pressure to make sure that they take you seriously but also keep in mind that you don’t want to spend too much resources because, if they don’t have the cash in the first place, then you’re not going to get anything anyway. That applies to both consumers and businesses because the last thing you want is some kind of bankruptcy filing where your claim becomes virtually worthless or pennies on the dollar.

MATT: Yeah. A quick tangent – and I don’t think this is that off-track but it’s an argument I’ve made many times before with the IRS when I’ve represented individuals or businesses – is, if the IRS wants them to make some sort of monthly payment to be more and I’m arguing less or they want to maybe settle it and I’m arguing less, you know, I tell them, especially for businesses, they need the money. “Here are your two options. You’re either going to accept less money and they’re going to be able to run their business or you’re going to make them give you more money and they’re going to go out of business and then you’re going to get nothing.” I mean, you’ve got to kind of look at it from a macro level to see what’s going to be the best course to take in these situations. You’re not going to have all the information necessarily but you can make an educated guess.

NASIR: Absolutely.
And so, we’ve kind of talked about this a little bit in our third category of difficult and even malicious customers and clients. I think the only difference here is, if you truly have a customer or client that, frankly, they provided a great service, they have the money to pay, but they are either because they don’t care whether you get paid or not, they’re so big and you’re a small vendor that they can bully you around or whatever reason, really, the only response is to be aggressive. We’ve seen this a lot of times, if you’re a small vendor and you’re providing a service and they’re late in payment, you have to be prepared – even at the cost of losing that client – to cut off service. The whole business that you have enough negotiating power that it’s enough of a disruption that they start paying you on-time.

MATT: Yeah, and that kind of rolls into what’s the proactive steps you can take and we mentioned this previously but having a written contract obviously is going to help with the right terms in it. You know, there’s a lot that goes into that but one of the things – just kind of leading off what you said – is maybe, if it’s kind of an ongoing services, for example, you might want to make sure you have an out as a business owner, you might want to make sure you have an ability to terminate the contract for their breach and probably failure to cure the breach, too – and that breach being not paying you on-time – because you don’t want a situation where you’re stuck doing work and they’re not paying you and it’s running behind. You want to have some leverage in the situation. I guess you could just stop providing the services as well.
The point I’m making is a written contract is going to help you out a lot more in this whole process in a situation where you’re not getting paid or you’re not getting paid on-time even.

NASIR: Yeah, and you’re kind of transitioning into our next topic which is how to prevent this in the first place. Matt mentioned a contract is probably the number one way to do that but it also has to do with what exactly – and you touched on it, Matt – like, what terms do we want in there? I mean, there’s so many things to do.
First, the fee structuring. Getting paid upfront is, of course, ideal. But, of course, there’s some types of businesses that that’s (1) not customary or (2) clients and customers want the safety net of being able to be serviced or given the product before they pay because they want to make sure that they’re satisfied. And so, you mentioned website design is a very common kind of industry where you don’t get paid until you see the product. And so, a good solution in that industry – and in similar to that, any kind of coding or computer work – is you break it up into phases because the last thing you want to do is work for six months, give them the product, and they’re like, “Ah, I don’t like it,” and then you’ve done six months of work without getting paid. Frankly, most people in the industry understand that but being able to articulate and describe these phases in the agreement is often very difficult for many and I’ve seen a lot of people make mistakes in the sense that their business becomes half collection agency, half actually servicing their clients.

MATT: Yeah, and that’s a very good point and that’s really the nightmare scenario – when you’re spending time or even having to hire someone perhaps to do the collection aspect your business just because you’re having all these delinquent or outstanding balances. I mean, it’s just not going to be worth it. You could be paying somebody more money than to try to chase these funds than you’re going to get. It’s just something you don’t want to encounter. And so, the sort of milestone approach to payments can work. I mean, of course, this is all very dependent on the type of business and, like you said, there’s just so many things to consider. It’s difficult to narrow this down and, you know, short a podcast where we’re not even focusing on one particular business but just know that the possibilities, there’s plenty of possibilities out there as a business owner to protect yourself as much as possible.

NASIR: So, another tool that you can use is by allocating late fees. Late fees are enforceable. Everybody’s seen them – whether it’s paying our credit card bill late or rent bill, utilities bill late, you get a late charge. The only problem is that people tend to forget that you just can’t charge a late fee willy-nilly just because someone didn’t pay on-time. You do have to have some kind of agreement in writing that provides what the late fee will be and how that’s calculated. And then, also, there’s limits to how much you can charge.
For example, a lot of states – like California – would consider a late fee almost interest on that amount owed, that account receivable. And so, usury laws may apply as well. And so, you would have a limitation, in most cases, of 10 percent per year or however it’s calculated based upon the indexes.

MATT: Right. I think the keyword there that you just mentioned was “reasonable.” Of course, it has to be within the confines of any statutes, city laws, things like laws, things like that. But, if not, it does need to be reasonable or else, you know, if for whatever reason it went to a court and a judge had a look at it, he or she is going to say, “Look, this isn’t reasonable, it’s not enforceable.” It’s something that’s possible to do but it has to be within confines of – I don’t want to keep saying “reason” but…

NASIR: Yeah, well, it can’t be reasonable just to you because we’ve seen contracts that people have written where it’s like 5 percent per day. Looking at it, that seems, you know, 5 percent, that’s not a big deal, but when it’s per day or it’s calculated per day, that ends up being a lot more than just 5 percent. Annualized, it’s 5 percent times 365 – a little bit different than what maybe they anticipated or would be considered reasonable.

MATT: Yeah. You know, you said that it’s going to be good no matter what to get this in writing, like you said. I know some states do have statutes where it’s kind of a default charge whatever X amount or X percent if there’s late payment but it’s always going to be the right route to go – to get it in writing – just so there’s no issues of ambiguity.

NASIR: Yeah, absolutely. I’m almost reluctant talking about this because it can be kind of misconstrued or misused but attorney’s fees clause and an attorney’s fees clause in a contract basically says, okay, if there’s a breach and the prevailing party of a contract dispute will be able to obtain or recover the attorney’s fees that are spent. And so, in theory, if you put an attorney’s fees clause in your agreement, if your client or customer fails to pay and then you hire an attorney to collect, then you can recover those legal fees.
That sounds really nice but the only problem with that is, oftentimes, most states, even if you put it on a one-sided deal, they may automatically make it two-sided in a sense that, if there’s any kind of breach, even if you breach the contract and the customer sues you, then they can recover attorney’s fees. Or, if you sue them thinking that you’re right but you end up being wrong, then you still may be liable for their attorney’s fees. So, I’m just mentioning it because it is a tool out there but, like any tool, you’ve got to know how to use it and when to use it. Depending upon your industry where it’s more likely that your client is not going to pay you than it is for you to breach the contract, then an attorney’s fees clause is great. This is, like, for example, credit card agreements all have that because it’s very unlikely that the credit card company is going to breach their contract against you. It’s more like that you’re going to fail to pay the credit card or what-have-you and, if they file a lawsuit, they’re going to be able to recover their attorney’s fees and that’s why they do enforce credit card judgments against people that have the money.

MATT: That’s a good point. I’m glad you brought that up.

NASIR: You’re welcome. That’s why I did it.
Let’s see. What else?

MATT: Yeah. More or less, I think that’s really kind of the quick overview. I mean, California, we keep mentioning it depends on the industry. There’s the Prompt Pay Act which deals more with owner contractor issues.

NASIR: You mentioned Prompt Pay. Another way to encourage customers and clients to pay on-time is to give them a discount if they pay within thirty days. It’s almost a reverse late fee. But it’s a little bit more politically correct. This works really well if you’re a small vendor and you’re dealing with a very big company because, to them, it’s like, “Okay, if I get a one percent discount for paying early and it’s a sizeable invoice,” for them, it’s just an easy mathematical problem because the reason they pay late is because of cashflow issues. And so, if there’s no real penalty to it, then they’re going to do that. Thar’s a very effective way. if it’s a one percent discount, it’s virtually one percent late fee, you know?

MATT: Yeah, that’s a good point.

NASIR: Also, I was thinking – and this we kind of should have started out with – you need to have, especially if you’re not getting paid on the front end, you need to have a procedure of collections and a procedure of escalation, especially if you’re doing a lot of volume of business in general – meaning a lot of small transactions. You need to have a routine of invoicing in the sense, let’s say you have a 30-day invoice, that means that after you send your invoice the first day, if you don’t receive it by the 20th day, you send another invoice to follow-up. “Hey, don’t forget your invoice or your payment is due within ten days.” As soon as they don’t get payment on the 30th day, then you need to have another follow-up and it could be an email, it could be a letter, or it could be even a phone call, and then you escalate from there. You have another tickler at 45 days or 60 days and then 90 days you need to escalate that correspondence – whether it becomes, “Hey, final notice” or what-have-you. Hopefully you don’t get this but we’ve all seen it at least elsewhere that you get that final notice stamp or “you’re about to be evicted.” There’s an escalation to that.
Know you should also have an internal policy. At what point are you going to have your attorney send a demand letter? At what point and for how much money are you going to file a lawsuit for? For most businesses, you pretty much need that policy because you’re going to encounter this over and over again. There’s some businesses that tend to not have too many kind of late payments and so it may depend on a case-by-case basis but I would say most businesses, there’s always a certain percentage of just customers and clients that are late or nonpayers. If you’re smart enough – I shouldn’t say “smart enough” – if you’re able to and your industry is capable of doing so, getting rid of those trouble customers will make your life much easier.

MATT: For those listening, if you can’t get rid of trouble customers, you’re not smart, according to Nasir.

NASIR: That’s not what I said. Don’t put words in the mouth that I actually just said five seconds ago.

MATT: One last thing, too. I know we just keep piling on this but we could look at the opposite side of this equation. You have a customer or let’s say in this situation customers aren’t paying you, you’re expecting that money to come in. Now, you as a business can’t pay maybe some of your expenses or vendors, et cetera. You know, you’ve got to look at it from the other side of the mirror, I guess. And so, obviously, you have to pay wages. You’re going to pay things like that but you have to have some sort of plan in place for whatever reason, you’re not getting paid from a big client or multiple big clients, you know, you need to have some sort of reserve or something or else you’re going to run into the same problem we’ve essentially been discussing this whole time from the opposite side.

NASIR: Yeah, and especially if your financial condition is such then getting deposits and upfront money becomes very important. For example, one of the ways that you can offset a client or customer’s kind of reluctance to pay you upfront is to make it a refundable deposit in the sense that you’re contractually obligated to return the funds upon some event. But, in good faith, you know, I‘m going to collect a deposit. Now, attorneys, for example, have a trust account that they actually put the money into a trust account before it’s actually earned. Now, some businesses can do the same. Most businesses don’t have a trust account or escrow account but, when you’re talking about a large amount of funds, you know, as an example, when you’re buying a business, you’re not going to put a million dollars in their hands and they’re going to hand the business over. You’re going to put it into an escrow just like you’re buying a house. And so, you know, if the amount is large enough, you can definitely go through an escrow service and it makes sense. I know, if you’re buying anything illegal online, they have escrow services in the Dark Web. So, why not for people that are doing legitimate business? I don’t buy anything on the Dark Web. I’m just, you know, as an FYI.
All right. Well, I think that’s our podcast.
Thanks for joining us!

MATT: Keep it sound and keep it smart!