As a business attorney for the past twenty-five years, I have represented numerous creditors and debtors in collection lawsuits.  As such, I am aware of the strategies of debtors and their attorneys when faced with a collection lawsuit, and the difficulties associated with collecting a commercial debt.  This short essay is intended to provide basic information to assist creditors in their efforts to secure payment of a commercial debt.

The first thing to recognize is obvious.  All activities of a company to collect a commercial debt, regardless of the outcome, represent a loss to the company—either through in-house collection efforts, or through the payment of collection fees to third parties.  This means that even if 100 % of the debt is collected—a rare occurrence—the creditor will not be made whole.  Moreover, if the debt turns out to be uncollectible, the bad debt loss is compounded by unproductive collection efforts and fees.  This scenario is makes the debt collection practices of a company extremely important—including, determining on a case by case basis the appropriate professionals to retain, if any, to assist in the collection process.

If a debt is in fact uncollectible, this should be determined as soon as possible.  However, a creditor should not “bail-out” prematurely on collection of a debt because of suspicion of debtor insolvency, or out of fear that the cost of collection will exceed, or unduly undermine, the net recovery, even if collection is successful.  Note, however, that the initial determination as to whether a debt is collectible, and thus whether collection costs are economically justifiable, is very complicated in itself, and often requires professional assistance to investigate the debtor.  In addition, the creditor must access the debtor’s business personality, and consider whether the debtor might turn to alternative sources when pressed for payment as an alternative to filing bankruptcy, or simply going out of business.  Also relevant, is the debtor’s general character and moral sense.  Some debtors, or their corporate business owners, become embarrassed when faced with collection activity, and feel morally compelled to find a way to pay the debt, drawing upon resources, such as family members, that otherwise not legally available to the creditor.  On the other hand, many debtor take the attitude that avoiding payment of a debt is simply a part of business, and have no moral scruples about blowing it off.

You can see that collection of a debt can be extremely complicated.  The first lesson that should be learned is that of foresight.  A business owner or general manager simply must have policies and procedures in place (1) that avoid, as much as possible, large, unpaid, accounts that cannot be easily collected, and (2) that make the collection process as easy as possible, if such becomes necessary.  I will mention only a few things here.  A business owner should, whenever possible, require either prepayment, or a substantial deposit before delivering a product or providing a service.  I realize, of course, that this is not always possible, or even legal, for any number of reasons.  If this isn’t possible, insist on a personal guaranty from someone you are confident has money to pay, usually the business owner.  If this also is not feasible, at least use your own contracts to define the payment obligation and the consequences of default, and include language that facilitates debt collection, including language providing for recovery of attorney’s fees if collection becomes necessary.  Also, make use of any statutes that protect creditors, for example, the mechanic’s lien and stop notice statutes that protect California contractors.  Finally, do not forget that every transaction is ultimately business, and not personal.  Thus, be very careful about cutting corners on good business practices because you are dealing with a “friend,” or “your best customer.”

So, how should a creditor proceed when faced with a debtor who is not paying.  Remember, the entire process is about cost-benefit, and risk, analysis.  In this context, you should ask yourself the following questions: (1) Do I have an in-house employee who I can and should assign to attempt to collect this debt; (2) Should I refer the debt to a collection agency; (3) Should I immediately retain an attorney to file a lawsuit, or (4) Should I just write it off and move on.  There is no question that each of the above responses is appropriate in some contexts.

An in-house person with the right temperament and skills can be very effective, and if successful, will be the most cost effective collection method.  Note, however, that the wrong person can do great damage.  Someone who insults the debtor, or uses harsh and threatening language, or a derogatory tone, might very well make matters worse.  Even if deserved, such conduct invites the debtor to irrationally justify non-payment by making the creditor, or the employee the “bad guy.”  It can quickly turn a cooperative debtor facing a temporary hardship into an uncooperative debtor bent on either avoiding the debt entirely, or placing you last on his payment list.  On the other hand, an employee able to finesse the situation can create a friend who wants to make payment as soon as possible, and who naturally feels the obligation to do so.  Note, that there is an appropriate and effective way to “threaten” a debtor, as well as a way that is not helpful.  Consider the emotional reaction of a debtor who hears, “You’re nothing but a deadbeat.  If you don’t pay this debt by Friday, I will get an attorney and destroy you and your business.”  Contrast this with, “I know you want to pay this debt, but are struggling right now, but if we don’t get some payment to me by Friday, we will have no choice but to turn it over to our attorney.  We really don’t want to do that.  We would prefer to work with you.”  These are, of course, extreme examples.  You get the idea.  I once had a client who by disposition was very fair minded, but who was harassed by a collection agent on a small commercial debt that he simply needed a few months to repay.  Finally, after being aggressively confronted by the creditor, he came to me angry and vengeful, not wanting to pay anything.  My research into the matter revealed that the collection agent committed several legal violations, creating not only legal damages, but affirmative legal claims against the creditor, that were well above the amount of the debt.  As a result, the collection agency ended up paying my client instead of the other way around, simply because of the misguided attitude and conduct of its agent.

If the amount of the debt is small, say $5,000-10,000, or less, and sufficient time has passed without payment, the debt should probably be turned over to a reputable collection agency.  However, not all such agencies are created equal, and some are, unfortunately, unethical in their dealings, not only with a debtor, but with their client creditor.  You need to check out the agency ahead of time.  Advertisements that guaranty recovery, or state a high collection rate should probably be avoided.  Consider whether the agency is a member of an association that has adopted collections standards of ethical conduct.  (For example, The Commercial Collection Agency Association (CCAI), or the International Association of Commercial Collectors (IACC))  Moreover, the fee term is crucial here.  The general rule of thumb is the larger the debt the smaller the contingency fee, with fees ranging from 20-50 percent.  Thus, for a small collection matter, expect to pay as much as half of whatever is recovered.  Your attitude for these debts should be, “Anything is better than nothing.”  Simply turn the debt over to the agency and let them deal with it while you go about running your business.  Some agencies will want you to pay a non-refundable, upfront fee, or collection “costs.”  Sometimes, this may be appropriate and legitimate.  However, avoid “on-going’ charges that are beyond your control, or fee agreements that put all of the risk of collection with you, the creditor.  Use common sense.  Consider how the fee agreement might play out with various collection scenarios, including full recovery, no recovery, or something in between.  Also, make sure that the agreement has a time limit, such that it expires on its own if collection is not achieved within a reasonable time.

For larger amounts, the decision has to be made as to whether to go with a collection agency or directly to a collection attorney.  By the way, a good collection attorney will candidly assist you in making this decision.  Here are the tradeoffs:  A good collection attorney may be able to secure recover by simply writing a firm letter, and/or filing the lawsuit.  Perhaps an early settlement can be reached involving payments.  In short, paying an attorney $250.00 an hour (say) may result in full recovery or settlement, at a collection cost of maybe $2,000.00, or less.  A collection agency may also secure recovery, but take a contingent fee of 30%.  Thus, if the recovery was $20,000.00 (say), your cost to an attorney might be $2,000.00 in contrast to the $6,000.00 contingency fee payable to the collection agency.  On the other hand, if you hire an inexperienced attorney at a standard hourly rate and he spends a year in litigation, you will likely pay him at least $20,000.00, and if the debt turns out to be uncollectible, you have doubled your losses.

How about an attorney on a contingency fee?  That’s fine, but then, again, if he recovers quickly your payment to him will be grossly disproportional to the services provided.  Of course, there are many types of contingency fee arrangements, including: (1) combinations of contingency/hourly agreements; (2) advancement of costs plus contingency fee agreements; (3) staggered contingency fees, both over time and amount, etc.  In this latter arrangement, the fee might initially be low, say 10%, and gradually increase as more time and effort is expended  Alternatively, the contingency fee might vary depending upon the amount of recovery.  In short, there is really no end to the possible fee arrangements as related to the collection of a commercial debt.  So, what is the lesson of all this?

First, strategy is everything.  You need to have an effective collection strategy based upon everything you know about the debtor and the debt.  Second, your strategy needs to be flexible such that as more information becomes apparent, adjustments can be made.  For example, along the way you may find out that the debtor has no money and no assets, but has a spouse with money.  This, perhaps, suggests a different strategy.  Third, you need competent, professional assistance in developing a collection strategy.  Seek out both collection agents and attorneys who will consult with you without charge.  Talk to several of each, particularly if the amount of the debt warrants special care and concern.  If necessary, pay an experienced collection attorney for an hour of his time to assist you.  In addition, always remember the goal:  TO RECOVER AS MUCH OF THE DEBT AS POSSIBLE WITH AS LITTLE EXPENSE AS POSSIBLE IN COLLECTION COSTS AND PROFESSIONAL FEES.