The number one question I get asked by online freelancers and service providers is: “What if my client doesn’t pay?”
Before I tackle this question, know that everything I chat about is legal education and information under U.S. law, NOT business, financial, or legal advice and it doesn’t create an attorney-client relationship between us. You want to be sure to speak with an attorney in your local area so that you can take the right steps for you and your business.
Alright, now that my disclaimer is out of the way, let’s talk a little bit about the unsexy side of being a business owner.
Inevitably, you’re going to have a client who doesn’t pay. You may be cringing because you haven’t had to deal with nonpayment yet. Or you may be cringing because you have. Either way, my first question for the business owner is always: “Do you have a written contract?”
Get. It. In. Writing.
There are certain scenarios where oral contracts are enforceable. However, it is a better business practice to have a written contract signed by both parties. And that’s because written contracts clearly outline expectations and responsibilities between you and your client.
A contract is basically an exchange of promises between people that both parties benefit from. Whether your client is someone you’ve never met in real life (thanks to the reach of the interwebs) or your cousin, you should ALWAYS have a written client agreement. Key terms include payment obligations (think how much, by when, and how) as well as what if a party breaches the contract.
This is NOT an exhaustive list of provisions to include in your client agreement.You can read more about written contracts and what they should include here.
“Breach of contract” occurs when one party to a contract breaks their promise. Failure to pay can be a breach of contract.
If possible, it’s smart business to get payment in full up front. However, that doesn’t work in every situation.
So, while you can’t guarantee you’ll never have a client fail to make a payment, having a contract in place is the first line of defense.
You can learn more about the types of contracts and policies your online business needs here.
So, I’ve got a contract.
What if my client doesn’t pay?
#1. Send a “friendly collection letter.”
Clients are human. Sometimes a missed payment is simply because life got in the way and they forgot. I always recommend sending a friendly collection letter to remind your client that payment is due.
You can outline what late payment terms your contract provides and ask that your client comply with their agreed upon obligations. Plus, you have the added benefit of creating a written record of collection attempts if you do have to take additional steps to pursue payment under your contract.
The key here is to read your contract’s notice provision (which outlines how each party is to receive notices about issues with respect to your contract – by email, fax, certified mail, etc.).
#2. Speak with a small business attorney about drafting a collection letter on their legal letterhead.
If the friendly collection letter doesn’t work, sometimes it helps to have an attorney draft a collection letter on their legal letterhead. It shows the other party that there will be repercussions if they don’t meet their contractual obligations.
I find that a lot of the time collection problems end here.
It’s important to evaluate the termination clause in your contract at this point – if a client is having difficulty complying with their obligations (or refusing to), you may make the decision to stop working with them.
I would also recommend that you chat with the attorney about what they think it will cost to pursue payment if your letter campaign fails. It lets you plan ahead. And helps you conduct a cost-benefit analysis to determine what makes the most financial sense for you and your business.
#3. Review what next steps your contract provides and make a decision about collections, arbitration, or court proceedings.
Depending on what your contract provides, next steps may be sending your client to collections, initiating arbitration, or starting court proceedings. It’s a smart business practice to include a provision in your client agreement that provides for the payment of your attorney’s fees or collection costs.
Many small business attorneys offer a free or discounted rate for consultations to discuss issues like these. It’s money well spent and a business write-off.
Send your client to collections.
Collection agencies typically recommended that you wait at least 90 days before starting the collections process.
A collection agency will pay you a percentage of what they collect on your behalf pursuing payment from your client OR buy the debt from you at a discounted price. The collection agency may also report the non-payment to credit bureaus and damage your client’s credit.
If it is a commercial (or business to business) debt, you want to be sure the collection agency is certified by the Commercial Law League of America (CLLA) and a member of the Commercial Collection Agency Association (CCAA). Do your due diligence to locate a reputable collections agency.
And note that even if you obtain an arbitration award or judgment as we discuss below, you may still have to hire a collections agency to help recover the money you’re owed.
Initiate the Arbitration Process.
If your contract contains an arbitration provision, you’ll be resolving your dispute in a private process outside of court.
The arbitration process will still allow you to submit evidence and provide oral argument for consideration, but is much less formal than court proceedings. Arbitration can either be binding or non-binding (so that the arbitrator issues an advisory that only becomes final if both parties accept).
You also have the option of retaining an attorney to help you through the arbitration process.
Start Court Proceedings.
If your contract’s dispute resolution provision provides that you have legal recourse in a court of law if something goes awry with your client (aka failure to pay), you want to review what state’s courts have jurisdiction to hear the dispute and what state’s laws apply pursuant to your contract.
Depending on the amount in controversy, you will initiate court proceedings in either small claims court or the superior court in the appropriate jurisdiction. And you want to be sure that you’re filing within the applicable time period, also called the statute of limitations.
In either process, you’ll present evidence that a contract existed, a breach occurred, damages exist, and your client is responsible.
Small Claims Court
You want to research the monetary limits for the small claims court your case will be heard in. Limits range anywhere from $2,000 to $25,000, with the average ranging between $2,500 and $5,000. In California you can sue for up to $10,000 if you’re an individual or sole proprietor and up to $5,000 if you’re a corporation.
Most courthouses have self-help centers that are staffed by attorneys so you can explore handling the small claims case yourself. But I ALWAYS recommend consulting with a small business attorney before you decide to do so.
If the amount you seek exceeds the small claims court’s limit, you may consider reducing the damages you seek to remain in small claims court or choose to file in superior court.
The superior court judge will set a series of case management conferences (CMCs) to gauge whether the matter is ready for trial as well as require attendance at a mandatory settlement conference (MSC) to encourage settlement negotiations.
As a practicing attorney, I can say that a majority of the time a case will settle before going to trial. But, at the end of the day, your next steps are determined by the specific situation you’re in. Only you can make the decision after doing a cost-benefit analysis of what is owed and what chasing the invoice will cost.
If your online business is based in California and you would like to review your current contract or have one drafted for you, you can book a call with me here.
If you’re a US-based online business owner, you can also check out my easy to use attorney-drafted legal templates here.