In movies, gangsters often use muscle to get paid. In business, that muscle takes a different form. Filing a lawsuit or hiring a collection agency can give small business owners and independent contractors the ammunition they need to get clients to pay them for the work they've done.
When the due date has passed on the invoice you've sent to your client, and you've taken all the follow-up steps outlined in the Nolo article, "What to Do if a Client Won't Pay," it's time to move on to more formal avenues for collecting payment. The options include:
Unlike the calls and letters you've already used, which can be followed sequentially, you'll have to decide among these more formal options. The option you choose will depend upon the amount of money you are owed, the reasons your client hasn't paid you, and how much money and time you're willing to invest in collecting the debt.
The simplest and fastest form of legal action you can take is to file a claim in small claims court. It should be a straightforward case: You'll claim that the other side breached your written agreement by not paying you, and you want the judge to award judgment to you for the entire amount owed. Then, if the client still doesn't pay, you can hand the judgment over to a collection agency, garnish the client's wages, or get paid from a bank account.
You don't need an attorney to bring your case (Some states even prohibit attorneys from representing you, though you can always pay for a consultation.) But you are also limited in the amount you can claim. The maximum ranges from $2,500 to $25,000, depending upon the state where you file your claim.
To find out the limit for small claims court in your state, see Nolo's article How Much Can I Sue for in Small Claims Court? If you're owed more than the limit, you can still sue in small claims court if you are willing to give up your right to collect the amount over the state's limit.
If you file a suit in small claims court and your client doesn't show up to dispute it, you'll win by default. A substantial percentage of clients don't contest claims for unpaid fees in court because they know that they owe the money and can't win.
For more information on suing in small claims court, see Nolo's article Small Claims Court and Business Disputes.
If the client owes you substantially more than the small claims court limit for your state, you can bring your lawsuit in regular trial court. Using an attorney would increase your costs substantially, but you might consider handling a simple debt collection case yourself or hiring an attorney for the limited purpose of giving you advice on legal points or helping with strategy. In truth, few collection cases ever go to trial. Usually, the defendant either agrees to settle before trial or fails to show up in court (which gives you a default judgment for the amount owed).
For information on how to handle a case on your own, see Represent Yourself in Court, by Paul Bergman and Sara Berman (Nolo).
Filing a lawsuit in court will allow you to ask for all the money you are owed. If you are willing to settle for less than the full amount you are owed, you might consider using a collection agency instead.
Collection agencies contact the debtor and exert pressure for payment, by explaining (not so subtly) that if the matter isn't settled, the creditor (you) will go to court and obtain a judgment for the entire amount, which can be satisfied by garnishing wages or attaching funds in a bank account.
These agencies typically work on contingency. (You are charged only if they recover money for you.) Agencies usually collect 20% to 80% of the debt owed, and charges range between 10% and 50% of the amount collected. In general, the smaller the amount of debt, the larger the percentage charged for recovery.
For example, if you are owed $5,000 and the collection agency recovers half that amount, or $2,500, and charges you a 25% fee, you would receive $1,875. If a collection agency recovered half of a $500 debt at a charge of 40%, you'd receive $150.
Creditors often chafe at the idea that not only will the debtor pay less than the full debt, but the agency will take a hefty chunk. But a realistic analysis of the cost of going after the whole debt in court should mollify most annoyed creditors. Preparing for and going to court, even when you win, is not without its costs, including the time and energy diverted from your business. And there's always a chance that you will lose. In the long run, recovering only a portion of the debt might be the most efficient way to end the dispute and return to doing business.