Handling past due invoices is one of the most unpleasant parts of running a small business. Business owners want immediate payment, but for a variety of reasons, you may have to invoice a customer, creating an account receivable. Depending on your terms with your customers, and industry custom, you might offer trade credit such as net 30, where full payment is due 30 days after purchase. However you handle your invoicing, accounts receivable are inevitable, but not unmanageable with the right resources and strategy. An understanding of your debt collection legal options, in addition to standard billing practices, is essential.
Debt collection is a business and a legal problem too. Companies should create or use systems that help manage the accounts receivable. Legal routes to debt collection are generally more expensive. They can prolong the debt collection process, so they are often last resorts for cases where a debtor refuses to pay or enter into a repayment plan.
Statute of Limitations
For consumer debt, collection agencies ( and creditors) can only sue a debtor if the debt is not too old. This duration varies from 3 years to 10 years depending on the state where the debtor resides. We have a in-depth article about Statute of Limitations.
Legal rights vs. Legal remedies
The legal options for debt collection include communicating with the debtor about the unpaid balance, which involves asserting a legal right to payment in full. To properly talk about the debt, you must have a clear understanding of your legal rights under the contractual agreements used for the underlying transaction. Knowing the terms of your contracts will better prepare you for negotiation and collection before pursuing the next steps. As a business creditor, your legal remedy is to sue the debtor in a court of law.
Suing on a debt involves numerous steps, which can vary depending on the jurisdiction — the laws that govern your transaction with the debtor. In most cases, debt collection cases are under the jurisdiction of state or local courts. Some states have a commercial claims part of their small claims courts, which can fast track the resolution of these matters. There are limits to the amounts in dispute for some of these courts. For example, in New York City, there is a $5,000 limit for commercial claims in small claims court. In Texas, the limit is $10,000.
For consumer debt, if a debtor does not show up in the court, creditor may be eligible for a default favorable judgement.
The steps and timeline of commercial debt lawsuits
The process of enforcing legal rights under a contract depends on the governing law, but in general, suing on debt requires the following steps:
- Demanding payment. Most courts will require that you prove that you actually asked the debtor to make a payment before commencing a lawsuit. This requirement is important as it ensures that a creditor attempts communication first rather than burdening the court system with numerous trials. In some states, giving notice of 30 days is a legal requirement to sue on a contract.
- Drafting and filing a complaint. After you’ve demanded the debt, and the debtor has not paid, you can then file a legal complaint with the court. If you are using a small claims part of the court, you may be able to use simple official court forms. The complaint should clearly state the terms of the agreement and the amount due. It also should provide evidence of these matters, such as a copy of the contract, emails about the transaction, and payment histories.
- Securing a court date. After filing, the court will provide a court date. In some jurisdictions, however, the courts leave this process up to the filer, requiring knowledge of how much notice must be given to the debtor.
- Serving process. Once you have a court date, the court clerk will tell you if you need to deliver the complaint to the debtor, or if the court will handle the process. Again, each court has its particular rules and procedures.
- After service. Once served, the debtor, who is now also the defendant in the lawsuit, will have a period to file an answer to the complaint. This period varies, but is generally between 20 and 30 days and can depend on the manner of service. Should the defendant not respond to the complaint, you may be awarded a default judgment.
- Negotiation. The time after service also is an opportunity for negotiation. In some cases, the filing of the lawsuit will prompt payment in full. In others, the defendant may continue to ignore the matter. It may also trigger a conversation about resolving the case outside of court.
- Trial or hearing. The ability to settle out of court still will continue until the final judgment. Most judges will require that the parties demonstrate a good faith effort to resolve the matter before trial. If the parties cannot agree, the case will eventually proceed to a hearing or trial. Most commercial small claims do not involve juries, with the judge being the sole decider of fact and law.
- Judgment. If you win either after a trial or because of a default judgment, your work is still not complete. This entire process can be just the beginning of a post-judgment collection process. Victory means you have an enforceable judgment, which is like the rights under your agreement with teeth — although not as sharp as you’d hope.
- Post-judgment enforcement. If your debtor is judgment-proof, meaning that they have no assets or are bankrupt, you may end up with little more than a piece of paper. However, a judgment opens the door to the next level of collections: enforcement. With a valid judgment, you may be able to garnish wages, file a lien against property, force the sale of property, execute against bank accounts, and more.
As you can see, even with a simplified commercial small claims court at your disposal, the process is lengthy, complicated, and often does not result in immediate payment. Because of the complexity of debt collection and the legal rights involved, it is advisable to engage the services of a professional debt collection agency. Professional collection firms know the requirements of the various courts, their backlogs, and the likelihood of getting paid.