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Collecting Accounts Receivable Part I:  What to do Prior to Commencing Legal Action
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Collecting Accounts Receivable Part I: What to do Prior to Commencing Legal Action

May 3, 2013 Banking & Financial Services Industry Legal Blog

Reading Time: 5 minutes

This Blog is Part I in a series of Blogs designed to provide business owners with a high-level overview of the legal process for collecting on past-due accounts receivables.  Specifically, Part I focuses on the steps a business owner can take prior to filing a lawsuit against a delinquent customer.

Often times, the hardest part of operating a business is ensuring that you’re getting paid for your efforts.  As a business chugs along month after month, it’s inevitable that its stack of past-due accounts receivables grows larger.  And that’s a situation even the most business-savvy entrepreneurs find themselves in eventually.

Unfortunately, most debtors who are delinquent more than 90 days often won’t respond at all until threatened with a lawsuit.  That is why it is important that business owners who find themselves in this situation begin efforts to collect this past-due debt before it’s too late.

It is surprising the number of businesses that sit on their past-due accounts, taking no action at all, because they are either unsure how to begin, intimidated by the process, or hesitant to reach out to a law firm and commence legal action against customers who refuse to pay.  As a result, accounts receivables become bad debts on the balance sheet, which can place the business on the road to financial disaster.

First and foremost, all businesses must have internal operating policies and procedures in place for handling past-due accounts.  The policies and procedures need not be extravagant or convoluted; however, most businesses fail to collect their outstanding debts because they never established a process for collecting.

The first policy must be to implement a standard business contract and/or credit application form that the business requires each and every new customer sign prior to placing orders or requesting services.  That form should require the new customer to provide the following information:  name, address and telephone number of the applicant; federal tax I.D. number (for a company) or social security number (for an individual); banking references (including bank name, address, phone number, individual bank contact, and bank account number); and trade references.

For every new customer that is a business entity, there must be a section on the form for an individual to sign a personal guarantee.  In the event the new customer is a business that ultimately fails, the personal guarantee provides your business with an individual to collect the debt from.  If your business starts a habit of gathering this information from each and every new customer, then collecting on past-due accounts receivables becomes much easier.

In the event a customer fails to pay, the first step in collecting is to call the delinquent customer.  That may sound easy, but you’d be surprised at not only how far a phone call will go but how often that call is never made.  The problem is that many businesses don’t have a procedure in place for calling the customer once the account is past-due ten days, twenty days, and so on.  The result is the debtor isn’t notified immediately of its past-due status, which leads to both parties ignoring the debt.  If your customers know you aren’t paying attention to the past-due amount, neither will they.  Before you know it, the account is 90-days past-due, which is often the point of no return.

The second step is to send out written notices to your delinquent customers, informing them of their past-due balances and reminding them that you are indeed paying attention.  After the billing statement has been sent, and the payment due-date has expired, this written notice should then be mailed immediately.  However, don’t abandon the phone call—a call to the delinquent customer should always follow receipt of the written notice.  The business should follow this procedure when the accounts receivables hit the 30-day, 60-day and 90-day past-due marks.

These procedures alone should dramatically increase the receipt of past-due debt; however, if these efforts produce no response from a particular customer, that customer should be sent a formal demand letter.  The formal demand letter is a step-up in rhetoric from the language of the written notice previously mentioned.  The demand letter states that unless payment is received by a certain date, formal legal action will commence.  For individual consumer debt, the demand letter must provide 30-days for the debtor to make good on the debt.  For commercial debt from a business, the demand letter need only provide 10-days.

The business itself is free to send out such a demand letter; however, they are often ignored unless sent by an attorney.  For many delinquent customers, the threat of a lawsuit only becomes real when it’s sent from an actual legal authority.

As a warning, it’s imperative that, prior to a business undertaking these efforts to collect on an outstanding debt, the business owner becomes familiar with the Fair Debt Collection Practices Act (FDCPA) and state collection laws that prohibit certain methods of debt collection.  The specifics of such laws are beyond the scope of this Blog.

The course of action outlined above will often result in the delinquent customer either making good on the total outstanding debt owed or entering into an acceptable payment plan.  But if these efforts produce no such luck, it may be necessary to file a lawsuit against the delinquent customer in order to protect your business from the dangers of large, uncollected account receivables.

Stay tuned for Part II of this Blog series, which focuses on commencing formal legal action against delinquent-customers-turned-debtors.  Part II discusses the filing of the Complaint, including the various counts that a business can bring against its delinquent customers.

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