In these days of shoe-string budgets, many small businesses try to get by with do-it-yourself solutions to a variety of business problems, including collections on their accounts receivable. In the process, these businesses often reduce the chances of actually getting paid. Here are five common mistakes.
No Written Contract. With relevant exceptions for contracts involving real estate and sales of goods with a price in excess of $500.00, contracts generally need not be in the form of a signed writing in order to be enforceable. This doesn’t mean that contracts shouldn’t be reduced to writing.
For a variety of reasons ranging from payment due date to warranty terms to indemnification obligations to intellectual property issues, contracts should generally be committed to a signed writing. And if a business must file suit to collect a debt, it is far easier to prove to a judge that payment in a certain amount was due by a certain date if there is a written contract spelling out the nature and amount of that obligation.
No Interest Clause. Pennsylvania law provides for the recovery of interest at the legal rate of six percent (six percent) on liquidated or fixed dollar obligations. The result is that even if there is no written contract or if there is a written contract that is silent on the question of interest, then if the creditor must sue on an account receivable, it can generally collect at least six percent interest.
The problem with 6 percent interest is that, particularly in age of credit cards and other obligations providing for interest of 18 percent or higher, six percent interest doesn’t provide the debtor with much of an incentive to pay the debt before the creditor files suit. That is, if the debtor is in a position where it is choosing which bills to pay and which bills to defer, that debtor will almost certainly prefer to pay higher interest obligations first.
Thus for any business that is typically paid after the completion of its work, it is critical that the business include in its contract, or at least in its invoice, a provision calling for interest at one percent to 1.5 percent per month (12 percent to 18 percent per year) on any invoice not paid within 30 days. This will help get invoices paid before going to court and will also help cover the tangible and intangible costs of collection if the claim does go to court.
No Attorney Fees Clause. With certain exceptions that don’t apply to most business collection scenarios, Pennsylvania law does not permit the prevailing party in a lawsuit to recover the attorney fees it incurs in collection unless there is a contract clause specifically allowing for the award of attorney fees. As a result, some debtors will feel comfortable rolling the dice on getting sued, knowing that if they lose, their loss will be limited to what they were already obligated to pay, plus interest, which may or may not be substantial.
Because attorney fees are often far more substantial than potential interest obligations, a clause allowing the creditor to recover any attorney fees incurred in collection can change the debtor’s calculation, and thereby make it easier for the creditor to collect. Contract clauses allowing for the recovery of both significant interest and attorney fees can maximize the chances of getting paid without having to file suit.
No Demand Letter. The law does not strictly require that a creditor make a written demand for payment before filing suit. But failing to do so can create unnecessary risks.
If a creditor sues without first making a written demand for payment, the court may well be persuaded that the creditor jumped the gun or was unnecessarily litigious, making an award of interest or contractual legal fees less likely. Further, in the absence of a prior written demand, the debtor has more opportunities to claim it didn’t know payment was due or didn’t know the amount due, and in general, more opportunity to dissemble with fabricated excuses.
On the other hand, if a creditor sends a written demand for payment before filing suit, and if the debtor fails to respond, that demand letter can often be used as evidence in court. Specifically, the demand letter can be used to show not only that the creditor exhausted other avenues for collection before filing suit, but also that any excuses for non-payment that the debtor offers in court but didn’t raise before suit was filed are just that – excuses.
Reliance Upon Affidavits. Many lay people, creditors included, assume that they can prove some or all of their case in court by bringing in sworn affidavits of witnesses in lieu of having those witnesses appear to testify live. This is a mistake. For if the opposing party knows well enough to object to the introduction of such an affidavit into evidence, that objection should be sustained on grounds that affidavits are hearsay.
In general terms, and subject to many exceptions, any out-of-court statement, oral or written, which is used in court to prove the truth of the matter asserted in that statement is hearsay, and sworn affidavits are no exception. However, there is one important exception to the hearsay rule for proceedings in magisterial district court (where most smaller collection suits are filed), set out in the Pennsylvania Rules of Civil Procedure Governing Actions Before Magisterial District Judges, at Rule 321. Rule 321 provides that “[t]he magisterial district judge shall be bound by the rules of evidence, except that a bill, estimate, receipt or statement of account which appears to have been made in the regular course of business may be introduced in evidence by any party without affidavit or other evidence of its truth, accuracy or authenticity.”
As a result, while an affidavit as to the quality of work or as to reasons for non-payment, for example, is hearsay and is typically not admissible as evidence on a business collection matter, a written statement of account or an invoice typically is admissible even if there is no witness present in court with firsthand knowledge of the preparation of the document. This will allow a business to prevail upon a lawsuit without bringing its billing department or A/R administrator into court to testify. But there is no substitute for bringing into court the witnesses with firsthand knowledge of the transaction to provide unequivocal testimony as to why payment on that invoice is due.
All persons and businesses who regularly use contracts should consult with legal counsel to discuss how they can craft their deals to avoid future problems and to minimize collection efforts.