B2B Collections: When You Should Sue Your Customer

Dean Kaplan

Deciding if you should sue a business for unpaid invoices is not easy. If only it was as simple as: “they owe the money; sue them, and we’ll get our money.” Unfortunately, there are costs involved, the court process is notoriously slow, and actually collecting is highly uncertain. We believe Return on Investment (ROI) is the primary factor in deciding whether or not to sue.

When we get to the point where litigation is the only alternative left (either because the settlement offer or payment plan from the business isn’t acceptable, or they simply refuse to pay), our advice to our clients is based on ROI. That means taking into account cost, potential return, and likelihood of getting the return. Internally, we use a simple expected value equation as part of our thought process before giving a recommendation, such as:

If our clients only have to pay $500 to sue (our clients pay the out-of-pocket costs and non-contingent suit fee if any), most of them are likely to proceed with litigation in the situation described above. But if it costs $1,500, they won’t, even though a statistician would tell you that every time you can ‘bet’ $1,500 and have an expected return of $3,250, you should take that bet.

We win 99% of the lawsuits we initiate, so winning isn’t the issue. The biggest uncertainty in estimating ROI is determining the likelihood of actually collecting. In the example above, if the likelihood of collecting was 75%, the expected value of recovery would be $4,875 (75% x $6,500), and at that point, even a $1,500 investment looks more compelling. But, if the likelihood of collecting is only 20%, then the expected value of recovery would only be $1,300 (20% x $6,500), and at that point, it is hard to justify even a $500 investment.

When evaluating the likelihood of collecting, we look at a number of criteria, including:

• Is the company likely to still be in business by the time we can start the judgment collection process?
• Does the business appear to have cash flow or assets that would enable successful collection?
• Are there any secured creditors which would make collecting difficult or impossible?
• Are there other liens or judgments that could make it more difficult?
• Is there personal liability as a result of the corporation status being revoked, a personal guaranty, or is the business a proprietorship?
• Does the person with personal liability have assets or income that could satisfy a judgment?
• Does the business owner have personal assets to inject into the business, even if they don’t have personal liability for these specific invoices?
• Can we locate the company owner and/or guarantor for judgment collection efforts?

At our commercial collection agency, we use the collection process to try to learn the answers to these questions while at the same time pressing for payment. We also do extensive research to learn as much as we can if we can’t collect without litigation. We tell our clients what we think the expected likelihood of recovery is along with the information and analysis that lead us to this conclusion.

Our larger clients who have professional credit management staff tend to litigate when the ROI looks promising. These clients are familiar with collection litigation; they understand the costs, the lengthy time-frames involved, and the uncertainty. They have taken this into consideration during the collection process in evaluating any payment plan or settlement proposals. They understand that collection litigation is just another business investment opportunity, and they should proceed whenever it meets their standard investment criteria. Some clients have a greater tendency to sue, either because they want to send a public message that will encourage others to pay or they have greater comfort in the ROI estimates.

Many of our smaller clients and clients without professional credit management on staff are unfamiliar with collection litigation and how to evaluate alternatives. We recently created two short videos available on our website, one on collection litigation and the other on judgment collection, to explain the process, costs, timing and methods for actually collecting. This information tends to give clients more confidence in investing in litigation based on our ROI analysis or alternatively adjusting their willingness to accept longer payment plans or settlement offers instead of going to court.

Next week we’ll talk about the changes we have noticed over the last few years and how that impacts collection litigation. I encourage you to share your thoughts on collection litigation in the comment section below – whether it is on the factors you evaluate, how you make your decisions, or anything else relevant to this topic.