by Lisa Goldoftas and Steve Elias
Copyright © 1990 Nolo Press
It's happened again--you're stuck with another bad debt. Sure, you can write it off at tax time, but that's a year away. And your small business needs money, not tax write-offs, to survive. What about taking the culprit to court? Unfortunately, a whole set of myths has grown up, all with the same moral: that it's futile to sue for a bad debt. They claim that lawsuits are inefficient and costly, and even if you win, you'll probably never see a penny.
Here's a look at the myths that may be keeping your business from collecting what you're owed.
Most business people properly fear that a court case can quickly turn expensive and nasty. And what's the use if you'll have to hire a collection agency or attorney to do the job for a portion of the debt--often as much as 50%?
The good news is that small claims court is quick, cheap and effective. In most states, lawyers are barred. Even where they are allowed, procedures are simple enough for you to represent yourself competently if you carefully prepare your case. Most small claims courts let you sue for up to around $2,000. But even if your claim is for twice the small claims court limit, you'd probably still come out better if you sue for the limit than if you hired someone to collect the debt for you.
To file a lawsuit, you don't need proof that the debtor will be able to repay the debt now--or ever. Even if the debtor has evaded your collection efforts, doesn't have a steady job or seems like an ideal candidate for bankruptcy, it can make excellent sense to sue.
The main reason is that judgments last a very long time. Each state sets its own limit; ten years isn't uncommon, and you usually can renew a judgment for even longer. That means that the irresponsible eighteen-year-old who wrote a bad check to pay for his stereo system still can be faced with a court judgment after he's graduated from school, set roots down in the community and bought a house. And during the wait, judgments collect interest--often about 10% annually.
If a debtor didn't pay before you sued, why should she pay just because you have a court judgment--a piece of paper--that says she's supposed to? Because a court judgment gives you legal standing and the right to have certain of the debtor's assets seized to pay the judgment. The debtor's wages, business and personal property, real estate and bank accounts all open up as possible sources for payment.
Collecting a judgment against a wily debtor or one with few resources is like trout fishing. If you thrash around a lot, you may scare up some bottom feeders without getting a trout--but if you set up patiently, you rarely miss. You can spend considerable money and energy trying to collect a judgment but only end up sending the debtor into bankruptcy or deep retreat. Or you can be patient and put yourself in the position to collect your judgment somewhere down the road.
This approach is inexpensive and easy to implement. A court judgment gives you the right to put legal claims, called liens, on the debtor's property. You set up liens and wait for them to pay off when the debtor goes to refinance or sell the property. Because the judgment lien is legally attached to the property, it will go to the new owner unless it's paid. And since new owners won't want to buy property that has a claim on it, the debtor must first pay off the debt.
In most states, you can create a judicial lien without a lawyer's help. Typically, you'll have to prepare and file one or two simple forms. For instance, you can create a lien on real estate by filing official proof of your court judgment with the county recorder of deeds. In some states, a lien automatically attaches to real estate the debtor buys later.
If you're suing a business, you may be able to create a lien against business property by filing proof of a court judgment with the Secretary of State. Then, if the business is sold or borrowed against, your lien shows up when the purchaser or lender makes a search of the records.
Usually, you can put a lien on a debtor's personal property (anything but real estate) by taking simple preliminary steps to collect the judgment, such as sending the debtor certain court forms. If the debtor tries to use the property as collateral for a loan or files for bankruptcy the lien will show up, and very possibly produce payment.
The conventional wisdom is that once a debtor files for bankruptcy, a judgment is as good as dead. In fact, judgment liens that were created more than 90 days before the bankruptcy filing date can survive the bankruptcy process. It depends on the type of property involved and whether the debtor (or her attorney) contests the liens during the bankruptcy. The more liens you create against the debtor's property, the greater your chance of getting your money.