When a customer fails to pay, you face one of the most difficult situations for a small business owner. The lack of payment could be because of cash shortfalls or other issues, but the fact remains that you are out a substantial amount of money and time.

What can you do?

Plan Ahead

Before you do any work, there are many ways to minimize the risk of nonpayment.

The first and best approach is to get payment in advance. If you cannot get full payment, then seeking partial payment to cover your costs is the next best approach.

In addition to asking for money up front, customer agreements can help you get paid. Your customer agreements should include:

• Late payment interest (e.g. 18 percent interest on outstanding amounts).
• Provisions that provide for payment of your attorney fees if you sue to collect. (Except in limited circumstances, you will not receive your attorney fees unless you have a contractual right.)
• A stipulation allowing you to assert a lien on the product provided or other assets of the customer in the case of nonpayment. Having the right to assert a lien may give you priority over other claims as a purchase money security interest.

If you are covered by mechanic’s lien statutes, which are broader sometimes than people understand, you can assert a lien on the real property that you have improved. You must act quickly on mechanic’s liens, however, because the deadline to act can be as short as three months after the last day of work. Further, under certain circumstances, pre-lien warning statements may be required.

If you are providing a product, include a provision in your customer agreement that title does not transfer until you have received payment in full. That way, if there is a default, you have a better chance of recovering the good or tangible asset because you still own it.

If you can withhold some final piece of the product or service until you are paid, you should gain leverage. Think of it as holding back the key to the car until you are paid. This is not always possible, but to the extent you can plan the delivery of your product or service to allow you to hold back the final part until you are paid, you will improve your chances of avoiding problems.

When Plans Fall Through

What are your options if the customer still won’t pay? When trying to collect on a debt, you want to have leverage. So, as discussed above, the first thing you want to think about is whether your contract or the law grants you a security interest or lien. If it does, you have more leverage with the nonpaying customer. You will want to secure your leverage and then approach your customer to collect.

If you do not have lien rights, then your customer agreement can provide leverage. If in addition to the principal amount you have claims for interest and attorney fees, your small claim can become a much bigger claim. The customer might pay up in order to avoid a much larger claim.

You may need to bring a lawsuit if your attempts to collect aren’t effective. If you have planned ahead and have good terms in your agreement—such as an interest rate of 18 percent and payment of attorney fees—your claim will be more substantial. You must remember, however, that if you are incorporated, state law requires that you hire a lawyer to represent you in any court proceeding.