This article was originally published by Dean Kaplan in InsideARM, August 2012.
Deciding if you should sue a business customer 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 the primary factor in deciding whether to sue or not is Return on Investment (ROI).
When we get to the point where litigation is the only alternative left (either because the settlement offer or payment plan from the debtor 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:
Potential recovery: $10,000
Net recovery (after 35% contingency fee) $ 6,500
Likelihood of actually collecting 50%
Expected value of recovery $3,250
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 at our collection agency, 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 the business is 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 debt 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 debt collection litigation, they understand the costs, the lengthy time frames involved, and the uncertainly. They have taken this into consideration during the collection process in evaluating any payment plan or settlement proposals. They understand that debt 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 in place are unfamiliar with debt 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.
Our philosophy is that any lawsuit can be avoided is better than any lawsuit we have to initiate. On the cases where we collect, 98% is accomplished without going to court. At the same time, we don’t hesitate to recommend litigation when the information available indicates that is the appropriate course of action to take. We have a nationwide network of debt collection attorneys who work on a contingency basis, so we can commence litigation wherever the debtor is located.
Next week we’ll talk about the changes we have noticed over the last few years and how that impacts collection litigation.