Deadbeat Clients: Exact Your Revenge for Bad Debt!

You can follow all the right procedures, but sometimes clients still stiff you.  What can you do?  How about revenge?  Does that appeal to you?

Let’s say you have a strong engagement agreement.  You got a decent retainer.  And at first the client kept up when the retainer ran out.  By the time you realized that the client was falling behind, you were too far in, or too close to the end, to extricate yourself.  It happens all the time.  You follow up with calls and letters, but the client is silent and non-responsive.  You ask whether there is a problem, hoping you can at least get a dialog started which will result in some compromise payment.  The client is still silent and non-responsive.

If your engagement agreement is well written, you have the option to sue the client.  But we know that isn’t always the right move.  First, some insurance companies forbid it.  (Not the PA Bar-endorsed plan.)  Second, even those who don’t forbid it ask about your practice on your annual malpractice insurance application.  Admitting that you sue clients for fees may impact your premium, or even your ability to get insurance.  It will depend on whether or not you have ever been counter-sued for malpractice, and on how many times you have sued clients for fees.  A lot of suits will indicate to the carrier that your procedures are not what they should be, or that your clients are not as happy as they should be. 

Yes, past due receivables are sometimes an indication that clients are unhappy.  So if you have lots of past due receivables, and have had to sue clients more than once or twice, it will not reflect well on your firm.  And frankly, sometimes the amount of the deductible on your policy outweighs the outstanding debt, making the risk of suing, and being counter-sued, not worth the amount at stake.  So you bite your lip, write it off, and consider it a hard lesson learned.

But there is one more thing you can do.  It probably won’t get the client to pay, although sometimes it does.  However, what it will do is provide you with a measure of psychological satisfaction even as you write off the debt.  First, make sure you have sufficiently dunned the client to take away any doubt that the debt is uncollectible by any fashion other than to file suit.   Wait for the statute of limitations to toll on a malpractice action.  Once the statute has passed, send the client a letter in November or December saying something like the following:

I have done everything within my power to get you to pay your outstanding debt in the amount of $xx.xx.  It is clear at this point that you have no intention of doing so.  Accordingly, you leave me with no alternative than to write off the debt.  In accordance with IRS regulations, you will be issued a 1099C for the full value of the forgiven debt, so that you can declare the amount on your tax return as taxable income.  You will receive the 1099C  by 1/31/xx.

Although financial institutions and similar other entities are required to file a 1099C, any entity can do so voluntarily to ensure that income from forgiven debt will not go undeclared by the debtor.  The due date for sending the 1099-C to the debtor is 1/31/12.  The due date to send it to the IRS is 2/28/12.  You can get the forms, and all instructions on the IRS site here.

Since most people cannot send off an estimated tax payment in time to cover the 1099C income, you will derive some measure of satisfaction knowing that you have probably messed up their financial planning and created a taxable situation for the client.  Even better, you know that anything dealing with the IRS and tax returns creates high anxiety for most people, so at least they will feel some of your “pain.”  Sometimes the threat of the 1099C will cause the client to send payment at the zero hour.  It’s always nice to have the money, but the revenge factor may be even sweeter.

Keep in mind that from your internal accounting perspective, the transaction is handled differently.  If your firm is like all the firms I’ve encountered, you are on a cash basis for tax purposes, so you will not actually have a write-off of fees to expense on your profit & loss.  That’s because you don’t declare fees until they’re actually collected.

However, when you write off the receivable, you may expense any unreimbursed hard costs.  Client costs are — if handled correctly — considered a loan to the client.  They sit in a liability account through which costs “wash” in and out.  This account is on your balance sheet, and does not impact your profit and loss.  In other words, when handled according to IRS guidelines, you don’t actually deduct client costs as expenses on your profit and loss as they are incurred.  When you declare a client debt unrecoverable, at that time you can remove the unpaid client costs from the liability account, and deduct them as an expense on your profit and loss. 

Be sure to consult with your accountant.  In my experience, a lot of firms still “mishandle” client costs by expensing them immediately.  So your required action may be different.

Happy new year!

2 Comments

  • By montereylawyer, October 31, 2013 @ 6:41 pm

    This is brilliant. Lawyers seem to be the only professionals who are unable to collect fees due to threat of malpractice, and clients know this and get away with murder. You’ve given me hope and a practical tool for revenge, if not payment. I don’t always have the client’s SSN – now I realize the value of collecting this information in EVERY case. Thank you.

  • By Ellen, January 28, 2014 @ 2:36 am

    Thank you, and please accept my apologies for overlooking this comment.

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