by Bob Staed, JD

Summary: With more clients facing financial problems, managing collections more diligently has become a necessity. The impact of not getting paid is significant. Depending on a firm’s profit margin, writing off a $100,000 receivable is the equivalent of giving up $1 million to $1.5 million in gross fees—not something many firms can afford when revenues are declining.

In good times and bad, some design firms are able to get paid more quickly than others and have fewer disputes over a client refusing to pay. What’s their secret? It’s a combination of effective management of the process from beginning to end, good communications and documentation, and appropriate accountability for project managers.

Billing and collection practices
The process of avoiding problems with collections starts with client selection. Trust your gut, and always remember: firms do not lose money on projects they do not take. But even a good client’s financial circumstances can change quickly. For clients with large upcoming receivables and for all new clients, many design firms perform periodic credit checks. One approach is to subscribe to a credit service, such as Dun & Bradstreet or Experian. The cost of getting a credit report ($25 to $100 for a single report) is small compared to the cost of a client that cannot pay. Another approach, especially for new clients, is to ask for references from their banks and from firms they have done business with in the past. Successful firms develop metrics for monitoring and assessing clients’ payment performance.

Particularly with larger clients, there is another question: “Is the person with whom you are dealing empowered to authorize your services?” It is important to ask questions and understand organizational hierarchy up-front to avoid problems down the road.

And be cautious about accepting more work from clients that have been slow to pay or haven’t paid in the past. If the firm decides to accept the work from these clients, consider requiring a retainer against the final bill. If the client is not the owner of the project, it may be possible to arrange being paid directly by the owner.

After deciding to accept a project, the most critical component to effective receivables management is having a written, signed contract. An oral contract is not any less binding than a written one, but it is sure more difficult to prove.

Billing promptly
Assuming a client has good credit and the job moves ahead, establish a billing and invoice follow-up schedule, and stick to it. When times were better, some project managers and some firms may have been slow to get the invoice out the door. After all, who wouldn’t rather meet with a client or design a project rather than submit hours to be billed?

A client’s staff and financial condition can change quickly. If a slow-moving invoicing process results in a firm’s billing in September for work done in July, that firm may be facing a different and likely more difficult environment for collection. And with everyone’s memories dimmed by time, resolving billing disputes becomes much more difficult.

Managing the billing process
The following guidelines are an example of one firm’s approach to managing the billing process.

• Project managers (PMs) submit billable hours, and the initial invoice is sent with a cover letter or e-mail and appropriate backup material in accordance with the billing schedule. The PM is then required to call the client within 10 days to be certain the invoice has been received.
• If the terms are 30 days and the client has not paid, PMs are required to start calling the client on day 31 or 32 to determine the issue.
• For the next 60 days, the PM is responsible for the receivable and makes periodic calls to check on the status of the bill. PMs are required to be polite, but persistent. Each call is summarized and confirmed in an e-mail.
• PMs are advised to pay attention to their clients’ payment habits. For example, if a client that previously paid on time and in full now pays later or only sends partial payments, the PM must meet with the client and try to discover if there is an underlying problem. The key risk tip is to meet and communicate with the client at the first hint of a problem. If there is a problem, it needs to be addressed and fixed.
• PMs are encouraged to be flexible about the time frame—not about extending it, but about reducing it. If something doesn’t “feel” right, they don’t need to wait until day 91 to escalate. They can take more forceful action sooner if appropriate.
• After 90 days, the invoice is written off for the PM (so the project profit isn’t artificially inflated and the PM “feels the pain”) and turned over to accounting. Of course, the revenue is re-recognized if received.
• After 120 or more days, take one or more of the following final options: negotiate a settlement; sue for payment; file a lien; for subconsultants, go straight to the owner; turn to professional collection; or accept that payment will never be received and (really) write it off.

Handling additional services
Disputes over payment frequently arise out of additional services—change orders. The most common complaint from clients is that the architect or engineer performed services not ordered. Here are three key steps to avoiding the potential for such problems:

• One important practice is not to negotiate requests with just anyone. Any request must come from an individual or individuals the client has designated as being authorized to amend the scope of services.
• As with the initial contract, accept only written requests.
• Perhaps the most critical aspect is to make sure the design firm employee is up to the task. Not everyone is equipped to match scope and fees.
  

Communicating with clients
As soon as a client’s payments slow down or stop, communication becomes paramount. Call the client or bring up the issue at the next meeting. Tackle it politely, but head-on. Let the client know the firm is aware that payment is not being received in a timely manner and initiate a discussion. Ask questions to try to understand the root cause.

If the client is unhappy over service issues and his/her way of telling the firm is by not paying, find out what the issues are, and address them. Strangely enough, this is actually a marketing opportunity. If the client has an issue and the firm resolves it, the relationship will be stronger than if there never had been an issue, because the relationship was tested and the firm performed. Always document any resolution in writing.

If the client acknowledges receipt of the invoice and agrees that payment is due, but states that the only issue is that his/her firm is financially unable to pay, document the following:

• The service provided is what was requested.
• The client is satisfied with the service.
• The invoice was received, and the amount due is correct.
• The client’s only issue is inability to pay due to financial concerns.

If possible, have the client sign off by sending the above to the client in writing and asking for an affirmative response to all four issues.

Final options
If a firm has done everything right and the client still has not paid, what can be done? Before taking any action, have a person within the firm who is not emotionally invested in the issue investigate.

The first step is to check the file. If the client did not pay and the PM followed the process, then there will be documents explaining what happened.

The second step is for the investigator to talk to the client. There may, in fact, be a problem the PM did not discover, or the client may have changed his/her story. If it is the latter, remind the client that there are documents confirming he/she was happy with the firm’s service, and nonpayment was due to a financial issue and nothing else.

If after researching the problem and taking all possible steps, the firm is still not getting paid, it has the following options discussed in the following sections.

Negotiate a settlement. Depending on the circumstances, a firm may decide to accept a discounted lump sum or perhaps to allow a payment plan or deferred payment.

If a payment plan or a deferred payment is selected, insist on a promissory note and possibly a release from issues known to date. Consider tying the promissory note to an event; the client will pay when 20 percent of the units are sold, when the baseball (or football or opera or ballet) season starts, or when some other event relevant to the project occurs. If the client truly cannot pay now, this might be the best option, at least in the short term. After all, one cannot get blood out of a stone.

But, as noted earlier, do get some written commitment from the client that the money is due and some promise to pay the bill, perhaps in installments over a specified period of time.

Sue for payment. If it seems clear the client is not going to pay, another option is to file a lawsuit seeking payment. A well-drafted contract will include the firm’s home state as the jurisdiction and the firm’s own home county as the choice of venue as well as contain the right to recover attorney’s fees.

File a lien. Another option is to place a lien on the project. Sometimes, just the threat is enough to trigger payment. The time for filing a lien is usually tied to the last date service was provided and, depending on the state, can be short. Investigate deadlines as soon as a payment problem is discovered. A lien may secure preferred rights if the client declares bankruptcy.

Go to the owner. If a firm is working for an architect or general contractor (GC), but not the owner, it is possible to threaten to go to the owner about the payment problem. If the owner has paid the architect or GC, but the design firm has not been paid, this might change the dynamics of the discussion. As with any threat, follow through to maintain credibility.

Turn to professional collection. Some firms transfer their collections to a professional collector—either an employee in a corporate credit function or a collection agency. This may have a considerable upside:

• Collection becomes the responsibility of someone for whom the primary and, in fact, only job function is collecting money.
• This option puts some distance between a project’s personnel and the enforcers. It may help to preserve project relationships because none of the project personnel is the person on the phone insistently asking for a check.
• The downside is that a firm must incur additional overhead or give up a portion of any funds ultimately collected. This solution is not necessarily the right one for every firm, but if a firm is having trouble with collections, it may be a viable option.

Write off the receivable. Always, as objectively and unemotionally as possible, determine at the outset of any formal procedure whether the expected costs to pursue payment exceed the maximum probable recovery. In this situation, the best course may well be to cut one’s losses and move on.

Counterclaims. If a firm takes formal legal action to collect fees, how concerned should it be about a counterclaim? Will it be expensive to defend? Is the client likely to prevail? Counterclaims are always a possibility when a firm takes a more aggressive approach to collections. When they occur, the allegations are often vague and intended only to dissuade the firm from the collection process.

Anecdotally, the recent history of the connection between collection efforts and counterclaims varies geographically. One professional liability insurance claims adjuster in the vicinity of Washington, D.C., reports no perceptible change in claims activity, while another in the Midwest has seen an upward trend in claims and counterclaims. What seems to be universally true is that the more timely and professional a firm is about its collection process, the less likely it is to trigger a counterclaim.

Whether a firm will face a counterclaim depends in part on its preparation. If a firm follows the recommended steps throughout the collection process, counterclaims will be less likely and possibly less expensive to defend. At least one firm noted that when it is well-positioned and has well-documented files, it has been able to respond effectively to counterclaims for less than $5,000 in legal fees.

The insurer’s role. If a firm does receive a counterclaim, how much of a role will its insurer play? The answer will depend on the allegations, but professional negligence is normally at least part of the claim. As soon as a firm gets wind of a counterclaim, it should contact its insurance broker and/or insurer and bring one or both of them into the picture. If the firm’s insurer provides pre-claims assistance, consider contacting it before initiating formal legal action.

With the insurer in the picture, there may be a better shot at a successful mediation’s resulting in collection of the fees. If a collections attorney has already been retained when the counterclaim arrives, be sure to connect him/her to the insurer’s attorney to assure a unified approach.