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How to Recover Unpaid Debts? From Demand Letter to Legal Action

Cash is important to a business of any size. Businesses need to collect whatever money is owed to them to maintain positive cash flow and continue to operate. If you are a small to medium business, you have three options to recover unpaid debts:

  1. Use your in-house invoice and payment reminder system,
  2. Hire a debt collection agency, or
  3. Pursue legal action.

Use In-House Invoice System

Using the in-house invoice and payment reminder system is the most cost-efficient option to recover unpaid debts. This can be done by you, your accountant or your bookkeeper, using tools that are already available in your company, at no additional cost to you. This process will involve sending an invoice and payment reminder to the debtor company, calling its accounts department or its owner, and creating a payment plan, if the debtor company is unable to pay its debts in full.

While this is the cheapest option, some companies do not find this the most effective as most invoices still return unpaid. You or your accountant will also have no way of knowing the financial situation of the debtor company. There are lots of reasons why a certain company is facing hardship and thus cannot pay debts when due.

Hire Debt Collection Agency

When the first option is not effective, and the debtor company still does not pay or fails to follow-through with the payment plan you proposed, the second option is to hire the services of a debt collection agency. The debt collection industry is a highly regulated industry that is subject to compliance laws. Because of this regulation, debt collection agencies are also professionals who are trained not just to recover debts but to recover those debts through legal and ethical means.

The debt collection agency has the professional training to investigate your debtor’s financial situation and analyse why the debtor is unable to pay its debts to you when they are due. This knowledge helps the debt collection agency to craft a more effective payment plan. After investigation, the debt collection agency will send the letter requesting the payment. When this is unheeded, the debt collection agency will send a formal letter of demand to the debtor company. The letter of demand is important because it can be a cause of action when there is no other better way to recover a due debt other than legal action.

Pursue Legal Action

Legal action can start with the letter of demand sent by the debt collection agency. The demand letter is very important before commencing the legal action because, without it, no legal action will prosper. Legal actions are handled by lawyers and should be handled by lawyers. A lawsuit will be filed to demand for payment of money claims. The lawsuit should notify the debtor company. If the judge rules that the debtor should pay but it doesn’t, you can force the debtor company into bankruptcy or liquidation.

Lawsuits and bankruptcy or liquidation is the most expensive option for businesses, especially small businesses. A legal action can guarantee recovery, although there would be instances when the debt owed to you will not be paid in full because the company may have other creditors who have superior priority than you (e.g. banks).

Whatever Option You Choose, Seek Professional Advice

All three options have their benefits, but also their disadvantages, especially in terms of cost and the effectiveness of credit recovery activities. As a business, you can use all three options, but before proceeding, it is best to go through each option with the help of a professional who has both legal and financial knowledge and who can help you properly weigh your options for an improved debt recovery system.