The Problem With Service Contracts

As a service professional, the services you offer are valuable - you do something that others are unable or unwilling to do themselves. So valuable, there are times when not everyone can afford to pay up-front. Luckily, for your customers, it’s a common practice to allow them to pay after the work is done. This practice is so common, many small business owners don’t consider they can be assuming a great deal of risk. After all, the customer may even have signed a contract promising to pay. However, in many cases, there are unanticipated obstacles to enforcing a contract. Thus, it’s important to understand the downsides that can come with contract enforcement.

But, Isn’t a Contract Enforceable in Court?

Pending specific circumstances, the answer is “yes.” Written contracts are always a crucial part of obtaining payment after the services have been rendered. Even if a contract is not in writing, it may still be enforceable. However, the contract can’t enforce itself - and there are costs to doing so. For example, if you’ve performed $2,000.00 worth of work and a customer later decides they are dissatisfied with the work, calls go unreturned, letters unanswered, and you eventually find yourself in court suing your customer for payment. At the end of the day, the customer will claim their obligation to pay is excused by your failure to uphold your end of the bargain, and low quality of work performed (whether rightfully or wrongfully). Although there is a signed, enforceable contract, this document simply serves as evidence your customer promised to pay you. It does not, however, prevent the customer from using complaints about the quality of work to try and avoid the obligation to pay.

In a perfect world, you could obtain the small claims judgement yourself (if your bill is $6,000.00 or less - otherwise you must sue in district court), and be awarded court costs. One of the purposes of small claims courts is provide people with a simplified process they can navigate themselves. Unfortunately, some customers go so far as to pay a lawyer to come up with dozens of ways to say you didn’t do your job, or there is some aspect about the contract’s terms or formation that makes it unenforceable. Some customers hire a lawyer knowing you will either: (1) represent yourself against a lawyer; (2) pay a significant portion of what you stand to collect to your own lawyer - thereby reducing what you’ll actually collect on what you’re owed once your lawyer is paid; or (3) realize these options are unattractive and decide they are not worth the money/time (allowing the customer to keep the benefit of your work). Although a customer using this specific reasoning may constitute an actionable abuse of the court system, this is incredibly difficult (and expensive) to prove. As a result, many small business owners’ attempts to collect what they are owed turn into an expensive game of “he said/she said.”

Wait, if I Win the Case, Wouldn’t My Customer Have to Pay My Attorney’s Fees?

While the losing party to a lawsuit is generally ordered to pay the “court costs,” these are separate from attorney’s fees. Further, a court in Iowa cannot order the losing party to pay the winner’s attorney’s fees in a breach of contract case. Without an appropriately drafted attorney’s fee provision, the answer is “no.” Most service providers’ contracts (such as a simple work authorization) are obtained from the internet or other non-lawyer sources and do not contain the right language.

To put this in perspective, if your lawyer obtains the full $2,000.00 judgement on the unpaid bill discussed above, a $1,000.00 bill from your attorney means half of the money you were owed will go to your lawyer for their work investigating, drafting documents, engaging in discovery, legal analysis, preparing your case for trial, and actually trying the case. Additionally, expenses (copies, printing, postage, service of documents, etc.) are generally paid separately, and are not built into the lawyer’s hourly billing rate. Therefore, litigation with a picky or even dishonest customer can often prevent you from recovering the amount you expected to gain under a perfectly valid contract.

What Options are Available to Secure the Contract’s Full Benefit?

A well-written contract with the right terms is crucial to control the cost with enforcing a contract down the road. An attorney experienced in drafting contracts and dealing with business transactions has several tools at their disposal to give your business an appropriate level of protection.

“Liquidated Damages”

The term “liquidated damages” refers to a clause in a contract in which the parties agree to a fixed dollar amount that would be fair compensation in the event one party breaches the contract. However, the dollar amount cannot be arbitrary, and the circumstances of the contract and parties’ performance need to be considered by a qualified attorney before it is included in any contract.

However, it is important to know that liquidated damages clauses do not prevent litigation entirely. Liquidated damages can, however, help encourage earlier resolution and can prevent the risk of a court or jury awarding a lower amount than the parties are entitled to.

Liens & Security Interests

A lien or security interest can be helpful in deterring customers and clients from non-payment of a bill. You are likely familiar with the term “collateral.” When a contract gives a service professional a lien or security interest, the customer signing that contract is effectively using an item of property as collateral to satisfy the value of the bill if they fail to pay (similar to pawning an item with a pawnbroker). However, before a lien can be enforced, specific legal requirements need to be met. In fact, if the proper steps are not followed, a court can rule the lien invalid. If you believe a lien would be right for your business, be sure to consult with an attorney so you can rest assured the appropriate steps were followed.

For service professionals who perform work on real property (including residences, commercial buildings, or are involved in building construction), Iowa law creates a lien in favor of the service provider before the work. These statutory liens are, in a sense, “automatic.” However, specific steps need to be followed under Iowa law before these liens can be enforced.

Again, a lien or security interest in property is not something that can prevent litigation altogether. It can, however, encourage settlement before litigation, as it will make it more difficult for the customer to sell that property in the future. If the customer still refuses to pay, you should contact an attorney about bringing a “lien foreclosure action” to enforce your rights.

Attorney’s Fees

Though a party bringing a successful breach of contract action is not automatically entitled to having their attorney’s fees reimbursed, the parties may agree to do so. Such a provision is an important part of the effort to recover the full value of a contract. Without this, though a party may recover the entirety of the bill, it will lose out on whatever had to be spent to hire the attorney. However, attorney’s fees must generally be “reasonable.” Therefore, it is important to select an attorney who will not charge an unreasonable rate, or bill you for inappropriate items.

“Alternative Dispute Resolution” (ADR)

One of the only ways for a party to recover under the contract and avoid litigation is by subjecting the dispute to a binding mediation or arbitration. These are forms of resolving a dispute without the necessity of filing a lawsuit. In each, a neutral party will consider evidence and statements of the parties, and render a decision. However, a key in avoiding litigation is by making the mediation or arbitration “binding.” This means any disagreements must be resolved by the mediator or arbitrators, whose results are final (meaning they cannot appeal the decisions to a court or seek to have it thrown out except in specific circumstances). Before doing this, consult an attorney to draft an agreement making the proceedings binding, and setting forth the procedures to be followed. Mandatory and binding ADR can be particularly effective if used in conjunction with other contract provisions, such as liquidated damages.

Though it is highly recommended you hire a lawyer to represent your interests and communicate your position to the mediator or arbitrator(s), resolution takes far less time and costs substantially less money is spent in attorney’s fees.