If your contract has such a clause, you'll be barred from suing the client in small claims court or any other court. This is not necessarily a bad thing. Arbitration is similar to small claims court in that it's intended to be speedy, inexpensive, and informal. The main difference is that an arbitrator, not a judge, rules on the case. An arbitrator's judgment can be entered with a court and enforced just like a regular court judgment.

When to Give Up

If the client has gone out of business or vanished from the face of the earth, or you know that he or she will likely never be able to pay you anything (either now or in the future), your best option may be to write off the debt. As the old sayings go, you can't get blood out of a turnip -- and you shouldn't throw good money after bad.

Unfortunately, if your business provides only services, you can't take a tax write-off for the bad debt. The rationale behind this rule is that it would be too easy for independent contractors to inflate bills and claim large deductions for bad debts that were never really incurred. (If any part of the bad debt is for goods, however, you can deduct the cost of goods that the client received but never paid for.)

To learn more about collecting bad debts, writing service agreements, and everything else you need to know about pricing and getting paid for your services, get Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants, by attorney Stephen Fishman (Nolo).