IANAL and this is not legal advice. This is an opinion and if you are really serious about this, you should really be talking to an attorney, an IRS Enrolled Agent AND a collection agency instead of a bunch of people who know more about software than what a Civil Code is.

First, SORRY to see this happen to you, but in my two decades of dealings, this is nothing new, infact pretty mild, so if I were you, I would chalk this up as a learning experience.

Here are my thoughts:

1. Stop extending credit to your clients.

  You are in the software business. What were you doing extending a NET30 to your customers? Sign up with a invoice agency and let them do what they do best and you focus on what you do best.
  Hate paying 5% of your receivables as fees? How does it feel paying 150% of your receivables as fees now?

2. f#k Paypal.

  I only use Paypal to pay when Chase Freedom gives me 5% cashback for using Paypal or Paypal sends me a coupon because I have not used them in a while. I NEVER receive money over Paypal unless it's a really close friend.
  Karma just got you buddy for supporting a f#ked up company that tries to be a bank but is not competent enough to be one. Stop using Paypal unless you use it to loan money to friends you won't mind never recovering from.
  f#k Paypal.

3. You will not do business with this client ever.

  You will, while working with an attorney AND a collection agency be advised to report the delinquent amount over to all the credit reporting agencies.
  You will also have to notify the IRS for not only your lost income but also their income (the amount they did not pay you).
  They owe the IRS taxes on the "discount".

4. > I have 2 others willing to follow through with legal action

  That's bullsh*t.

  They have done nothing so far and will do nothing. It's all just hot air. I have been screwed over so many times by clients and their "ex" consultants who wanted to "follow through with legal action".
  Those "ex" consultants became "current" consultants as soon as they got paid.
  Don't want to trust a stranger on the internet? Good, you're learning fast. Also, Try this: "Hey pissed off ex consultants. I have this fascinating lawyer that will represent us for $2000/pop. Flat fee, great deal. When do you guys wire me the $1000 upfront and $1000 after our initial meeting?".
  Tell us how this goes.

5. > Can I also be sued for threatening him with reaching out to his customer base and buyers.

  You can be sued for farting in my general direction.

  Will the judge throw the case out? Depends on what you have.
  Will the judge hold you in contempt if you continued to stay and argued there is merit? Report back and let us know.

6. > I didn't take the 3500, as I would like to see at least 9k. But he isn't willing to reach to that.

  That's not how it works if you have a half decent contract.

  A half decent contract will mention that any amounts paid will apply to the balance on the account but will not be considered a full and final payment unless the terms of the contract are adhered to.

  You have this in your contract, don't you?

So the three questions are:

A. What the hell was your billing rate? I charge $350/hr in general. All these tirekicking f#kers say Thank you and get the hell out of my way. They go and target the poor clueless souls that charge $50/hr (aka those who have no clue about the overhead of running a sustainable business)

  My clients are happy to pay me this rate because they know I work with clients who let me live a happy, sustainable life allowing me to focus on high quality work instead of bullshit. They want their business to run smoothly and unless I deliver, that won't happen.

B. Was this a "startup" thing? In that case, Sweat equity only applies to founders. It only rarely works for anyone else unless the company becomes mega successful. If you want to learn how to gamble, do it right and learn about Slicing Pie models. No? They wont follow a Slicing Pie model? OK, then they need to pay cash. Now. Today

C. What's your and your "client's" jurisdiction? How much of your gross income does this "client" account for?

PS: ANY attorney will represent you if you have a case and pay them money.

In my experience, you will get back your $10k back and more if you create a VLOG of this from start to finish than you will from your "client". Just make sure to call them, say, "GongBanger" instead of their real name in your vlogs. Sign me up.