Business Debt Relief: 5 Measures of Whether a Plan Will Last

People often ask if some big debt relief plan will really get rid of the problem. If it doesn’t keep them open for business long enough, it’s a waste of time and cash. The tests for a good plan are simple.

• (1) It doesn’t require you to default and hope the lender doesn’t sue.
• (2) Your costs for setting it up are reasonable.
• (3) It holds up if the lender sues.
• (4) The payments fit your real revenue.
• (5) It accounts for the tax bill that comes if some debt gets written off.

Stop Payment Program

If your plan includes defaulting on the loan, it’s not really a plan - it’s just a hope that it will work. Just hoping something will work is never a good idea. When someone suggests that a lender won’t sue even though you defaulted, that’s just a sales pitch.

A missed payment to a Merchant Cash Advance funder can trigger an Event of Default. That means they can accelerate the full balance owed immediately. Any settlement company offering a “stop payment program” is just using that threat to get a settlement deal. But the settlement company never is sued if the funding company makes good on that threat. The lawsuit is your problem. If a business has taken multiple MCAs, a default on one can trigger a default in all the others because of cross-default clauses. And any of them can freeze your bank accounts. That could leave a business with no money to make payroll or pay the light bill.

On the second test, cost, the government limits settlement companies’ fees. A for-profit company that calls to sell debt relief over the phone has to settle one debt before charging any fee. Many MCA settlement firms get around that by charging a set-up fee or administrative fee - sometimes 10% to 15% of the amount owed. So ask for a written breakdown of the fee structure. If you hear a song and dance about “enrollment fees” or “administrative fees” and you see that they add up to a large chunk of your overall debt, the warning lights should start flashing.

As an example, assume $100,000 in MCA debt. An “enrollment fee” of $15,000. An “administration fee” of $1,000 a month for 12 months. Assume the business sticks to a payment plan and the funding company cuts its demand to $60,000. And assume the settlement company’s fee comes out of the savings at a rate of 35%, that means $14,000 more. The math shows that plan will end up costing $101,000, more than the original debt. If the funding company sues, attorney fees can push up the price tag even more. The idea of cutting your debt by 50% or 80% is attractive. But no firm can guarantee that deal. Some lenders won’t settle at all. Watch out for a settlement company that wants you to put money into an account it controls.

Legal Trouble

The third test is about legal trouble. If the funding company sues, you want a plan that keeps working. That means someone still pushing for the settlement deal. But most settlement firms aren’t law firms, and they can’t represent you in court. When lenders sue, the settlement company often says it can’t help, or maybe hands you off to another lawyer you need to pay. Meanwhile, the lawsuit can mean account freezes and other pressure. Without someone on your side who can fight it out with the lender, your debt relief “plan” becomes a plan to lose.

In New York a funder can take a Confession of Judgment to the county clerk. Within days, or even hours, the clerk will enter it as a judgment, no trial needed. That judgment means bank account garnishments and other liens. And another threat is a UCC 9-406 notice. A notice like that tells your customers to pay the funder instead, wiping out your cash flow.

The real leverage for the MCA company is its lawsuit, but a business can use legal leverage too. In many cases, MCAs are high-cost loans disguised as “purchases” of future income. A lawyer will first look for two signs a contract is a loan disguised as a “purchase”: (1) it has no reconciliation clause to allow for short months, and (2) the term is finite, meaning it ends after a set time or amount. If a New York court finds the contract an illegal loan, the entire debt may be unenforceable. It’s common sense: the bigger threat the funder sees, the better deal they’ll make.

Can Your Business Make the Monthly Payments?

The fourth test of a plan is simple: can your business make the monthly payments? The Bankruptcy Code reflects this - a judge can’t confirm a Chapter 11 plan unless convinced it is not likely to be followed by liquidation or another reorganization. You can use the same standard in planning debt relief. If a debt relief plan looks like it will end up in the same problem later on, it’s not really a plan. Don’t agree to more than you’re really able to pay, because that just starts a new problem.

Small-business bankruptcy under Subchapter V has a special list of requirements. One rule is that, without creditor consent, the plan must show the business will be able to make every payment, or at least show a reasonable likelihood it will and remedies if a payment does not occur (e.g., the sale of nonexempt assets).

The final test of a plan is the tax bill that can come if the funder forgives some debt. Generally the IRS treats forgiven debt as income in the year it is canceled, and the creditor may send a Form 1099-C. An exception is debt canceled in bankruptcy, or while insolvent up to the amount of insolvency. But the IRS generally requires a taxpayer to report that on Form 982 and reduce certain tax attributes.

In any market, someone will say there’s a quick, safe way to get out of a business debt. But just like in the fairy tales, you have to be careful about the deals offered by strangers. Before you stop a single payment, hold any plan up to all five tests, and talk to an experienced attorney before you stop paying or sign with anyone.