Delaware Business Debt Settlement: 5 Questions Before the Company Commits

If you are a business owner buried in debt, and looking at debt settlement, don’t commit until you know five things: does Delaware law even cover your company, when is the debt settlement company’s fee charged, how much will the forgiven debt cost you at tax time, how long will it be before you can be sued by a creditor, and would bankruptcy work better.

Delaware’s debt-management laws were written around an individual, not a business. They focus on unsecured debts and lay out processes for negotiating with those creditors. The Delaware law requires debt-settlement companies to get a license from the state to work with Delaware residents, even if they contact residents only by phone from another state. They must carry a surety bond of at least $50,000 and may only charge fees of up to 18 percent of the principal for their services. Residents may cancel the agreement up to midnight on the third business day.

But many debts look different for a business, particularly a small business. Your agreements may be written up differently than most consumer credit and lack protections like the right to cancel. You may not be helped by Delaware’s law.

So make sure you ask when the fee is taken. For consumer debt-relief services sold by phone, federal rules only let them take a fee after a debt is settled and at least one payment made under it. The Federal Trade Commission says a company still violates federal law if it gets around the ban by going through attorneys, and calling the fee a “retainer” will not make it lawful. That federal rule applies only to consumer debt-relief sold by phone, so a settlement deal for a company may fall outside the rule. Ask your provider anyway, and get the answer written in the contract.

Next, tax law. The I.R.S. says canceled debt is generally taxable income in the year it is canceled. The creditor may send Form 1099-C to the I.R.S. If you get hit with a tax bill afterward, check to see whether you qualify for an exclusion. The I.R.S. lets insolvent people exclude canceled debt up to the amount their total liabilities exceeded the fair market value of their assets just before cancellation. Form 982 is used for this exclusion. Sole proprietors report taxable canceled debt on Schedule C, line 6.

How much time you have: For Delaware, a lawsuit on a contract generally must be filed within three years of when the claim arises. And as you wait, interest is running. It could be set in your contract, but if not, the state’s legal rate, even after a judgment, is five points above the Federal Reserve discount rate.

Bankruptcy Filing

Last question: Would bankruptcy work better than debt relief? In some cases, it may. A Chapter 11 lets your business keep operating while reorganizing, and management usually stays in control as a “debtor-in-possession.” The filing includes an automatic stay of most collection, and most lawsuits. In Chapter 11, you can reject leases you do not like with court approval. A landlord who sees rejection coming would rather keep getting rent than hold an unsecured claim, so just the power to reject can get a rent cut.

Another part of Chapter 11 can make it tough for lenders. You can ask the court to value the collateral as of today’s market value. The lender only keeps a secured debt to that amount, and everything more than that becomes unsecured debt. That unsecured debt can often be repaid with a steep discount. A Chapter 11 plan must be confirmed by the court after a vote of impaired creditors, but the court may still “cram down” a plan that is fair and equitable and does not discriminate unfairly.

The catch: Chapter 11 is complex, and often expensive. It can take several years, and you will have to pay for lawyers, financial advisors, accountants and others. Creditors may form committees that fight your reorganization plan.

Many smaller businesses can use Subchapter V of Chapter 11. Subchapter V applies to debts up to $3,424,000, and the trustee is there to help you reach a consensual plan with creditors. Only the debtor files the plan, and it must be filed within 90 days of filing the case. There are no quarterly U.S. Trustee fees, and usually no creditors’ committee. In a Subchapter V, if you commit all projected disposable income to a plan, you may keep equity even if creditors get less than full pay.

Chapter 7 is liquidation: the business usually closes, a trustee sells the assets, and owners rarely get anything. The company gets no discharge, and creditors can still go after anyone who personally guaranteed debts. Chapter 7 is mostly for a company with no viable path to grow out of its debt.

Whichever route you take, if a debt-settlement provider seems unlicensed, report it to the Delaware Attorney General’s Consumer Protection Unit at 302-577-8600. The main idea is to stay skeptical. The more a salesperson makes it sound like a sure thing, the more you should doubt it. To check the claims, ask to see the contract and other paperwork. Slow down, take your time, and feel free to consult an attorney.