How Business Debt Settlement Works: 5 Stages From Review to Release

When you don’t have all the resources you need to meet your financial obligations, you can approach your lenders and make an offer for less than the full balance. That is business debt settlement: it is a negotiated deal between a creditor and a debtor. A settlement can be paid via a lump sum, a term payment plan or a combination of the two. Creditors settle debt for less as a way to improve the prospect of receiving payment. The process runs in five stages, from the review of the company’s finances to making an agreement and making payments, ending with the release.

Debt that can be settled includes merchant cash advances, even when they come from different funders. Business lines of credit and business credit cards can be settled. Ditto for online loans, vendor balances and sometimes equipment leases.

The Company’s Finances

The review requires a look into two areas of the company’s finances. First, of course, is the money owed. Start with a list of every obligation, with the creditor, balance, contract terms, personal guarantees, UCC liens, lawsuits or judgments. The second part of the review is a look at the money available to put into a settlement. The objective is to make an offer to settle the obligation that the company can afford to complete.

To be affordable for both sides, a debt settlement will usually be paid as a single lump sum or in several monthly payments. Look at what the business could save if it is no longer funding the weekly or daily payments to service the loan. For many businesses, that is the source of the settlement money. Do not plan a payment to a creditor if the money is needed for another purpose. Any settlement should still allow for payroll, rent, inventory and taxes. If it’s not affordable, it’s not going to be successful.

It is easy to become overwhelmed when creditors start calling. When you pick a representative, the creditors are told that the business has a representative, and to communicate through that person. Any creditor who might have grounds to reach into the company bank accounts needs immediate notice.

The risk is that while you go through the settlement process your creditors may try to collect from you. The Consumer Financial Protection Bureau says debt settlement companies typically tell you to stop paying your bills. The CFPB says that can add late fees and penalty interest, bring a collection lawsuit and hurt credit scores. A good plan will anticipate which creditors are likely to sue. This is why you want to tackle the most aggressive creditors first. This is a process with costs and consequences, and should never be begun without a plan to complete it.

Negotiation is in two phases. One is the numbers: the amount and the schedule. The second is the fine print: the release of personal guarantees, the dismissal of lawsuits, the termination of UCC-1 filings. Also how the creditor intends to report the matter to business credit bureaus. The release needs to be tied to the last payment made, and a personal guarantee could outlast the debt if the contract wording does not lock them together.

When negotiating a debt settlement the lump-sum offer can yield a bigger discount and fewer headaches than a payment plan, but if the money is not available that is not an option. Some creditors like working out payment plans. Others want a lump sum. It helps to know in advance who you’re talking with.

Never pay a creditor who hasn’t signed an agreement stating that if the business makes the payments outlined then the creditor will settle the obligation and release any claims it has, without exception. Payments must be made on time and in the way agreed. Keep a copy of every payment with proof. Get a paid-in-full letter.

Once a secured debt is paid off, secured creditors don’t have to do anything unless the business makes a written demand. They have 20 days to file the termination or send you the document. Confirm they did it.

Settling company obligations is not simple or quick. Most programs run anywhere between six months and two years. It varies on how much a company owes and to how many creditors, how quickly they can build up the settlement fund, and how aggressive the lenders have become.

For debt relief sold by phone, consumer debt settlement rules restrict the point at which a company can bill its clients. For example, it cannot charge a fee until the debt is actually settled and payments have been made to the creditor. With debt that is not strictly consumer, including most business loans, the rules are not as strict. Be sure to ask about the fees and get them in writing.

When a lender cancels a debt by settling for less than the full balance, the IRS generally treats the forgiven amount as ordinary income. The creditor may report the cancellation to the IRS on a Form 1099-C. There can be exceptions based on the business’ level of insolvency at the time of the settlement, reported on a Form 982. Before settling any debt, see a tax professional to review the possible tax consequences.

When you sign a personal guarantee to a creditor, you can be as much a target of a lawsuit or collection action as the business. Further, any debt that is not paid can appear on your credit history, as well as the company’s. Not every creditor will settle for less. Some are only willing to collect on the full amount; it is a judgment call for each one.

The warning signs with a business debt settlement company are much like a consumer debt settlement:

• It quotes you a percentage to settle before it reviews the documents.
• It uses pressure to get you to sign on the same day.
• The fee structure is not in writing and not crystal clear.
• You’re told to stop paying your creditors before the risk of lawsuits is reviewed.
• Fees are collected before any debt is settled.

Don’t pay anyone anything until you get a written quote that explains the full fee structure.

Settlement usually fits best for a viable company whose only issue is that the debt payments are too high, or a company being pulled down by a merchant cash advance. When the company can get a refinance with reasonable terms, or when a temporary cash crunch can be fixed with a deferral agreement, look at the other possibilities first. A successful negotiation will take patience, as will setting aside money for the payoffs.