Starting Business Debt Settlement: 5 Groups of Documents to Prepare

Complete Documentation

Banks don’t have employees who read minds. They can deal only with whatever you put on the table. Before you begin negotiations, assemble the following five groups of information:

• (1) Recent business tax returns and current financial statements;
• (2) loan documents for each debt;
• (3) all the personal guaranties and any other personal obligations;
• (4) an accurate narrative of the events leading up to your current trouble, a statement of the problem you face and a collection of letters from collection agencies, lawsuits and any other evidence of your straits;
• (5) Completed Offer in Compromise forms for any Small Business Administration loans.

The many separate documents required by the bank may seem excessive. From the bank’s point of view, however, the papers represent a good faith effort on your part. Each lender has its own policies, and each lender is going to have its own idea of an acceptable settlement. Besides that, many lenders won’t talk settlement at all unless you’ve defaulted or they’ve charged you off. By having complete documentation ready, you can make the talks more productive. It also helps to lower the risk of you being surprised by a lawsuit down the road.

In order to negotiate, you must first prove that your repayment numbers represent what the business can really afford, and to do that, you should submit the most recent business tax returns and year-to-date financial statements. The tax returns must be an accurate accounting of your financial state. Likewise, you should offer accounts receivable and accounts payable aging reports as of the date of negotiations.

For each debt, gather copies of the loan’s promissory note, security agreement, personal guaranty and any UCC lien filing documents. The important facts here are the security items, how much you owe and if there are liens on the business property. These documents and a statement of your payment history will show the bank’s true leverage on the loan. UCC filing dates are complicated and do not last forever. Generally the liens last five years but the lenders are able to refile in six months prior to it lapsing.

Group three’s documents are all about the owner’s skin in the game. A personal guaranty can be more dangerous to your personal assets than you know. The guaranty gives the lender a legal right to pursue your personal bank accounts or any non-exempt property you own after the lender obtains a judgment in court. You may be unaware of how a personal guaranty works until your lender freezes accounts or you’re presented with a demand letter to pay up. You should bring copies of every single personal guaranty you signed. Anyone listed on the loan documents as owner with 20 percent interest or more generally must offer a personal guaranty on an SBA loan. If you have submitted personal financial statements to the lender as part of the original loan application, it helps to attach a signed, updated statement and statement of income to your new request for terms, outlining any new debts or assets.

Explain in your own words how you arrived at this point: What were your assumptions about the future, the market, interest rates or competition? If you knew then what you know now, what would you have done differently? Did you have unexpected costs? Did your competitors outsell you? Did your customers simply fail to buy? Stick to the facts in writing your hardship explanation. This explanation, together with the various bills and threats from collection agencies and lawsuits you may have against you show the bank that you are ready to settle and that the problem is real. Be sure to attach all the original notices and lawsuits against you. If you have a trial date pending, that should be part of your narrative.

Before you sit down with the lender, write down those expenses like payroll and taxes that simply have to get paid, so that whatever offer or terms you settle on, your business can reasonably meet them. Part of the paperwork you need to present shows that you have a plan for keeping the business running after you settle.

For any loans insured under the Small Business Administration, you will typically need a detailed offer in compromise. When dealing with the SBA in getting yourself and other parties off the hook, you should expect to submit a detailed financial package plus a signed Form 1150 from each individual or entity seeking a release. The SBA requires the eight-tab format with all the attachments, so that the loan file is complete. Include a Form 770 or business financial statement with every individual or entity’s package. In addition to the offer, your package must include two years of complete federal tax returns. The SBA will also need signed Internal Revenue Service Form 4506-C or Form 8821 so that it can pull your transcripts. The SBA wants to know where the settlement cash comes from. Note that Form 1150 lists the details of any property transfers since the loans originated. Before the SBA dumps your debt with the Treasury Department, a borrower gets a heads-up in the mail, called a Due Diligence Notice. Once the notice arrives, you have 60 calendar days to pay the note in full or agree on an acceptable payment plan. So the key is to be ready with your plans before they send it.

Get It in Writing

In the end, when an agreement is reached, get it in writing. Do not accept a verbal agreement with the lender. When you receive it, make copies of the settlement agreement; keep it somewhere it will be safe permanently, and hold on to the cancelled check or checks from any payment plan you established to satisfy the settlement. Also check that the lender discharged any lien as promised.

Report All Debt Forgiven as Taxable Income

Banks and other mainstream lenders will typically send Form 1099-C to borrowers whose debts they cancel, when the canceled amount is $600 or more. The IRS expects you to report all debt forgiven as taxable income, whether you receive Form 1099-C or not, unless an exception applies. If you are insolvent (when the amount you owe to all of your creditors is greater than the value of everything you own), part or all of that canceled debt could be excluded. To prove your insolvency, attach Form 982 “Reduction of Tax Attributes Due to Discharge of Indebtedness” to your return. Work with a tax expert to get it right.