Out of Court Settlements

There are several ways to deal with an insolvent or financially distressed customer.  The two extremes are:

1. Try to help keep the debtor in business, or 
2. Try to put the debtor out of business.  This would include liquidating the assets of the debtor company, and distributing the proceeds among its creditors. 

General unsecured creditors in particular usually prefer to try to work with distressed debtors. One option for a customer with serious financial problems is an out-of-court settlement.   An out-of-court settlement involves the resolution of a dispute prior to a final decision by a trial court.  In disputes between debtors and creditors, out-of-court settlements involve or require compromises.  These compromises typically involve creditors accepting a fraction of their outstanding balance due as payment in full.  When rehabilitation through an out-of-court settlement is not possible, creditors can try to arrange to liquidate the debtor company's assets outside of bankruptcy through a general assignment for the benefit of creditors... or force the debtor company to file for bankruptcy protection.

Voluntary Settlements

A structured voluntary settlement generally involves an agreement or contract between the debtor and all or at least the overwhelming majority of its creditors in which the creditors agree to accept a partial payment in full and final settlement of the balance due them.   The principal advantages of voluntary settlements are their simplicity and relatively low cost.  For example, there are no costly court proceedings as would be the case in a bankruptcy.  The cost of administering a voluntary settlement are typically much lower than in a bankruptcy.   If costs are lower, the amount recovered by general unsecured creditors should be higher than it would be in a bankruptcy.

Initiating a Voluntary Settlement

Either a debtor or its creditors can initiate voluntary or out of court settlement negotiations.  A debtor in financial difficulty may go to an attorney for advice. The attorney may contact a few of the largest creditors and eventually arrange a meeting. In that meeting, the following issues are usually discussed:

• The customer's current financial condition; 
• The problems that caused the financial crisis;
• The steps taken by the customer to address and resolve the underlying problems;
• The position held by the customer's secured creditor;
• The customer's proposed payment or settlement plan;
• Any provisions for payment of interest on the debt to be settled;
• Any provision involving offering security or collateral to creditors that agree to the out of court settlement;
• Data about ongoing business operations, plans and prospects. 

In the event that an out of court settlement can be negotiated, the creditors usually prefer to work closely with a local NACM (National Association of Credit Management) affiliate. The function of the affiliate is to act as an independent and neutral third party that will attempt to ensure that the debtor meets all of its commitments. The affiliate will also become the point of contact for creditors. The advantage to the debtor is that by having a single contact, the debtor is not inundated with questions, calls and inquiries from anxious creditors.

Reprinted with the permission of Credit Research Foundation.

Edited by Michael C. Dennis.