Out of Court Settlements

There are two ways to deal with the problem of an insolvent or financially distressed customer:

1. Try to help keep the debtor in business, or
2. Put the debtor out of business, liquidate the assets of the debtor company, and distribute the proceeds among its creditors.

Some creditors, particularly general unsecured creditors, usually prefer to try to work with a distressed debtor. One option for a customer with serious financial problems is an out-of-court settlement. When rehabilitation 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.

Voluntary Settlements

A structured voluntary settlement generally involves an agreement or contract between the debtor and the 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. There are no court proceedings as in a bankruptcy. There are no court costs, and the general costs of administration are much lower than in a bankruptcy. As a result, the amount paid to general unsecured creditors may be higher than in a bankruptcy and if structured properly out of court settlements are legally binding on the debtor and may include specific penalties for nonperformance.

Initiating a Voluntary Settlement

Either a debtor or its creditors can initiate a voluntary settlement. Most frequently, a debtor in financial difficulty goes 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 taken by the customer's secured creditor
• The customer's proposed payment plan
• Any provisions for payment of interest on the debt
• Any provision for offering security or collateral to creditors that agree to the out of court settlement
• The kinds of information the creditors will receive from the customer about its ongoing business operations.

In the event that an out of court settlement can be worked out, the creditors usually prefer to work closely with a local NACM (National Association of Credit Management) affiliate Occurs when 50% or less of an entity's stock is held by the parent company. or adjustment bureau. 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 Dennis, author of "Credit and Collection Handbook" available at the NACM Bookstore.