corporate debt restructuring
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This article is written by Muskaan Aggarwal who is pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.

Introduction

Lending someone money, irrespective of them being a corporate entity, an individual, or any other entity capable of taking a loan, is always filled with risks. In spite of doing everything in your power to minimise the risk factor, there is never a guarantee that the entire amount would be returned. This is because the external factor attached to the entity or the individual, complements the risk involved, and hence, does not make the task easy for the creditor.

Often is the case that the loan amount given becomes difficult to recover, and it becomes important to explore ways to regain the loan amount from the debtor, in a timely manner. This is where the concept of ‘Debt Settlement’ is used by creditors, and hence, a debt settlement agreement is often executed. This article aims to understand the concept of debt settlement along with providing ways for efficient drafting of a debt settlement agreement between the creditor and the debtor.

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Debt settlement

Debt settlement can be understood as the process through which the parties negotiate with each other and try to reach a middle ground with a reduction in the outstanding debt of the debtor. This is often done through the acceptance of a lump sum amount by the debtor to the creditor (or lender) after the negotiations are completed. The entire process of debt settlement is held to be completed once the lump sum payment is accepted by the creditor. The amount that is reduced is dependent on the negotiations between the parties, keeping in mind the financial situation of the debtor.

It is important to note that parties engage in a debt settlement mostly for unsecured loans, which are loans where no guarantee has been provided by the debtor to the creditor, which can be used by the creditor in case of default by the debtor. This is because, for secured loans, such as home loans, study loans, etc., which are taken by banks, security is kept in exchange for the loan which is credited by banks in case of defaults. Hence, it becomes difficult to negotiate the pre-mediated terms and conditions of secured loans, and settlement is not a process that the parties engage in.

Hence, for unsecured loans, debt settlement is the best scenario for the parties to have some advantages on their side. For the debtor, the court trials and other legal hassles are saved, and the debtor gets free of the debt by making a reduced payment than the actual debt amount. On the other hand, the creditor also gains an advantage by gaining whatever the debtor is able to give at that point, and hence, bankruptcy chances are taken care of.

Advantages of debt settlement

Some of the advantages of engaging in a debt settlement are:

  1. Single Payment – Through this process, multiple bills and transactions between the creditor and the debtor may be combined in a single payment, and the stress of repaying the amount over a period of time, with timely payments and rate of interest, is avoided.
  2. Bankruptcy is avoided – Through this process, the debt burden on the debtor is reduced by a great amount, and the debtor is now capable of paying the debts in a more comfortable fashion, as they have to pay only what they are able to pay. This avoids extreme situations of sale of assets by debtor for the repayment of loan, and hence, avoids situations of bankruptcy or insolvency.
  3. Elimination of extra charges – With the amount being payable in a single payment, monthly interest rates are avoided. Moreover, late payment fees are excluded or often negotiated between the parties.
  4. Unfair collection practices are not engaged into – Creditors often engage in unfair practices of harassment, to make the debtor pay the amount in a timely manner. This often leads to losses to debtors, not only in the financial sense but also in a mental sense. Therefore, such a situation is also avoided, as parties mutually negotiate the terms of the settlement.
  5. Legal Actions and lawsuits are avoided – Default in the repayment of the loan leads to lawsuits being filed or appropriate legal actions being taken by the creditors against the debtors. This not only leads to a lengthy dispute resolution process but also deteriorates the working relationship of the parties. Hence, this situation is also avoided by engaging in the process of debt settlement.

Disadvantages of debt settlement

Some of the disadvantages of engaging in a debt settlement are:

  1. Fall in credit score – Engaging in a debt settlement often leads to a fall in the credit score of the debtor. This is because debt settlements with banks or any other financial institution are reported to credit rating agencies like CIBIL (Credit Information Bureau India Limited) and others, which results in a decrease in credit score. The debtors are then likely to face rejections for engaging in any future loan transaction, as they are viewed to be less reliable for the timely repayment of the loan, or the repayment of the loan according to prior terms agreed between the parties.
  2. Increased payment of tax – The waived balance of the debtors, through negotiations with the creditor, is often included as the income, within the balance sheets. This leads to a situation where the debtor has to pay taxes for the waived amount as well, and hence, increased payment of taxes.
  3. Prior planning required – It is important for the debtors to not default in the payments of the debt settlement, and hence, the debtors must engage in prior planning, where they make sure that they have enough funds available for the debt settlement beforehand.

Debt settlement agreement

A Debt Settlement Agreement is a written agreement of the negotiated debt settlement between the debtor and the creditor for the loan amount. Through this document, the parties are legally bound, and therefore, have proof about their negotiations. A debt settlement can be legally enforced through the attachment of the non-judicial stamp paper, the cost of which is dependent on the state laws related to the stamp duty and charges for various court documents and agreements. It is important to note that the debt settlement agreement must have the signatures of both the parties involved, i.e., the debtor and the creditor. In case any of the entities is a company, the representative of the company must affix their signatures on the document.

Important contents of a debt settlement agreement

For undertaking the proper execution of a debt settlement agreement, the agreement must be submitted by and between the parties and must specify the details of the parties to the agreement. All details of the creditor and the debtor must be included at the very start of the agreement, and specific terms must be used to refer to them throughout the document, such as “Debtor” or “Creditor”. This helps in making the agreement less confusing and more concise in its reading.

This should be followed by a brief account of the facts leading to this agreement. Only the relevant facts related to the transaction between the parties must be added to the agreement, in a neutral manner. Considering that the agreement is entered into by both parties, the clauses should not be biased towards any one party, unless both the parties agree to such an arrangement.

The main content necessary for adding to the debt settlement agreement are as follows:

  1. Date of the Agreement – The execution date of the agreement is important to be included, as this helps in avoiding any future conflicts between the parties.
  2. Details of the original loan amount and the agreement between the parties – considering that a debt settlement agreement is executed after a loan agreement is already in place between the parties, it is important to give details of the previous agreement as well. Therefore, the details of the original loan amount given by the creditor to the borrower must be added, along with the execution date of the loan agreement. The loan agreement might also be annexed to the debt settlement agreement, for convenience, however, the same is not necessary to be done.
  3. Original due date of the loan amount – This is again in relation to the loan agreement between the parties. The original due date of the loan amount must be added to provide clarity on the negotiations undertaken by the parties.
  4. Settlement amount decided – This clause shall refer to the final settlement amount that has been mutually agreed by both the parties within the debt settlement agreement, after the waiving off of the decided debt amount.
  5. Settlement of Debt – It is important to state that the payment of the settlement amount shall complete the payment and settle the debt once and for all.
  6. Representations and Warranties – This clause shall include the representations made individually by the debtor and the creditor to the respective other party, where they also warrant that the representations made are true to the best of their knowledge.
  7. Governing Laws and Jurisdiction – considering that this agreement is legally enforceable, the agreement shall have clarity on the court having the jurisdiction to decide on this agreement, if need may be.
  8. Any other clause as the need maybe – most of the clauses in a debt settlement agreement are dependent on the type of transaction between the parties. This includes the date of repayment, mode of repayment, details of notices pertaining to the agreement, severability of clauses within the agreement, etc. These clauses are subject to the decisions mutually made by the parties. Therefore, any clause which the parties think should be added to the agreement for further clarity, should be included in the Agreement as well.

Finally, the agreement, as discussed before, should be concluded with the signature of both the parties, along with witnesses.

Conclusion

Debt Settlement Agreements are an effective way for the repayment of the loan amount if the debtor is unable to pay the entire loan amount. However, it is important to note that these agreements are entered into only for unsecured loans, where the parties have not made any prior agreement on the guarantee or security to the loan amount. Otherwise, for secured loan amounts, the debt settlement agreements have no use.

References

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