For most financially trouble consumer debtors, the only non-bankruptcy alternatives are: (1) liquidating and/or confirming extent of debtor’s liability for one or more significant debts, and (2) formal or informal out-of-court agreements with creditors for the repayment of all or a significant portion of the debtor’s debts.
Determining the extent of the debtor’s liability for a significant debt may be necessary if the debtor’s financial crisis is caused by one or two large debts, such as a substantial child support obligation, an unliquidated claim for personal injury or breach of contract, or a large medical bill. In these cases the debtor is likely to need independent representation or advisement on the claim giving rise to the debt, rather than debt relief in general.
Settlements with creditors offers the advantage of avoiding the stigma of bankruptcy. If such an agreement is simple and easy to negotiate, it may also be less expensive to the debtor than a bankruptcy proceeding. The principal disadvantage of such an agreement is that dissenting creditors cannot be bound thereunder and a single hostile creditor can often scuttle an otherwise workable agreement. Also, if the creditors are too numerous or geographically widespread, it may be logistically difficult to consummate an agreement. Finally, there is no way to prevent adverse creditor action while such an agreement is being negotiated.
An agreement with creditors is most likely to be feasible when there are only a few creditors, when most major creditors are unsecured, when the debtor has sufficient income or assets with which to make realistic payments to creditors, and when the debtor does not need the emergency relief provided by the automatic stay that is provided in bankruptcy proceedings. The best method of notifying creditors of a debtor’s desire to negotiate an out-of-court agreement is in person or by telephone. If the creditors are so numerous that telephoning is not practicable, an agreement with creditors is probably not practicable either. The agreement should be negotiated quickly because it is usually necessary to disclose the debtor’s nonexempt assets to creditors, and delays may give hostile or aggressive creditors an opportunity or excuse to proceed against the assets.
When negotiating with creditors it is important to understand that it is not legally necessary to treat all creditors alike. Even creditors with identical claims can be treated differently. Some creditors may prefer to take substantially less than 100 cents on the dollar in return for early payment, while others may prefer to collect all or most of their claims over an extended period.
An agreement with creditors may be drafted so that the debtor makes payments directly to each creditor, or so that the debtor makes payments to a disbursing agent, who, in turn, makes the disbursements to creditors. Much depends upon the number of creditors and the preferences of the parties. If a disbursing agent is appointed, it is a better practice to appoint someone other than the debtor’s attorney to perform this task.