Settlement Strategies: Minimizing Risk to Maximize Return
Both consumer and commercial creditors are constantly faced with the issue of how to maximize return on troubled credits. Whether an account is in the initial stages of being flagged “high-risk,” or the credit is clearly in default and collection appears to be the only option, creditors must weigh their options for potential workouts and settlements with an eye toward cost and likelihood of collection. Employing productive settlement strategies and carefully considering the various layers of settlement benefits will net a much greater return to the creditor than simply evaluating settlement solely on a direct comparison of the settlement proposal to the current debt obligations. Thorough settlement and workout considerations can be broken down into two parts:
- Cost benefit analysis: Is settlement profitable given the amount of risk and potential cost to the creditor?
- How valuable are the underlying benefits of settlement?
Let’s examine the common situation of a debtor’s request to make payments over time after an acceleration of the full balance due. Payments over a period of time, particularly on a fully-accelerated debt, may be an administrative hassle for the creditor and cost-prohibitive if the proposed payment period is too long. Thus, a creditor must find the perfect balance between a reasonable repayment term and the debtor’s ability to pay. When negotiating payments, the creditor should demand a personal financial statement that will allow the creditor to evaluate how much the debtor can afford to pay. The obvious urge is to demand higher monthly payments from the debtor, but that may ultimately force the debtor into bankruptcy. If the debtor files bankruptcy, the creditor may then be exposed to preference liability under Section 547 of the Bankruptcy Code, requiring the creditor to pay the bankruptcy estate an amount equal to the payments received in the 90 days prior to the bankruptcy filing.
Another critical step is developing a realistic expectation of recovery if the case proceeds to judgment. The fact that a debtor is willing to offer structured payments does not necessarily mean the debtor has assets that can be seized to satisfy a judgment. Debtors may be funding settlement payments with monies that would otherwise be protected by statutory exemptions, such as retirement accounts or assets held jointly with spouses or third parties. Many debtors that are actually “judgment proof” will agree to make a monthly payment in order to avoid having a judgment entered against them. The debtor’s fear of judgment gives the creditor great leverage to get money in hand, even if received in stages, as opposed to incurring legal fees and going through several months of the collection process only to find that the judgment is uncollectible.
After reviewing the numbers, it is critical that the creditor then weigh the potential, often hidden, benefits to an early settlement. If properly drafted and negotiated, a settlement agreement, forbearance agreement, or workout can save the creditor great expense and improve the creditor’s position on the account. In a workout setting, creditors can enhance problem credits by adding collateral, modifying interest rates, and obtaining personal guaranties. Moreover, settlement agreements empower the creditor to eliminate the variables associated with any dispute, including the whims of a judge or jury; problematic service issues; locating and chasing assets conveyed to a third party; seizure and liquidation of collateral, which is subject to challenges by the debtor as to commercial reasonableness; and general disputes over the amount owed.
A well-drafted settlement agreement may include an admission of liability on the part of the debtor, an acknowledgment of the amount due, a consent to immediate seizure of collateral if the debtor defaults on the settlement terms, a provision addressing the creditor’s right to object to discharge of debts in a subsequent bankruptcy, and a waiver of all potential claims against the creditor. Although often overlooked, the debtor’s waiver of any and all claims against the creditor may prove to be the golden nugget in the settlement agreement. The profitability of extremely beneficial settlements can be quickly destroyed by subsequent debtor claims. Regardless of the debtor’s clear liability on a debt, the debtor is often armed with various potential claims such as violations of the Fair Debt Collections Practices Act, violations of the Truth in Lending Act, violations of the Fair Credit Reporting Act, and actions for avoidance of settlement payments made by a debtor prior to bankruptcy.
Provisions regarding dischargeability of debts in bankruptcy are equally critical considerations. A creditor may unintentionally waive its right to object to discharge of a debt in bankruptcy if not explicitly reserved in the settlement agreement or consent judgment. An example of a potential implied waiver would be the creditor’s settlement of a case involving a potential fraud claim against the debtor. The creditor opts to dismiss the fraud claim in exchange for the debtor’s willingness to sign a Consent Judgment and make a lump sum payment in full satisfaction of the debt. Prior to making payment, the debtor files for relief under Chapter 7. The creditor’s only chance of collection then becomes exempting the debt from discharge in bankruptcy. Without explicit language in the settlement agreement preserving the creditor’s right to object, the court may deem the settlement a waiver of the right to object, thereby sacrificing the creditor’s only chance of recovery.
Another common settlement strategy that should always be explored is the signing of a confession of judgment or a consent judgment. Even if entering into settlement and obtaining a confession of judgment appears to be delaying the inevitable, the confession of judgment eliminates all potential variables, thereby minimizing risks as well as legal expenses associated with obtaining judgment. Many debtors will be willing to sign a confession of judgment in the early stages of a default situation, while the debtor is still optimistic about the ability to comply with the settlement. That same debtor will rarely agree to sign an acknowledgment of debt or consent to judgment after collateral has been liquidated and the debtor has been forced to hire counsel to defend a lawsuit.
The various elements of settlement evaluation and negotiation discussed herein illustrate many of the hidden benefits of settlement and emphasize the importance of a thorough analysis and well-drafted settlement agreement. Creditors’ counsel can be instrumental in negotiating and drafting agreements that will empower creditors to maximize net returns on troubled accounts.
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