Back when times were good, you probably saw your line of credit as a lifeline — you could pay bills when cash was tight. Then the interest rate went up, over-limit and late fees piled on, and the payments stopped being possible. Many owners try to call the bank early to work something out, only to find that all anyone wants is a payment.
Here is how it often plays out. Your business has $58,000 in a line of credit that includes interest and late fees. You had the chance to settle it for $24,500 (about 40 cents on the dollar). The bank gave you three days to decide whether you wanted to settle it for that amount, and until the end of the month to make a payment. They then said the account is going to the bank’s legal department.
A 40-cents-on-the-dollar settlement offer on a business line of credit is a pretty good deal if you can afford it. If you can’t come up with that money in time, you still have options. Before getting to them, it helps to understand what you are dealing with.
A Business Line of Credit
A business line of credit is just a right to draw funds against a credit limit. The idea is to provide short-term working capital needs, like covering inventory costs or other operating expenses. A line of credit is for businesses with seasonal expenses or uneven cash flow. It’s not intended for major purchases, like property, new equipment or other long-term assets.
Most small business lines of credit are unsecured, which means they are not secured by anything. They are like most credit card debt, medical bills, signature loans and other types of unsecured debt. Some business lines of credit are secured by inventory, fixtures or equipment. With an unsecured line, the lender is gambling on the business’s profitability to pay off the debt.
Next, the charge-off. A charge-off is when a lender writes an unpaid debt off its books as a loss. Creditors must charge-off an account 120-180 days after the last payment, according to accounting rules and federal guidelines. But a charge-off does not mean the debt is forgiven. The important question is whether you still owe the money. Of course you do! Whether it has been charged off or not, the bank has every right to continue to collect on the account.
The bank is under no obligation to let you know it’s charged off the account. Once it’s charged off, it may retain the account in-house or it may be sold to a collection agency, which buys the debt for a fraction of its value. The collector can still seek the entire balance plus interest. The charge-off date on a loan has almost nothing to do with the statute of limitations on the debt or when the debt must come off a credit report.
Debt Negotiation
That brings us to settlement, also called debt negotiation. The lender agrees to forgive part of the balance, and you pay the new amount and no more. A settlement reduces the amount owed by up to 60 percent. The lender may accept payment in a lump sum or as a monthly payment plan. There is a catch. The amount forgiven is considered taxable income. You’ll get a 1099-C in the mail that you will have to report as income on your tax return. If you settle a $58,000 balance for $24,500, the $33,500 that is forgiven is considered income and you owe taxes on it. The settlement may also appear on your credit report.
Creditors are under no obligation to negotiate. You can negotiate with the bank yourself, but be prepared to bargain hard. Professional debt negotiators are usually better than amateurs because they know which creditors are likely to settle for how much and under what terms. They also know which creditors will not settle at all. If you are not a born negotiator, hire a debt settlement firm. They do the heavy lifting for you.
Whoever does the talking, expect the bank to negotiate aggressively and to set deadlines that seem arbitrary, like three days to decide. Remember that the person on the other end of the phone is going to have a reasonable fear of appearing weak. Debt negotiators are incentivized to get deals done quickly. That can work in your favor: sometimes a negotiator will make a better offer on the last day of the month than on the first.
What if You Can’t Reach an Agreement
What if you can’t reach an agreement? If negotiations don’t work, the lender can sue for breach of contract. If you don’t mount a viable defense, the court will award the lender a judgment. A judgment is simply an order from the court that the money be paid. If the lender wins a judgment, it can garnish wages if your state permits it, levy accounts and attach liens on property.
Keep talking to the bank. In the meantime, you should consult with a bankruptcy attorney in your state. You may never file. Learning more about bankruptcy will give you leverage to bargain. Tell the bank you don’t want to file bankruptcy, but if a settlement cannot be reached, they will get little or nothing in a bankruptcy discharge.
So if your business can’t pay its line of credit, don’t disappear. The best thing to do is continue negotiating with the bank. A settlement you can afford is better than a lawsuit you can’t win.
