Negotiating Debt Settlements When You Go Out of Business

Here are five steps to settle your business debts, plus tips on negotiating with different kinds of business creditors.

By , Attorney · UC Law San Francisco
Updated by Amanda Hayes, Attorney (University of North Carolina School of Law)

When a business closes, it usually has a good-sized pile of debts—to landlords, suppliers, utilities, service providers, and possibly a bank or private lender. After you notify these creditors of your upcoming closure (which can limit your liability), you'll want to make plans to pay these bills in full, settle them for less than full payment, or consider filing for bankruptcy.

The fourth approach—ignoring your debts and hoping your creditors will ignore you—might be tempting, but don't go that route. It'll probably result in your spending the next couple of years hounded by collection agencies, repo people, lawyers, and lawsuits.

How to Negotiate a Business Debt Settlement

Assuming you can't pay all your debts in full, the question becomes: How much less will your creditors settle for? As you might guess, it depends on the type of creditor, the legal details of the debt, and the attitude of the creditor.

For example, suppose your business is an LLC or corporation without any personally guaranteed debts. In that case, a creditor will know that it doesn't have the option of collecting from you personally, so it might be more willing to accept a small portion of what your business owes as complete payment. But if you owe a debt personally—or perhaps worse, a friend or relative cosigned for it—the creditor has much more leverage.

Whatever the amount or type of debt, it's not going away. You'll need to negotiate a debt settlement with each creditor to have your debt paid or forgiven. You can negotiate your own debt settlement or hire a business lawyer, specifically one with experience in debt settlement or bankruptcy.

If you want to try it on your own, follow these five steps to debt settlement negotiation.

1. Prioritize Your Debts

When you're short on cash, it's a good idea to prioritize your debts. Determine which debts are most important and pay those first.

If you've pledged an asset as collateral and want to keep it, you'll want to pay that debt first. The collateral is also called "secured" property and your creditor will be a secured creditor. For example, a business might offer its machinery as collateral for a business loan from a bank. The bank would be a secured creditor and the loan would be secured by the collateral. Because you have something to lose, you should prioritize secured debts first, as long as you want to keep the property.

After paying your secured creditors for property you want to keep, you should then pay:

  1. any wages and benefits owed to employees, and
  2. loans for which you are personally liable (in particular, court judgments).

If money is left over, then you can pay suppliers, credit card companies, lease deficiencies, and bills for random business expenses—for instance, advertising, travel and entertainment charges, dues and subscriptions, and repairs and maintenance.

2. Decide on a Reasonable Offer to Settle a Debt

No matter the legal status of your debts, it's worth trying to settle if you can pay 30% to 70% cash upfront. Many creditors, knowing that they'll have a hard time collecting the debt once you're out of business, might agree to settle your debt for 50, 60, or 70 cents on the dollar—or even less if you hire a lawyer to negotiate for you.

Keep in mind that it won't help you much to settle one or two small debts for a reasonable amount while not being able to settle larger ones. So it might make sense to tell your creditors that your offers are contingent upon all of your creditors agreeing to settle their debts.

3. Contact Your Creditors

It's easy to procrastinate this step, but it's important that you reach out to your creditors sooner rather than later so you're not falling even further into debt. Depending on the number and type of creditors you have and your relationship with them, you should send them a letter or email, call them, or meet with them. (We get into negotiating with the different kinds of creditors in more detail below.) If you have an attorney, they can contact your creditors for you.

Reach out to equipment lessors first. Since you're likely required to make payments in exchange for use of the equipment you're leasing, time is a factor. You don't want another payment to come due while you're trying to decide whom to call and what to say.

Next, call your secured creditors. Because a secured creditor can take your collateral for nonpayment, you should focus on working out a deal before that can happen.

Call your unsecured creditors last. Because debts to unsecured creditors can be fully or partially discharged in bankruptcy, these creditors will normally be motivated to negotiate a settlement. (If you end up filing for bankruptcy, they'll need to go through the court process for payment, with the possibility that there's not enough money available for them.)

4. Finalize and Sign the Settlement Agreement

If the creditors accept your terms, great. Get each creditor to sign a release for the entire amount in exchange for your partial payment.

But the release is critical—without it, you have no proof that the debt has been satisfied. Creditors could sue you or the business for the remainder of the debt, which would be expensive and time-consuming to deal with, even if you end up not being liable for the debt.

5. Make Your Final Payment

Once an amount is agreed to, make your final payment to each creditor. If your business has set aside some money to pay its creditors, use those funds.

If you have a partnership, there should be some agreement between the partners—for instance, a partnership agreement or partnership dissolution agreement—that outlines who's responsible for the business's debts. If there's not, it's likely that you'll divide the payments equally. But look to your state's laws on partnerships or consider speaking with a lawyer before you come to any understanding.

Regardless your business's structure, and regardless of whether the money is coming from your business or personal account, keep a record of:

  • the amount of the payment
  • the difference between the payment amount and what you originally owed
  • whom the payment went to
  • the terms of the payment, and
  • when the payment was made and cashed.

You should work with an accountant to make sure your accounts have been reconciled and that you can track your debts from when you took them on to when you paid them off. An accountant will also help you sort through all the numbers and prepare your tax filings for you.

Negotiating Debt Settlements With Different Kinds of Creditors

Now that you know the five basic steps to negotiating a business debt settlement, you should know about considerations having to do with the type of creditor you're dealing with. Each type requires a different approach and strategy in debt settlement.

Negotiating With Equipment Lessors

Make arrangements to return leased equipment such as copiers, machinery, and vehicles. But, if you return the equipment before your lease term is up, you'll no doubt be liable for either the remainder of the payments in the lease term or for an early return penalty.

Try to negotiate a better deal while you've still got the equipment. For example, you might offer to return the forklift to the leasing company along with two months' additional payments in exchange for a complete release of further obligations.

Again, if lots of money is at stake and the lessor isn't willing to cooperate, having a lawyer call, possibly with the suggestion that you might file for bankruptcy, can be a huge help. No lessor wants to cope with bankruptcy court and the fact that their property might deteriorate in the meantime.

Negotiating With Secured Creditors

Before you turn over any property to a secured creditor, try to negotiate with them to release you from owing a deficiency, which is the difference between what you paid the creditor and what you owed on the lease or contract. If you surrender your collateral, aren't able to negotiate a release, and still owe the creditor money, there's a deficiency. That deficiency is now like any other unsecured debt. In other words, it's not secured because there's no collateral attached to the debt.

Again, a call from a lawyer could make a big difference. In bankruptcy, a secured creditor's debt is satisfied when you surrender the collateral, and any deficiency is wiped out (or "discharged"). Your attorney can help explain the bankruptcy alternative to your secured creditors, including the fact that it'll be hard for them to collect any unsecured deficiency. Also, if you file for bankruptcy, your secured creditor will have to wait to recover their property. They'll likely prefer recovering their equipment now and agreeing to waive their claim to any deficiency.

Negotiating With Unsecured Creditors

Next, you'll need to negotiate with unsecured creditors. After you notify your unsecured creditors that you're going out of business, they'll start calling you, demanding payment. Often it's best simply to explain that you're preparing as fair a settlement offer as possible and will be in touch. Even if it takes a few weeks to be sure how much you owe and how much cash you have to divide among your creditors, it's worth the time to get it right.

After you've collected outstanding accounts receivable and sold off any unsecured inventory and equipment you own, you should have at least a small amount of cash to use to discuss settlements.

Prepare for your negotiations by following these tips:

  • If you have just a few unsecured creditors. It's helpful to use an individualized approach and to explain your terms one-on-one. You can call them or meet with them, either in person or remotely. Explain that your business doesn't have the money to pay the creditor in full but that you can offer a partial payment to settle the debt.
  • If you have more than a few unsecured creditors. Offering a settlement in writing is often your best course of action. In your letters or emails, spell out:
    • what you can pay as settlement of the debt in full
    • that you're offering each creditor the same percentage (which you should), and
    • that you'll need all creditors to agree to sign a settlement releasing the debt before you can make the payments.

If some creditors want to negotiate for substantially more or are threateningly uncooperative, it's time to involve a lawyer. Doing so will immediately raise the seriousness of the negotiations because the lawyer will be able to convincingly let the creditors know that you might file for bankruptcy if settlements aren't reached.

Creditors know that the costs and delays inherent in bankruptcy would mean that they'll almost surely receive less than what you're offering, and that they wouldn't get the money for many months. So most will probably accept your settlement.

A lawyer can also advise you on whether it makes sense to fully pay a creditor who refuses to accept less. Similarly, if a creditor makes a request for payment that you dispute, an attorney can tell you what your next steps should be or get involved on your behalf.

Preparing for Future Business Debt Claims

If, after making settlements with your creditors, you have any cash or assets left, you should set aside some money for potential future claims. Invariably, after you close up shop, a creditor will come out of the woodwork.

Do your best to estimate any unpaid bills that might later surface or any potential lawsuits that could come up against your business. Some experts recommend you set aside 1% of your annual revenue to provide for surprise creditors, but a reasonable amount depends on the hazards of your particular business.

You can keep the money in your regular business bank account, a savings account, or, if the amount is significant, an escrow account. Some states actually require you to deposit the money into a trust account with the state controller or commissioner of revenue.

If your business is an LLC or corporation, keep the money set aside for two to five years, depending on your state's law. Doing so is important because if a corporation or LLC distributes its assets to its owners after it dissolves and then a creditor appears within the two- to five-year period, the creditor can sue the business owners personally, to the extent of the assets distributed.

If your business is a sole proprietorship or partnership, you might want to keep a contingency fund for three to ten years, depending on your state's statute of limitations. You can keep the funds in a trust account and name yourself or your partners as the trust beneficiaries. Doing so will allow you to dissolve and wind up your business—because the trust account won't be under your business's name—but still give you access to your business's dedicated funds.

Example of How to Handle Future Claims

QuickClean Cleaners, Inc. closes its doors after months of competing with three different dry cleaners within a three-block radius in downtown Stamford, Connecticut. After laying off employees, paying suppliers and creditors, and dissolving their corporation, the owners want to tie up loose ends.

They know that customers take a while to make claims for lost or damaged apparel and that QuickClean usually has to pay out about $6,000 per year in claims not covered by insurance. Wanting closure but not wanting to risk later personal lawsuits, QuickClean sets aside $6,000 in a trust account, distributes the remaining assets to its three shareholders, and dissolves the corporation.

If there's money left over in the account in six years, they can split the money among themselves.

Get Help If You Expect Big Creditors' Claims

If you think significant claims could surface after you close your business, see a lawyer. They can help you determine whether the claims are valid and how much you're on the hook for. They can also explain what your options are if you don't have enough money to pay your creditors.

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