Which is Advisable? Debt Settlement or Bankruptcy?

Bankruptcy is a constitutional right provided to all the people or companies who have acquired debts that have turned out to be, for one reason or another, greater than their financial ability to pay them.

Bankruptcies can be classified into two: individual’s bankruptcy and company bankruptcy. In Chapter 7 individuals get clemency of their debts outright. In Chapter 13 individuals formulate a “Plan” whereby they make arrangements on set payments of their debts to the creditors over a period of time.

Not all chapters of bankruptcy are meant for everyone. In general, people who own moderate property will prefer to file for Chapter 7 while people with larger asset holdings, and higher levels of salary, will file Chapter 13.

Debt consolidation allows you to make decisions on how to settle down your debts accordingly without following any court order. The insolvent may not lose all their assets in the debt payment process. However, in the case of bankruptcy filing, the insolvent have no say over their assets.

In the process of debt settlement a debt settlement company is hired to sell all the assets of the insolvent party and use that money to settle down the debts. Sometimes this is more economical than filing bankruptcy.

How reliable are the Settlement company?

Most debt settlement companies keep advertising their good reliable services in the media. It’s hard to identify the companies which are reliable vs the counterfeits unless you get the information from the clients who have employed them before. If you live in Connecticut you can do a search yourself through ct.gov website (link) for a reliable debt settlement company to verify a license and even report scammers if you come across them. The statement ‘buyer beware’ applies in this case.

What is The Debt Settlement Process?

• A. Payments: The creditors should be paid in installments. This could be monthly or any other time period that the committee agrees upon. If the available liquid cash is not enough to pay the debts then you will have to dispose some of the assets so that you get money to settle the debts.The manner of payment should follow a certain order as well as per international financial reporting standards (IFRS). The order is as shown in the list below:
  1. Secured creditors – These are creditors who have sufficient security of the insolvent to meet their claims in full. Any surplus of the value of security is recorded as part of the realisable assets or it is used as a security for another debt.
  2. Any unpaid legal charges – These are those charges which the insolvent owes to the government which should be paid in full before any other debts are settled.
  3. Liquidator’s remuneration – In this case you will pay the debt settlement company for the fee which you agreed upon.
  4. Pay preferential creditors – These are actually creditors but the law gives them some preference over the other creditors on payments. This implies that they are paid first after the assets have been sorted out.
     The preferential creditors should be paid in this order:
     • Local rates due to the city or municipal council up to one year in arrears
     • Rent due to the government not exceeding five years in arrears
     • Statutory payroll deductions up to 1 year in arrears
     • Income and other taxes due to the governments up to one year in arrears
     • Wages and salaries due to the employees for work done during the four months preceding the day of bankruptcy order up to $5 per employee.
  5. Creditors secured on a floating charge – These are debts which are to be paid when an asset is sold. They float on an asset. They would lose their money if there are no asset to dispose.
  6. Unsecured creditors – These are creditors who do not have a security to fall back to in case of any default. They could be trade creditors and sundry creditors.
  7. Preferential dividends in arrears – They are dividends which have a first priority over other dividends. They should be paid first before any other dividends.
  8. Preferential share capital – They have preference over other share capital
  9. Ordinary share capital – This is capital belonging to the owners of the business
• B. How are the debt payments utilized?
  The debt payments should be made to the creditors and to the company that is hired to do the debt consolidation work. Most people think that the money collected is paid to the creditors first. However, this money goes to the company first.
• C. What can happen in a case where your creditors are not being paid as arranged and instead the debt settlement company is paid?
  In such instances, the creditors may act to secure their rights. This could include harsh calls and collection letters. The creditors may move to court to sue the debtor.
• D. Debt settlement should not be guaranteed
  The debt settlement companies cannot guarantee a full settlement of the debts. Remember that your total worth could be less than the debt which you have.

Will You Pay Income Tax While Carrying Out Debt Settlement?

Most people do not know that there could be significant tax implications associated with debt settlement. Tax implications may arise when there is debt forgiveness during the process of settling debts. This debt forgiveness is taxable income for that particular tax reporting period.

Does Debt Settlement Affect Your Credit Reports and Credit Score?

Yes. In most cases the credit score is reported in a negative status. This gives little opportunity for the credit score to increase during the process. Sometimes the decrease would be even after the debt payment process.