Bad debt occurs when one party loans another party money, but the borrower fails to repay the amounts according to the loan agreement. For instance, if the borrower has failed to keep up with monthly repayment amounts, or has completely defaulted altogether, the debt becomes “bad debt” because the lender has lost some of their investment.
Bad debt can be particularly troublesome for both business and non-business lenders. Rather than providing the lender with return on the amounts they have lent, a bad debt situation can stall income and create further financial and legal issues. Thus, it’s important to have a debt agreement clearly spelled out in writing in order to avoid misunderstandings and disagreements between the parties.
Lenders should be aware of a few legal issues that may be related to bad debt circumstances. Some of these can include:
- Tax consequences- being in a bad debt situation can sometimes affect the way the lender files their tax deductions. These can either be advantageous or can sometimes be a setback for the lender depending on the situation
- Bankruptcy- Filing for bankruptcy can sometimes have the effect of releasing the borrower from their debt. Some, though not all forms of debt are non-dischargeable in a bankruptcy claim
Also, debt laws often overlap heavily with other areas of law, including contact laws and consumer protection laws. You may need the services of a legal professional when dealing with bad debt situations that are particularly complex.
If one of your debtors owes you money, you may have the legal right to collect the money, especially if you have a clearly written contract. If referring to the contract doesn’t resolve the problem, you may have a number of options that may be available to you:
- Discharge of debt- sometimes a partial discharge of debt may help the borrower to regain financial footing, which may lead to them paying the full amount in the future
- Cancel the person’s debt: Attempt to finalize a debt cancellation agreement, especially for old or outdated debt. This might help preserve good business relations with the other party, but is not always practical for the lender
- File a lawsuit- you may be able to obtain an official lien on the person’s property to satisfy the debt, or the court may order a payment in your favor
Again, the most important aspect in any bad debt claim is the existence of a valid contract for the debt agreement. Without a contract, it may be difficult to have one’s collection rights enforced in a court of law. The contract needs to be clearly written and should satisfy the requirements for a valid contract.
Bad debt can present various difficulties for both parties to the agreement. If you are facing a situation involving bad debt, you may wish to speak with a lawyer immediately. Your attorney can help you file a claim or take other steps so that you can obtain legal relief. Also, you may wish to hire a lawyer before you enter into a debt or lending agreement- your attorney can help you draft and review the contents of the contract so that disputes can be avoided in the first place.