What can creditors do if you don't pay? (2023)

First, know that you can't go to jail for not paying your debts (with the exception of overdue child support, if you could pay but don't). And a creditor can't just take money out of your bank account or collect your tax refund unless you owe back taxes or default on a student loan. To collect a debt, the general rule is that most commercial creditors must first sue you and obtain a money judgment (judgment) against you.

But there is one major exception to this rule: Creditors don't have to sue first if the debt is secured by collateral. Common examples are a car loan where the car you bought is collateral (collateral) for the loan, or a mortgage or home loan where the house itself is pledged as collateral (although about half state, a lender has to going to court before foreclosure).

As you may face some creditors with sophisticated financial knowledge and legal resources, it is important that you understand the legal status of any and all debts and what each creditor's rights are.

Debts and creditors fall into different types of legal categories, which means that some of your creditors have more collection rights and greater ability to negatively affect you and your business than others. The two main categories of debts and creditors are secured and unsecured.

Guaranteed vs. unsecured creditors

Secured Debts

Many businesses have secured debt: Businesses often pledge collateral for lines of credit, and business owners often pledge their personal assets to business debt. Let's take a look at how quickly creditors can call or foreclose on a security when a secured debt is not paid.

embargoes

As you probably know, if you miss a payment or two on your car loan (and, as is typical, the loan was used to buy the car and is secured by the car), the lender has the legal right to physically repossess the car. . and sell it to recoup the money you owe, plus the costs of the sale and attorneys' fees. To do this, the lender does not need to obtain a license or court order. As per the terms of the contract you signed with the lender, a repo agent can simply claim the lender's property. (In many states, the lender doesn't have to notify you of the repossession; you'll just wake up and find your car gone.) When all is said and done, you'll still owe the difference between what the lender sold the car and what you owed on the loan, called a "deficiency". In addition, recovery will appear on your credit report for seven years.

Cars are the most common type of repossessed property, but if you borrowed money to buy commercial equipment or machinery and used the purchased equipment as collateral, your lender will have the same repossession rights. Also, some department store credit cards provide that the lender automatically takes a lien on the property you buy, so if you don't pay the bill, the lender can try to repossess the property. However, since creditors must obtain a court order to enter your home or business, repossession of property other than vehicles is rare.

Likewise, with leased commercial vehicles or equipment, if you miss a lease payment, the leased property can usually be repossessed immediately without a court order.

foreclosures

If you have a mortgage or deed on your home, or a publicly traded line of credit, you must make timely payments to maintain the home. If you don't, the lender can and probably will foreclose on your home because it is collateral for your debt. But foreclosures aren't as quick as vehicle repossessions. In half the states, the lender must go to court before foreclosure, and in the other half, notice from the lender is required.

Likewise, if you pledge your home as collateral for a business loan or line of credit and you default on that loan, the lender may foreclose on your home. (In this situation, the creditor should always file a foreclosure action in court, no matter what state you are in.) To prevent the creditor from foreclosure, you must either pay the debt or, if the debt is greater than your equity in the home, at least pay the lender that amount so you no longer have a reason to foreclose.

The shutdown process works differently in different states. In some states, the lender must file a lawsuit to foreclose on a home (called a foreclosure). In others, you can foreclose without going to court (out of court foreclosure). An out-of-court foreclosure usually takes several months longer than an out-of-court foreclosure (although in California an out-of-court foreclosure can take a year or more), giving you time to save some money and, if necessary, find a new one. place to live.

Avoid Foreclosure

If you are late on your mortgage, you can negotiate a loan modification with your lender. For example, the lender may agree to add your missed payments to your loan balance, extend your loan to a longer term, or convert an adjustable rate mortgage to a fixed rate mortgage. Your other options are to sell your home for less than you owe (called a short sale), return the deed to the lender (called a deed in lieu of foreclosure), or refinance through the Federal Housing Administration (FHA). ) or the Owner's Stability and Accessibility Plan. For up-to-date information about your options if you are facing foreclosure, seeThe Foreclosure Foreclosure Survival Guide, by Esteban Elias (Nolo).

Filing for bankruptcy can delay foreclosure.When you declare bankruptcy, all creditors, including mortgage lenders, must cease foreclosures and collection activities. However, the creditor can ask the bankruptcy court for permission to proceed with a foreclosure if you are late on your payments, so a bankruptcy can only delay the foreclosure by a few months. (For more information on bankruptcy in general, seeNolo Bankruptcy Center.)

unsecured debt

Unsecured creditors such as credit card companies and most commercial creditors must first sue you and obtain a cash judgment against you before they can take your income and property. This is true whether you are personally responsible for the debt (as is the case with sole proprietors and partners, or because you signed a personal guarantee for your corporation or LLC) or if only your corporation or LLC is responsible for the debt. (Find out if you arepersonally responsible for paying your business debts.)

Usually, however, before seriously considering a lawsuit, a creditor tries to collect the debt for several months and then turns it over to a lawyer or collection agency, who will restart the process. In some cases, the creditor will conclude that you don't have enough easily seizable assets to pay the judgment and won't bother suing you.

For example, let's say your house is worth less than what you owe on your mortgage, which means there's no equity for lenders to take over. Also suppose your consignment store has little business assets and is doing so poorly that you don't anticipate having more than a few dollars of steady income that a creditor could collect (by ordering the sheriff or sheriff to withdraw money from the business establishment). Your creditors, or whatever lawyer or collection agency your debt was turned over to, may not sue you because they know it is unlikely that they will be able to collect the judgment money. This is called being "judgment-proof."

Instead, the creditor can simply write off your debt and treat it as a deductible business loss for income tax purposes. Typically, in five or six years, depending on your state's statute of limitations, the debt will become legally bad. (Only a few states, such as Kentucky, Louisiana, Ohio, and Rhode Island, have longer statutes of limitations, up to ten or fifteen years.)

However, youhe canExpect to be sued if there is a lot of money at stake and you have valuable personal or business assets (or just business assets if your business is a corporation or LLC), or if the creditor expects you to acquire significant assets in the future. For example, if you're a sole proprietor and have an advanced degree, your lender may assume you'll eventually earn a decent wage and sue you now and just hope you earn some income. (In many states, a court judgment can run for at least ten years.)

Why would a creditor think it's worth suing? Significant amounts of cash or accounts receivable, valuable business property and equipment, and, if you are personally responsible for a debt, valuable personal property such as jewelry, artwork, collectibles, antiques, motorcycles, expensive bicycles, boats, or a luxury home vacation .

Don't try to hide assets.Sometimes, in desperation, a business owner tries to protect personal or business assets by giving them to friends and relatives or trying to hide them from creditors. While few small business owners have the knowledge to transfer money to an offshore bank account, many try to hide it on behalf of a parent, child, co-worker or friend. Don't do that. Creditor attorneys are experienced in uncovering such hidden assets, and in extreme cases these tactics can even result in civil and criminal fraud charges.

If a creditor takes you to court and wins a judgment against you, it obviously makes sense to pay the court judgment before any other unsecured debt you have not yet been sued for. (See Nolo's article onPrioritize which business debts to pay off first.)

How a creditor should collect a judgment

Collecting a judgment is more difficult than winning it. If a creditor went to court and won a judgment against you for collecting an unsecured debt, theoretically the creditor (now called a court creditor) could collect any money in your business bank account, your business income, and your business. goods to pay the debt. If you are a sole proprietor or partner, or have signed a personal guarantee on a debt, the creditor may also pawn your wages and withdraw money from your personal bank account, as well as take your non-exempt personal assets, to pay off the debt. debt. However, to take money or property, the creditor must first locate it, then obtain a court order and pay the sheriff to take it.

Probably the most common collection method is for the creditor to obtain a writ of garnishment, under which a sheriff can pawn 25% of your wages to settle the debt (except in Pennsylvania, South Carolina and Texas where it is not permitted). . embargoes are allowed). But assuming you're a self-employed business owner without a side job, garnishing your paycheck will be very difficult as you don't get a paycheck (unless you're an employee of your corporation). However, your spouse's salary can be used to pay your business debts if you live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin), assuming your spouse be named in the court decision.

Often, a more effective collection technique (if your business sells goods or services for cash) is for the bailiff to come to your business and take whatever money he finds there at the cash register (called a "cash register"). ") or on your person. Or a sheriff may be authorized to take commercial vehicles, equipment, or tools of the trade to pay off your debts, which will happen only if those items are clearly worth more than you owe. It is also possible that the creditor has a court order for their major customers to pay the money they owe directly to the court.

However, most lenders will not do anything to get your property. Instead, many will simply attach a "lien" to any real property or assets the business owns (or valuable personal property or real property you own, if you are personally responsible for the debt). The lien will allow the lender to cover the debt when you sell or refinance the property.

Check if there are any liens filed against your business.The Secretary of State's office in each state maintains an encumbrance register, listing judgment liens, tax liens, or liens that creditors claim on your property. You can perform an online Uniform Commercial Code (UCC) record search on the Secretary of State's website to search your personal and business names to see what liens have been filed against you. If you find incorrect information, say you paid a debt but it was not reflected, ask the creditor in question for a UCC release, which is required by law.

Exempt Property: What a Judicial Creditor Cannot Take

While a court creditor can usually withdraw money from your bank account or force the sale of most business assets, a creditorcan notappropriation of personal assets legally exempt from creditors. Most states provide that a certain amount of your personal property, such as food, furniture, and clothing, cannot be taken by creditors or the bankruptcy trustee in bankruptcy court. In addition, most states exempt creditors from:

• the equity you own in a vehicle, up to a certain amount, usually $1,000 to $5,000, and
• a significant amount of equity in your home, usually between $10,000 and $50,000 depending on the state.

Find your state's exemptions.To find out how much your state exempts for your car and house, and a complete list of exempt properties, see our section onbankruptcy exemptions.

Most states also allow you to keep a few thousand dollars worth of business equipment and tools, as well as money in tax-deferred retirement plans. Also, in most states (except the common property states, mentioned above), a creditor cannot take property that belongs to you and your spouse if the debt is in your name only. (For more information, seeResponsibility of spouse and partner for common debt.) The practical effect of these exemptions is that no matter how much debt you owe and no matter how many judgments are passed against you, creditors cannot confiscate many essential assets.

EXAMPLE:For years, Dax's hobby has been restoring classic cars; he owns two himself, a 1964 Shelby Cobra and a 1959 Cadillac Eldorado. After being urged by friends to quit his job to do what he loves, Dax opens his own shop offering custom auto detailing, dent repair without painting, car painting and classic car restoration. He applies for a business license, rents a small warehouse in an industrial area, buys two car lifts, and adds to his already sizeable supply of tools. To pay it all off, he takes out a personal line of credit at home after trying a line of credit at a commercial bank. Sadly, almost as soon as Dax opens its doors, the economy slumps and people cut back on luxury services like regular car detailing and even dent and dent repairs. At the same time, many classic car enthusiasts are being forced to put their hobbies on hold. As a result, Dax cannot raise enough money to cover his costs, is unable to pay his rent, and closes the business, leaving a mountain of debt.

If you get sued or have to file for bankruptcy, here's what you stand to lose and what you should be able to keep:

Since Dax lives in California, is married, and has only $60,000 in equity in his home (he owes $300,000 and the house is worth $360,000), he will be able to keep his home (California law exempts $75,000 in equity for families). You will also be able to keep your clothes, furniture and appliances. You'll only be able to keep $2,550 in equity in personal vehicles, so you'll likely lose your classic cars. You will also be able to keep up to $6,750 in business assets if you have paid them off in full and continue to use them for a living, including tools, equipment and a business vehicle. Unfortunately, they are likely to take the rest of your company's assets. You also risk losing the money in your business bank account as well as your personal bank account because you were a sole proprietor. If you get a new job, up to 25% of your salary can also be withheld. And if Dax's wife brings home income, 25% of that income can be used to pay off business debts, if his wife is listed in the judgment. (However, if Dax files for bankruptcy, the wage garnishments will stop.) Fortunately, Dax's IRA is safe from creditors.

Bankruptcy can get rid of unsecured debts.If you have been sued or threatened with a lawsuit, you risk losing money or property. If most of your debt is unsecured and you have little chance of paying it off, consider filing for bankruptcy, which may eliminate most, if not all, of your unsecured debt. For more information on bankruptcy and alternatives, see Nolo'ssmall business bankruptcy overview. Also, if you decide to go out of business, see the Nolo section ongo out of business, for information on how to minimize your personal liability when exiting the business.

Special rules for leases

Late rent is treated like any other unsecured debt, but is subject to streamlined eviction procedures if you fail to pay. If you are late on your residential rent, your landlord will likely file an eviction action against you within a few weeks. Unless the building is deemed uninhabitable (substandard or unsafe), you will likely receive an eviction order in about six weeks. A commercial eviction is faster than a residential eviction – it can be finished in a few weeks.

You can try to negotiate with the landlord to make up for the unpaid rent for the next few months, but do this before the landlord files for eviction. Your landlord will likely negotiate if many properties are vacant in your area. If you can show that even though your business is short on cash, you have a credible long-term survival plan, you may be able to get a new lease at a lower rent. Your chances will increase if you can show that you or a private lender will invest new capital in the business if rent and other obligations are reduced. (For more information on negotiating your rent, see our article onways to cut costs.)

If you have to move when you have time left on a lease (residential or commercial), your landlord can sue you for the remaining months of rent. However, in most states, the landlord is required to try to lease the space first to minimize the loss. This is called "damage mitigation". For more information, see Nolo's article onHow to get out of a lease earlywith the least consequences.

Find yourself a new tenant.A landlord who expects to collect all the rent owed on the breached lease may be slow to find a new tenant. If you help find a new tenant and fill the space faster, you will limit your future liability under the lease.