The business world runs on debt. The ability to borrow money allows companies to grow, but it carries major risks for everyone involved.
As a debtor, you’re expected to repay your debts on time. As a creditor, you have to accept the risk that a debtor won’t be able to pay. While there are options such as commercial debt collection, creditors are ultimately responsible for a large amount of risk that can dramatically alter how you do business.
In this article we’ll learn more about debtors and creditors, as well as their roles in debt arrangements.
Debtors are entities (including individuals and companies) that owe money to a third party (like a bank or lender). Debtors are more commonly called “borrowers,” but this term doesn’t apply in every situation. This is because debtors aren’t always borrowing money.
You are a debtor if you owe money, or if you have received goods and services that you haven’t paid for yet. For example, anyone who borrows money to buy a house or car is considered a debtor.
Similarly, you would be considered a debtor if you received a product before paying for it. This is especially common in the business world. In many industries, it’s normal for suppliers to provide raw materials and accept payment in instalments, or defer payment until a later date.
Creditors are entities (including individuals and companies) that have lent money to a third party. When you think of creditors you probably think of banks, but a creditor is anyone that has lent money, goods or services. For example, a creditor could be:
- A traditional bank or lender
- Materials suppliers
- Service providers
- Friends and family members
There are no major legal distinctions to be made here. Regardless of who they are, a creditor has a right to the money they are owed. The only major difference is how the two types of debts are treated:
- Secured debts – secured debts are a type of debt where the creditor holds a security interest over an asset (such as a car or home). The asset is held as collateral to ensure the debtor repays their debt. If the debtor doesn’t pay the debt, the creditor may be able to repossess and sell the asset to recover the money they are owed.
- Unsecured debts – unsecured debts are a type of debt that isn’t subject to a security interest. Unsecured debts are things like credit cards and materials delivered prior to payment. This type of debt is a much bigger risk for creditors, and they often come with higher interest rates, shorter loan periods and more strenuous payment terms.
The Responsibilities of a Debtor
Debtors almost always have responsibilities to their creditors. In most cases, creditors provide money, goods or services in exchange for payment. The exact terms of the payment differ and are set out in an agreement between the debtor and creditor.
This contract forms the basis of the debtor’s responsibilities. Debt contracts usually set out:
- Maximum loan terms
- Repayment terms (frequency, amounts)
- Interest rates and accruement periods
- Security interests over assets
- Break and establishment fees
As with other contracts, these are legally binding. Creditors may have a right to repossess secured assets or take the debtor to court to recover their money.
Recovering Money from a Debtor
Getting money from debtors can be a challenge. Most people are honest and are happy to repay the money they owe. This means that debtors often stop paying because they’ve become unable to do so. If that happens, you have a few options for recovering your money:
- Set up a payment plan – this is the most effective way to recover your money. Simply sit down with your debtor and renegotiate the terms of your deal. There is a good chance that extending the loan term, reducing repayment amounts, or reducing the interest rate will convince them to start making payments again.
- Work with a commercial debt collector – some debtors simply won’t be able to pay their debts. In this case, you can work with a commercial debt collector. Debt collectors are experts in recovering money. Some collections agencies may purchase the debt (putting money in your pocket right away) and assume the responsibility for recovering the money. Others may operate on your behalf and take a commission from any money they do recover. Either option works and is effective for recovering debts.
- Take legal action – as a creditor you have the legal right to your money. This can include taking your debtor to court. Suing a debtor can be a costly, time-consuming and complex experience, so it should not be your first port of call.
- Apply for bankruptcy or liquidation – if you are owed more than $2,000 by a company, or $10,000 by an individual, you can apply to the court to make them bankrupt. During bankruptcy or liquidation, the debtor’s assets are liquidated and you are paid a portion of the proceeds. This is a very inefficient way to collect debt and should be considered a last resort.