Debtor vs. Creditor Rights

It’s no secret that years of corporate research indicate that strategic debt can be beneficial for a business. Taking on corporate debt may confer certain tax benefits, and debt can be used to grow earnings and increase the value of the company. Companies may also be able to create higher returns on the borrowed money than the interest rate they are paying on the debt. However, too much debt or a poorly structured or executed financial strategy also negligently impact the marketability and value of a company, including Silicon Valley startups. In addition, both California startups and creditors alike must be mindful of the federal and state laws that apply to debtor/creditor relations.

Commercial Debt and The Fair Debt Collection Practices Act (“FDCPA”) 

The primary federal legislation governing debtor and creditor rights is the FDCPA; however, this legislation typically does not apply to business debts. It may apply to certain late payments of commercial debts. California’s version of the FDCPA, the California Fair Debt Collection Practices Act (“CFDCPA”), while broader than the FDCPA, also typically does not apply to business debts. As such, business debtors aren’t afforded the same protections as consumers but business and their creditors also have more latitude to negotiate and structure the financial arrangement they deem most appropriate. There are few, if any, state and federal laws that regulate business-to-business debt, but the FDCPA can provide some guidance for creditors. For example, creditors should generally not:

  • Make harassing phone calls,
  • Charge interest and fees outside the original written agreement,
  • Confiscate property,
  • Share sensitive information about the debtor,
  • Lie about reporting the debt or the amount owed, or
  • Unreasonably threaten litigation.

Commercial creditors and debtors typically have recourse through common law breach of contract claims and through the Uniform Commercial Code (UCC). 

Corporate Bankruptcy

Corporate debtors may file for Chapter 7 or Chapter 11 bankruptcy when they deem it in their best interest. Chapter 7 liquidation typically results in the dissolution of the business with corporate assets sold and distributed to claimants. In a Chapter 7, secured debts, such as a many bank loans or credit facilities, typically have first priority and have claims directly against the secured assets while unsecured debts, such as a high-interest unsecured business loans, are paid out last which may result in that party not being paid.

Businesses may also file for Chapter 11 bankruptcy, which is a reorganization or financial restructuring. Chapter 11 bankruptcy temporarily halts (stays) the debt collection process with the company then typically attempting to negotiate and confirm a plan of reorganization pursuant to which creditors would be paid some amount on their claims over some period of time. Creditors file proofs of claim with the bankruptcy court, and the parties can then negotiate with the debtor.  If a debtor is unable to confirm a plan of reorganization, the business may be liquidated under Chapter 7.

Contact an Experienced Silicon Valley Business Attorney Today 

Contrary to popular belief, business to business debts are not governed by extensive debt collection regulations. Instead, your rights as a commercial debtor or creditor may be defined by your contract, the common law, or a bankruptcy court order. For more information on your rights as a corporate debtor or creditor, schedule your legal consultation with our Silicon Valley corporate attorneys at Structure Law Group, LLP by calling us at 408-441-7500 or contacting us online.