How to buy debts or when a third party buys the debt

An assignment of a claim means that the original creditor sells his claim to a third party who then enforces the debt in his place; the debtor’s consent is usually not required, but he must be informed of the change of creditor unless the contract prohibits the assignment. Debts are usually sold for less than their face value, as the price depends on the recoverability, the quality of the evidence, the age of the debt and the debtor’s financial situation. The main risks include prohibition of assignment, statute of limitations, disputability or lack of proof of debt and poor contractual liability.

What exactly is a debt sale

In legal parlance, a debt sale is most often an assignment of a debt. Importantly, it is not a “collection to order”, but an actual change of creditor: the claim passes from the original creditor to a new one. The original creditor is thus usually relieved of the worry of further recovery, while the new creditor takes over the chance of recovering the debt and making a profit on the difference between the purchase price and what it manages to collect from the debtor.

In practice, it looks like this: You are a supplier and you have issued an invoice for CZK 120,000. The customer has not paid even after urging you to do so and you no longer want to spend time on court, foreclosure, phone calls and uncertainty. So you find a buyer who will offer you, for example, CZK 70,000 right away. You will get immediate cash, the buyer will become a new creditor and continue to deal with the debt.

However, debt buying does not mean that you automatically get the full amount owed. If the debtor has been without assets for a long time, is in insolvency or has multiple foreclosures running against him, the likelihood of actually recovering the money is low. The buyer takes this into account when setting the price – the higher the risk that the debt will not be collected, the lower the amount offered. Therefore, when selling receivables, it is common to sell the debt for only a fraction of its original value.

Is the debtor’s consent required?

Generally, the debtor’s consent to the assignment of the debt is not required. However, this does not apply without exceptions: a claim that is extinguished by death or where the content of the claim would be changed by a change of creditor to the detriment of the debtor cannot be assigned. However, in normal commercial relations, the debtor typically does not really “care” to whom he pays – he just needs to know to whom he has to pay the new payment.

A specific example: a marketing agency enters into a contract with a customer that includes the phrase “The provider is not entitled to assign the receivable without the prior written consent of the customer.” The agency then sells the unpaid invoice to a collection company, but the customer argues that the assignment was in breach of contract. The result can be very unpleasant: the buyer will want the agency to return the money or sue the agency for liability because it bought something it could not safely acquire.

In practice, the prohibition on assignment appears more often than people think – and is often hidden in the terms and conditions. This is why it pays to have the documents checked by a lawyer before selling the claim.

How to buy receivables step by step

The whole process is simple to describe, but the details make the difference between a quick solution and a disaster.

First, you examine exactly what you are selling. After all, a receivable is not a feeling that someone owes you. It needs to be clear what it arose from, when it was due, whether it was properly accounted for and whether there is evidence. A buyer typically wants to see a contract, purchase order, invoice, handover report, email communications, reminders, and possibly an acknowledgement of debt. If you are selling a service claim, he or she will also want proof that the service was provided to the extent you are billing.

Example: a self-employed graphic designer invoiced CZK 35,000 for the creation of a logo and manual. He only has an invoice but no signed order or receipt, the communication was via Instagram and part of the assignment was changed in chat. Such a claim is risky for the buyer, because if the debtor starts claiming that he never agreed on a price with the graphic designer or the output was inadequate, it will be hard to prove. So the buyer will either not buy at all or offer a very low price.

Then comes the valuation. The price almost never equals the face value. Risk, cost and time are factored in. The buyer usually considers how quickly and with what probability the money can be raised. There is a big difference between a claim where you have an acknowledgement of debt and the debtor has assets, and a claim after someone who has three foreclosures and is in bankruptcy.

So a specific scenario might be that the landlord has rent arrears of CZK 60,000 for the last 5 months. The borrower has moved out, is not collecting mail, and has other proceedings on the foreclosure registry. The buyer (if at all) will offer the landlord maybe 10-15 thousand, because the chances of recovery are low and the recovery will be long.

Once you and the buyer agree on the buyout, an assignment agreement is made. Most mistakes are made at this stage. The most common one is that the buyer and the original creditor enter into an agreement based on some template from the internet that does not address the specific situation: for example, how exactly the claim is defined, what all is transferred with it (usually including any attachments and any collateral) and how the attachments will be dealt with in practice – for example, what default interest the parties confirm, whether liquidated damages are claimed and in what amount, and what documents are handed over.

For an assignment for consideration, how you set up the seller’s liability is key. The law assumes that the assignor is liable (typically up to the amount of the purchase price received) for the claim actually existing at the time of assignment and, in certain circumstances, for its recoverability – and it also depends on whether the buyer knew at the time of purchase that the claim was uncertain or unrecoverable. This is where a lawyer can save you money: He or she will set up the contract so that the liability matches the reality, evidence and risk.

The next step is to notify the debtor. Even though the debtor may not have given consent, he or she needs to know who to pay the new debt to. If he doesn’t know and pays the original lender, his payment may be valid. In practice, this can turn out to be unpleasant: the new creditor will want the money again, the debtor will claim he has already paid, and the original creditor may be between millstones.

At the same time, it is important for the debtor to know that the assignment itself does not turn the debt into “something new”: the debtor retains the objections it had to the claim before (for example, that the service was not delivered, that the amount was wrongly billed or that it has already paid the debt).

If, for example, a company assigns a debt of CZK 200,000 but the debtor does not know about it and sends the payment to the original account, there may be a problem. The original creditor is in payment distress and will use the money for operations. The new creditor then demands payment and threatens to sue. This is exactly the kind of situation that needs to be addressed contractually and organizationally.

Finally, the handover of the documentation takes place. Without documents, it is much harder for the buyer to recover. A well-written contract therefore clearly states what is to be handed over, in what form and by when. In the case of larger receivables packages, records, lists, file marks, recovery status and so on are also addressed.

Are you considering selling a receivable? Have the contract and enforceability checked beforehand – this will often determine the price and whether the deal becomes a dispute.

How the price is determined when buying receivables

In practice, the purchase price is a compromise between what the seller wants to get and what the buyer is willing to risk. The buyer usually calculates: how much it will cost in legal work, court, foreclosure, time, internal costs and how likely it is to actually recover something.

Significantly more expensive (i.e., more profitable for the seller) tend to be claims that are “clean”: you have a contract, the performance has been proven, the claim is not time-barred, the debtor is communicating or at least not completely indigent. On the other hand, disputed, old, undocumented claims or claims against debtors in insolvency are cheap.

As an example for comparison, imagine two claims, both for CZK 100,000. The first one is an invoice 45 days overdue, the debtor is a stable company, it just ran into a temporary cash flow problem. If the buyer believes the debt can be recovered quickly, he will offer, say, 70-85k. The second is an invoice 2 years past due, the debtor is self-employed with four foreclosures. Here the offer may be 5-15 thousand, because the chance of real recovery is small.

In some deals, you will find that the purchase price is not “fixed”, but includes an incentive component: you will get part of it now and part of it only depending on what can be recovered. This can be an interesting solution if you don’t want to go too low with the price, but you also want to transfer some of the risk to the buyer.

The most common risks for the seller (and how to avoid them)

The biggest risk is that you sell the claim “off the books”, without inspection, and later it turns out that the buyer has a claim against you. Typically, this happens when the claim is actually disputed (the debtor is claiming performance), has already been partially paid, is time-barred, or could not be assigned.

The other big risk is procedural – poorly communicated assignments and subsequent payments. When the debtor pays the original creditor and the new creditor demands performance again, a nasty dispute can arise. Proper notice and contract setup greatly reduces this.

The third area for businesses is accounting and tax implications. Selling a receivable can be an accounting loss, which is sometimes the opposite of the intent (tax-wise), but you need to know what you are doing. For larger amounts, it pays to coordinate the legal and accounting aspects.

When is it better to sell a claim and when is it better to collect it on your own?

Selling receivables makes the most sense when time and certainty are of value to you. Typically, when you need money quickly for your business, don’t want to deal with the courts, or when collection is costly for you (both in time and mentally). It is also suitable for situations where you have multiple smaller debts and pursuing them individually would be inefficient.

On the other hand, individual recovery is worthwhile when the debtor is solvent, the debt is well documented and the amount is higher. In such a case, it may be more economically viable to send a pre-action notice, apply for a payment order and possibly go into execution. Often, the debt can be recovered the moment the debtor receives a well-written notice from an attorney.

It is worth engaging an attorney when it is not just about “paper” but about real risk. Typically when the amount is higher, the documentation is not completely clean, there are terms and conditions with a prohibition on assignment, or you are buying/selling a package of receivables.

In practice, a solicitor will mainly help by:

• checking the enforceability and limitation period,
• checking whether assignment is even possible,
• drafting the contract so that the seller’s liability is fair and secure,
• setting up the correct notification to the debtor and the transmission of documents.

And most importantly: often the first check reveals that the claim has a weak point (for example, an undocumented performance) that significantly reduces the price. When this is filled in or a different procedure is chosen (e.g. a pre-action notice), the result can be financially better for the creditor than an immediate redemption.

Do you want to sell the debt safely or are you considering a buyout? Contact us. We will prepare an assignment agreement, review the risks and recommend the most advantageous course of action.

Summary

A debt buyout (i.e. the sale of receivables to a third party) means that the original creditor transfers its claim for payment of the debt to a new creditor, who then enforces it in its place.This is a legal assignment under the Civil Code and the debtor’s consent is usually not required unless the contract provides otherwise; the whole process consists of verifying the existence and enforceability of the debt, valuing it according to risk (age, evidence, debtor’s assets, insolvency or execution), concluding a good quality assignment agreement, notifying the debtor of the change of creditor and handing over the documentation, with the purchase price usually lower than the nominal value, as the buyer takes into account the risk and costs of recovery; the biggest risks are a prohibition on assignment in the contract, a disputed or time-barred claim, inadequate documentation or poorly set up seller’s liability, so it is worth considering whether it is more advantageous to sell the claim (for example, for quick cash and time savings) or to pursue it yourself, and for larger amounts or more complex cases, to engage a lawyer to check the legal position, set up a secure contract and minimise future disputes.