What Are Workouts?
The term “workout” is used to describe a nonbankruptcy negotiated modification of debt. More simply stated a workout is an agreement between the debtor and his or her creditors for payment of the debts between them that is negotiated without all the bells and whistles, and perhaps the stigma, of the bankruptcy process.
Workouts are sometimes called compositions or extensions. A composition is a contract between a debtor and two or more creditors in which the creditors agree to take a partial payment in full satisfaction of their claims. An extension is a contract between the debtor and two or more creditors in which the creditors agree to extend the time for payment of their claims. An agreement may be both a composition and an extension, or an agreement to accept less money over a longer period of time.
The same laws govern both compositions and extensions. Both are subject more to contract law principles than debtor-creditor rules. Compositions and extensions must meet all the formal requirements of contract formation. There must be an offer to make a contract, the offer must be accepted, and there must be consideration, or something or value exchanged between the parties. Generally, these contract law principles are governed by state, rather than federal, law.
While more than one creditor must enter into the workout agreement, there is no requirement that all of the debtor’s creditors agree to its terms. Creditors that do not agree to the workout are not affected by it. In other words, they are entitled to pursue other remedies to collect the debts owed to them and can proceed to recover the full amount, but they are forfeiting the right to automatically benefit from whatever partial payment the composition allowed.
There are a number of reasons why a debtor might prefer a workout to bankruptcy. By entering into a voluntary agreement with creditors, the debtor avoids the stigma that attaches to bankruptcy but achieves the same results-discharge from all or a portion of his or her debts. In fact, the workout discharge is even broader than a bankruptcy discharge. In addition, a workout discharge does not affect the debtor’s rights to file a future bankruptcy, whereas certain types of bankruptcy discharges do. However, the main advantage of a workout is that it is voluntary. In a workout, unlike bankruptcy, the majority of creditors cannot cram down concessions on dissenting creditors. All of the participating creditors must agree to the workout’s terms.
An attorney experienced in bankruptcy and debtor-creditor law can help a debtor determine whether a workout may be the best option for debt repayment, and can assist a creditor in determining whether to agree to the terms of a workout.
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