Composition with Creditors
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Composition with Creditors
A contract made by an insolvent or financially pressed debtor with two or more creditors in which the creditors agree to accept one specific partial payment of the total amount of their claims, which is to be divided pro rata among them in full satisfaction of their claims.
A composition with creditors is an agreement not only between the debtor and the creditors but also between the creditors themselves to accept less than what each is owed. It is a contract and such an arrangement is largely governed by contract law. There must be a meeting of the minds or mutual assent between the debtor and the creditors before a composition is created. A debtor must accept an offer by the creditors to accept partial payment of the amounts outstanding in order for the composition to be binding. The creditors themselves must also agree to the amount they will accept in satisfaction of their claims. They rely on mutual concessions of their rights to full payment in order to further the common purpose of securing their claims.
No standard form is required for a composition with creditors to be valid. A debtor can enter individual agreements with each creditor if it is clear that each follows a common purpose. All the creditors of a debtor do not have to agree to a composition. Those who do not participate are not bound by it.
Like any contract, a composition with creditors must be supported by consideration to be enforceable. Each creditor's promise to accept a pro rata share of the partial payment, as opposed to full payment of what is due, is consideration for the other creditors and the debtor. The surrender of debtor's right to file a petition for Bankruptcy is deemed consideration for the creditors.
Failure to obey the terms of a composition provides a basis for a lawsuit for breach of the agreement. The debtor is released from the duty of payment only after he or she has complied with the payment provisions. All the debts that are part of a composition are extinguished once a composition has been terminated.
If one creditor is secretly paid more or given a preference, the other creditors can void the agreement because the law guards against the inequitable treatment of creditors. The preferred creditor cannot enforce or void the agreement. The debtor is entitled to recover payments made to such a creditor on the theory that a debtor is vulnerable to pressure by a creditor who has the power to force the debtor to file bankruptcy by refusing to enter into a composition.
A composition with creditors usually benefits a debtor more than bankruptcy because it accomplishes the same end—discharge of all or most of a debtor's debts—without the stigma of bankruptcy. Unlike a bankruptcy discharge, a composition does not preclude future bankruptcy for six years. Creditors, however, are often reluctant to enter into a composition and those who refuse to do so are not affected by its terms.
A composition with creditors is not the same as an accord or an assignment for the benefit of creditors. Unlike an accord, which is an arrangement between a debtor and a single creditor for a discharge of an obligation by partial payment, a composition is an arrangement between a debtor and a number of creditors acting collectively for the liquidation of their claims.
A composition with creditors differs from an assignment for the benefit of creditors in a number of ways. It is created by contract, as opposed to Common Law or statute. Only creditors who agree to it are bound, while an assignment discharges debts voluntarily released by creditors. The terms of the composition determine whether the debtor retains property. However, in most jurisdictions, the property of a debtor who has assigned it for his or her creditors' benefit is given to a third person with orders to sell it and distribute the proceeds to the creditors. Unlike an assignment, a composition is not a basis for an involuntary bankruptcy proceeding.
A sample form for composition with creditors can be found above.