Debtor definition

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What is a Debtor?

A debtor is an individual or entity that owes money to a creditor. The concept can apply to individual transactions, so that someone could be a debtor in regard to a specific supplier invoice, while being a creditor in relation to its own billings to customers. Even a very wealthy person or company is a debtor in some respects, since there are always unpaid invoices payable to suppliers. The only entity that is not a debtor is one that pays up-front in cash for all transactions. Thus, an entity could be a debtor in relation to specific payables, while being flush with cash in all other respects.

When is a Debtor in Default?

A debtor is considered to be in default if it does not pay a debt within the payment terms of the debt agreement. Thus, a short payment or late payment could trigger a default. In a default situation, the creditor may be legally able to accelerate payment of the associated debt.

When to Record a Debt

In a situation where there is a possibility, but not a probability, of a liability, there is no liability to record. This means that the person or entity to which the event applies is not considered a debtor until such time as the liability becomes probable and it is possible to estimate the amount of the loss.

When is a Liability Discharged?

A liability is considered discharged for a business debtor when the legal obligation to pay or perform under a contract, loan, or financial obligation is eliminated. This can occur through various means, as noted below:

  • Full payment of the debt. The most straightforward way to discharge a liability is by fully repaying the debt in accordance with the agreed-upon terms. Once the debtor pays off the principal amount along with any accrued interest and penalties, the liability is removed from its financial obligations.

  • Debt negotiation. A creditor may agree to accept a lesser amount as full satisfaction of a debt. Debt restructuring, modification, or settlement agreements can lead to partial discharge, especially in financial distress scenarios.

  • Expiration of the statute of limitations. If a creditor fails to enforce a debt within the legally prescribed timeframe (statute of limitations), the liability may become unenforceable. The timeframe varies by jurisdiction and type of debt.

  • Bankruptcy discharge. A business undergoing bankruptcy proceedings may receive a discharge order from the court. Under Chapter 7 (Liquidation), the business’s assets are sold to pay creditors, and any remaining dischargeable debts are eliminated. Under Chapter 11 (Reorganization), debts may be modified, reduced, or discharged based on an approved repayment plan.

  • Novation. A liability may be discharged if the parties agree to replace the existing obligation with a new one. This occurs when a new debtor assumes the responsibility, or new terms replace the old agreement.

  • Debt forgiveness by a creditor. If a creditor voluntarily forgives a debt, the liability is discharged. However, forgiven debts may have tax implications, as businesses may have to report them as taxable income.

  • Legal judgment or court order. A court ruling can discharge a liability if it deems the debt unenforceable, fraudulent, or improperly assigned.

  • Performance of an obligation. In cases where the liability involves the performance of services or delivery of goods, once the debtor fulfills the contractual obligation, the liability is discharged.

Some liabilities, such as taxes, government fines, and debts incurred through fraud, may not be discharged, especially in bankruptcy cases.

Examples of a Debtor

Here are several examples of debtors:

  • Debtor as borrower. Gregory Company borrows $100,000 from Big Bank. Gregory is considered a debtor until such time as it pays the $100,000 loan back to Big Bank or settles the debt in some other manner.

  • Debtor due to trade credit. Franklin Company purchases $4,000 of goods from a supplier on credit. Until Franklin pays the supplier the amount owed, Franklin is classified as a debtor.

Terms Similar to Debtor

A debtor is also known as a borrower when the term used in relation to a loan. A debtor who issues bonds is known as the issuer.