A debt cancellation agreement is an agreement between a lender and a borrower, where the borrower is completely released from the repayment of a particular debt. The terms of release from the debt obligation between the lender and borrower are mentioned in this contract. The agreement should be prepared in accordance with the laws of the state to be valid.
An example of such a situation is when the bank releases a customer from the repayment of a mortgage. In case of a student loan, filing for bankruptcy will not result in automatic cancellation of the loan. So before taking a student loan, a debt cancellation agreement will need to be signed by the loan company, who may not agree to do do. However, this agreement can be made between two individuals, business or both.
Another term for cancellation of debt is the discharge of indebtedness. Gap insurance is a form of debt cancellation agreement related to automobiles to bridge the gap coverage. The gap is the difference between the cash value of your car and the amount owed by you to the finance company.
Who Takes the Debt Cancellation Agreement? – People Involved
A debt cancellation agreement is entered into by the lender and borrower, where the lender decides to cancel the debt owed by the borrower. These agreements are useful when debt cancellation does not occur even with bankruptcy. For example, student loans are not automatically canceled if they file for bankruptcy.
Purpose of the Debt Cancellation Agreement – Why Do You Need It?
A debt cancellation agreement is required because the borrower is not released from the repayment of the loan by the lender, even in the case of bankruptcy. Even after declaring bankruptcy, the borrower has to negotiate with the lender and request the cancellation of debt. There is no guarantee that the lender will agree. The debt cancellation agreement is normally drafted by the borrower and handed over to the individual or institution that is going to grant the loan. It is up to the lender to accept the terms and conditions of the contract.
There are situations like in the case of student loans when their loans are not dismissed even when they are bankrupt. Sometimes, the lender incorporates the debt cancellation in the original lending contract. In other cases, the debt cancellation agreement in a standard format is provided by the lender. Once the agreement is made and signed by the respective parties, the lender has no authority to pressurize the borrower to repay the debt that has been included in the agreement.
A debt cancellation agreement is like an emergency provision, where the buyer is protected from any kind of legal hassles if the loan is not repaid. There are certain terms and conditions to be fulfilled before the debt is canceled.
Contents of the Debt Cancellation Agreement – Inclusions
A debt cancellation agreement should include the names of the parties to the agreement, which would be the lender and the borrower. The contract agreement should also include the effective date of the agreement, the amount of loan being taken by the borrower, the proportion of the loan that could be canceled, the date on which the loan was granted, and the date on which the loan could be canceled.
The agreement should also mention the collateral provided by the borrower and that in the event of default, along with the cancellation of the debt, the collateral securing the debt should also be released. The borrower should also state that the cancellation of the debt is in the best interest of the borrower. The fact that the loan is being canceled in its entirety should be mentioned.
The credentials of the lender should be clearly mentioned in the agreement, the legal authority of the lender to lend the given sum of money, and the fact that there are no pending legal cases against the lender. The credentials of the borrower should be stated, including the fact that the borrower is someone of respectable standing and that they have the corporate power and authority to enter into this agreement. The fact that the lender is in good standing as per the laws of the state is to be mentioned. That the agreement is legal, binding, and valid as well as enforceable should be mentioned.
The agreement should also contain the fulfillment of conditions for it to be effective.
How to Draft the Debt Cancellation Agreement?
While drafting a debt cancellation agreement, the following points should be kept in mind:
- The names of the parties to the agreement and the relationship between them
- The amount of loan under consideration to be forgiven in the event the borrower is declared bankrupt
- The collateral being provided by the borrower to the lender is to be mentioned
- The agreement should explicitly mention that the loan is being canceled in its entirety
- The borrower should state that cancelation of the debt would be in the best interest of the borrower
- The representations and warranties of the lender, which include the full legal capacity to enter into this agreement, and perform the transactions mentioned in the agreement. There should be no record of any legal suits, arbitration, or any other kind of legal or administrative proceedings or government investigations pending against them. This section should also mention that the lender is a valid organization in good standing according to the laws of the state
- The representations and warranties of the buyer which include the corporate or individual authority to enter into such an agreement
- The conditions of effectiveness which include execution of a certain transaction for the agreement to be effective
Before entering into a debt cancellation agreement, you need to ensure that you have thoroughly read the terms and conditions. You should negotiate the amount of loan being canceled, the tenure of the loan, and any other clauses before formally signing the agreement. Negotiations will help you get the best terms from the lender.
Benefits and Drawbacks of the Debt Cancellation Agreement
The benefits of having a debt cancellation agreement are:
- The interest of the borrower is protected under such an agreement. The seller cannot place the borrower under any pressure to repay the loan as the lender clearly states in the agreement that the loan in its entirety will be forgiven in case of default by the borrower
- This agreement is admissible in a court of law as valid evidence and the borrower can file a suit against the lender if the he or she is being harassed by the lender for repayment of the loan. The lender will be severely penalized in such cases
- If there is a misrepresentation of facts by the borrower, then the lender can recover the dues from the borrower
The drawbacks of having a debt cancellation agreement are:
- The lender is entering into the agreement knowing that there is a possibility that the borrower may default in payment. In a way, it is a loss-making proposition for the lender
- The borrower may have difficulty getting a loan if they try to incorporate a debt cancellation agreement along with the loan agreement. The lender may refuse to sign the agreement for the cancellation of debt as it would not be a wise business decision.
What Happens in Case of Violation?
In case of violation of a debt cancellation agreement, the borrower can go to a court of law if the lender tries to pressurize the borrower for repayment of the loan. The agreement clearly mentions that the lender agrees to cancel the debt in its entirety and hence has no right to claim the dues if the borrower has met all the terms and conditions mentioned in the agreement.
Once both parties to the agreement have signed on the document, the lender has no right to recover the money from the borrower.
If there is any untrue representation, failure to perform any covenant laid down in the agreement or breach of trust by the borrower, he or she has to reimburse the lender for all loss, liability, or damage. If it is found that the beneficiary is a third party, the agreement stands null and void. In all these cases, if the borrower pleads bankruptcy, the loan will not be canceled, and the borrower has to repay the entire amount along with penal interest.
The borrower will also have to reimburse the lender for costs, expenses, legal fees, and expenses incurred to enforce the indemnity clause. Any expenses incurred by the lender directly or indirectly due to the lender will have to be reimbursed.
A debt cancellation agreement is important when there is a possibility of the borrower of the loan defaulting on repayment of the loan.
The lender will have to sign the debt cancellation agreement without which the debt cannot be forgiven. In certain cases, the lender may refuse to sign the agreement, and the borrower will have difficulty getting a loan. The reason for this is that the lender is aware that they might not get back the principal and interest. This makes such loans very risky for them.
These agreements are useful when the debt is not canceled under the normal course due to the bankruptcy(1) of the borrower. The borrower can take legal recourse if the lender forces repayment after this agreement.
The lender can, however, recover the loan from the borrower under certain circumstances, such as there are misrepresentations of a material fact or breach(2) of any clause in the agreement. The borrower, in such cases, will not be protected by this agreement and will have to repay the loan.