How does creditors work

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Unsecured creditors such as credit card companies and most trade creditors must first sue you and win a money judgment against you before they grab your income and property. This is true whether you are personally liable for the debt as is the case for sole proprietors and partners, or because you signed a personal guarantee for your corporation or LLC or whether only your corporation or LLC is liable for the debt.

Learn whether you're personally liable to pay your business's debts. Typically, however, before seriously considering a lawsuit, a creditor will try to collect the debt for several months and then turn it over to a collection attorney or agency, which will restart the process. In some instances, the creditor will conclude that you don't have enough property that can easily be grabbed to pay off the judgment, and won't bother suing.

For instance, say your house is worth less than you owe on your mortgage, meaning that there is no equity in it for creditors to take. Also suppose that your consignment shop has few business assets and is doing so poorly that you don't anticipate having more than a few dollars of steady income that a creditor could grab by ordering the sheriff or marshal to take money from the business premises.

Your creditors, or any collection attorney or agency your debt is turned over to, may not sue you because they know it's unlikely they could collect the money judgment.

That's called being "judgment proof. Instead, the creditor may simply write off your debt and treat it as a deductible business loss for income tax purposes. Typically, in five or six years, depending on your state's statute of limitations, the debt will become legally uncollectible.

Only a few states, such as Kentucky, Louisiana, Ohio, and Rhode Island, have longer statutes of limitation, up to ten or 15 years. However, you can expect to be sued if there is significant money at stake and you have valuable personal or business assets or just business assets, if your business is a corporation or LLC —or if the creditor expects you to acquire significant assets in the future.

For instance, if you are a sole proprietor and have an advanced degree, your creditor might assume you'll eventually make a decent salary and will sue you now—and just wait for you to make some income.

In many states, a court judgment can be collected for at least ten years. What does a creditor think is worth suing for? Significant amounts of cash or accounts receivable, valuable business equipment and property, and, if you're personally liable for a debt, valuable personal assets such as jewelry, fine art, collectibles, antiques, motorcycles, expensive bicycles, boats, or a vacation house.

Don't try to hide assets. Sometimes, out of desperation, a business owner tries to protect personal or business assets by giving them to friends and relatives or otherwise trying to hide them from creditors. Although few small business people have the knowledge necessary to move cash to an offshore bank account, many try to hide it in the name of a parent, child, coworker, or friend. Don't do this. Creditors' attorneys are experienced in ferreting out such hidden assets, and in extreme cases, these tactics can even give rise to civil and criminal charges of fraud.

If a creditor does take you to court and wins a judgment against you, it obviously makes sense to pay the court judgment before any other unsecured debts that you haven't yet been sued over.

Collecting a judgment is harder than winning it. If a creditor has gone to court and won a judgment against you for collection of an unsecured debt, theoretically the creditor now called a judgment creditor will be able to take any cash in your business's bank account, your business income, and your business assets to pay off the debt.

If you're a sole proprietor or partner, or you signed a personal guarantee for a debt, the judgment creditor could also garnish your wages and take money from your personal bank account, as well as take your nonexempt personal property, to pay off the debt. However, to take money or property, the creditor must first locate it and then get a court order and pay the sheriff to take it. But assuming you are a self-employed business owner without a side job, garnishing your wages will be pretty difficult since you don't get a paycheck unless you're an employee of your corporation.

However, your spouse's wages could be garnished to pay your business debts if you live in a community property state Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin , assuming your spouse is named in the court judgment. Often a more effective collection technique if your business sells goods or services for cash is for the sheriff to come to your business and take any money he can find there—in the cash register called a "till tap" or on your person.

Or a sheriff could be authorized to take business vehicles, equipment, or tools of the trade to pay your debts, something that will happen only if those items are clearly worth more than you owe on them.

It's also possible that the creditor could get a court to order your bigger customers and clients to pay any money they owe you directly to the court. However, most creditors won't go to these lengths to get your property. Instead, many will simply attach a "judgment lien" to any real estate or assets the business owns or valuable personal property or real estate that you own, if you are personally liable for the debt.

The lien will allow the creditor to collect the debt when you sell or refinance the property. Check to see if any liens are recorded against your business. The Secretary of State's office in every state maintains a registry of liens, listing judgment liens, tax liens, or security interests that creditors claim in your property.

You can do a Uniform Commercial Code UCC records search online at your Secretary of State's website to search for your personal and business names to see what liens have been recorded against you. If you find any incorrect information—say you have paid off a debt but it hasn't been reflected—ask the lender in question for a UCC release, something that is required by law.

If you do have regular wages coming in, perhaps from a side job or because you are an employee of your corporation, your wages can be garnished to enforce a court judgment.

That limit applies whether you have one creditor or many. And if your wages are low, there are additional protections—you must be left with weekly income equal to 30 times the federal hourly minimum wage.

A few states have lower limits. Social Security checks, retirement plan proceeds, unemployment and disability benefits, or workers' compensation awards cannot be garnished, except to pay federal taxes or child support or unless they have accumulated in your bank account. Although a judgment creditor can usually grab cash from your bank account or force the sale of most business assets, a judgment creditor can't take personal property that is legally exempt from creditors.

Most states provide that a certain amount of your personal assets, such as food, furniture, and clothing, cannot be taken by creditors or by the bankruptcy trustee in bankruptcy court. Real creditors: A real creditor is a financial institution, such as a bank or credit card issuer, that has a right to be repaid. Secured creditors: These lenders have a legal right — often through a lien — to property you used as collateral to secure the loan.

Unsecured creditors: A credit card issuer is a good example of this type of creditor. One way creditors can make money is by charging interest on the credit they extend. A creditor can often make money through fees, like late payment fees, which may be applied if a payment is received after the agreed-upon due date. The creditor may be taking a risk when extending credit to an approved borrower. A creditor is essentially a person or financial institution you owe money to.

If you owe money, you may be referred to as a debtor. If you ever come across these terms, make sure to read the fine print to understand how they are being used. Having a general definition can hopefully help you cut through some of the jargon to better understand some of the financial advice that comes with applying for credit.