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Sometimes a person, A, will run up debts that can't be paid. In these situations, a creditor, X, will often sell the debt to a third party, Y. My understanding is that it will be much easier for A to get out of paying the debt to Y than it would be for X, or at least negotiate a partial payment.

Why might that be? For instance, my understanding is that X will often fail to transfer the relevant paperwork to Y, so that if Y can't prove the original debt, the debtor goes free. And since Y bought the debt, presumably at a deep discount, Y would have an incentive to settle for less than 100 cents on the dollar. What are other issues that tend to put Y in a weaker position than X?

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    What’s the legal rather than the economic question? – Dale M Jan 13 at 19:43
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    @DaleM: One of the legal issues, according to my understanding, is that the original creditor (of trade debt) will often fail to transfer the bill of sale, or other relevant paperwork to the buyer of the debt. – Libra Jan 13 at 23:53
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    sounds like an admin issue, not a legal one. – Dale M Jan 14 at 0:27
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To what extent are a creditor's rights attenuated when debt is sold?

Short Answer

In principal, no legal rights change. In practice, is the assignment is done without appropriate cooperation agreements and supporting documentation, it can be harder to enforce.

Also, in practice, an assignee tends to have more legal rights than the original creditor, not fewer.

The reason that assignees of debts that are in default are often willing to take deep discounts are the same as the reasons that the debts are in default in the first place: the debtor isn't paying voluntarily and there is usually a reason for that. Sometimes, the debtor isn't paying voluntarily because the debtor is unable to pay or has no significant assets that aren't exempt from creditors claims or at least not enough to pay the debt in full. Sometimes, the debtor has gone bankrupt or the statute of limitations has run on the debt. Sometimes, the debtors isn't paying because of a dispute regarding the amount owed (e.g. the debtor may claim that payments have been made but not properly credited by the original debtor). Sometimes, the debtor is just stubborn, requiring costly litigation to collect a small amount owed and the debtor may not have an ability to pay both attorneys' fees owed from collection as well as the debt, or the fully collection costs may not be awarded by the court on the grounds that they are unreasonable relative to the amount owed. Sometimes, the debt is not bankrupt but can credibly threaten to go bankrupt and wipe out the debt. Often the debtor has diminished or non-existent income subject to creditors claims due to illness, death, job loss, or incarceration, or because an ex-spouse or children have priority claims on the income for alimony and child support.

Post-Default Assignments

Transfer of a debt, post-default, doesn't change the rights of the new creditor with respect to the original creditor, although proving a debt may be harder if the new creditor didn't get all relevant documentation or lacks knowledge or witnesses needed to bring the claim. In practice, the new creditor may have slightly more rights than the original creditor, but also more practical enforcement difficulties.

The new creditor wouldn't be held to have knowledge other than the new creditor's actual knowledge of setoffs and defenses of the debtor to the debt that was transferred but the debtor could still assert those setoffs and defenses. In some cases, bringing suit for the fully amount, had the new creditor had knowledge of the defects, would have been subject to a litigation sanction, similar to Federal Rule of Civil Procedure 11, under a court rule or state statute, and lack of knowledge will protect the new creditor if due diligence was taken by the new creditor prior to commencing the litigation.

Until recently, most courts held that the transferee of a debt was subject to the that don't apply to suits by the original debtor. But, a recent U.S. Supreme Court ruling held that transferees of a debt are not subject to the requirements of the Fair Debt Collections Practices Act (in U.S. cases), since they are the actual debt holder and not some collecting as an agent of the debt holder.

Suits to enforce promissory notes generally require possession of the original promissory note, or the posting of a bond to guard against the possibility that the alleged assignee doesn't really own the debt, because promissory notes are presumptively assigned by physical delivery of an endorsed note, without giving public notice of the transfer. But, with regard to other debts, possession of original debt instruments is not required

Pre-Default Assignments And The Holder In Due Course Doctrine

When a debt is assigned prior to default, and it is a very simple debt such as an obligation on a check or other negotiable instrument or promissory note, under most circumstances, the assignee of the debt, i.e. the new debt owner, becomes what is known as a "holder in due course". A holder in due course has more rights than the original debtor, because a holder in due course is not subject to any defenses to the debt in the nature of setoff or affirmative defenses arising from the original transaction in which the debt came into being, other than what are called the "real defenses" (e.g. payment or release, the debt instrument was forged, and statute of limitations).

This used to be a big deal in the early days of mail order commerce and widespread use of commercial banking in consumer transactions when lots of transactions were done because lots of payments were in the form of checks or promissory notes and communications were by snail mail with "low bandwidth." These days the holder in due course doctrine rarely comes up in consumer transactions because checks are rare in those transactions now and there is very rapid settlement of payments made by check. Also, purchase money transactions where the seller and lender are the same allowing for setoffs are now much more rare with most financing provided by third-party companies against whom there are few setoffs or defenses anyway. But, it did come up with some frequency in the subprime lending part of the financial crisis of 2008ish.

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