Discharge of an obligation

What it means

Discharge of an obligation is the end of the debtor's duty to the creditor. The most common way is performance, meaning payment of the debt or delivery of goods or services. An obligation can, however, also end in other ways set out in the Civil Code and the Commercial Code.

Other ways include set-off of mutual claims, agreement of the parties, novation, where the original obligation is replaced by a new one, a settlement agreement on disputed rights, debt forgiveness, impossibility of performance, the debtor's death for personal obligations, or lapse of time for fixed-term obligations.

Limitation does not extinguish the obligation but means the creditor cannot enforce it in court if the debtor raises the limitation defence. If the debtor voluntarily pays a time-barred debt, it cannot claim the money back, because the obligation continues to exist as a so-called natural obligation.

How it works in practice

On performance, it is important to have proof, such as a payment receipt, a bank statement or confirmation of delivery. For set-off, a clear written declaration is needed specifying which claims are set off and in what amount, and it must be recorded in both parties' books.

In the accounts, discharge of an obligation is reflected by derecognising the receivable or payable. If the obligation ended other than by performance, for example through debt forgiveness, income or an expense arises. Receivables that cannot be collected may, under certain conditions, be subject to writing off.

Debt forgiveness or limitation can have tax consequences. For the debtor, a forgiven debt may be taxable income, and for the creditor a write-off may be tax-deductible only under statutory conditions. For larger amounts, the tax effects should be assessed in advance.

What to watch out for

Creditors should monitor limitation periods and act in time, for example by filing a lawsuit or obtaining an acknowledgment of debt, which extends the period. Once it expires, the chances of recovery drop sharply.

Settlement, debt forgiveness or novation agreements are best made in writing, specifying precisely which obligations end and which continue. Vague wording can lead to disputes over whether, and to what extent, an obligation has actually been discharged.