Circular debt is a situation in which a string of debtors and creditors exist in a fashion such that the net final creditor in the string is indebted to the first creditor. Every member is both a debtor and a creditor.
Net Balance of Zero
A simplified form of a circular debt would involve, for example, three individuals. Individual A owes $100 to individual B. Individual B owes $100 to individual C. Individual C owes $100 to individual A. The net balance of all debts between the three individuals is zero.
Reconciled Positive Balance
Using a three person example, person A owes $100 to person B, who owes $50 to person C who owes $100 to person A. This circular debt may be reconciled such that C owes B $50 and the remaining debts are canceled.
Linear Debt Chains
In order for a circular debt to exist, there must be a closed loop between all parties. For example, party A owes party B and party B owes party C, but party C does not owe either A or B. This situation is sometimes incorrectly referred to as a circular debt, but is more properly termed a "linear debt chain" or a "linear chain of receivables."