Out of Court Bankruptcy Settlements

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 What is a Settlement Agreement?

A settlement agreement is an agreement between two parties that resolves a legal issue. It is essentially a contract between the two parties, each agreeing to a particular terms or conditions that result from negotiations.

The purpose of a settlement agreement is to end a current dispute between the parties. It is often used to end negotiations and resolve future disputes. 

An effective settlement agreement considers all possible risks and evaluates those risks to create a solution the parties agree to themselves. Although it is not always required for a settlement agreement to be in writing, it is very important to do so, especially when dealing with money issues. 

What is Bankruptcy?

Bankruptcy is a legal proceeding that can be used by an individual or a business to resolve certain debts with their creditor. Bankruptcy may provide an individual with a fresh financial start while still allowing their creditors to be repaid.

A creditor may not collect or attempt to collect on most debts once an individual files for bankruptcy. A creditor must wait until the bankruptcy proceeding is finalized before resuming any collection efforts. 

At the beginning of bankruptcy proceedings, the bankruptcy court will order an automatic stay. These are issued because debts are often reorganized and re-evaluated during the bankruptcy process.

There are numerous issues an individual needs to consider prior to filing for bankruptcy. One of the most important considerations is that there are debts that the individual will not be able to discharge in a bankruptcy.

There are different types of bankruptcy that may be available, known as Chapters, depending on how the individual wants to handle their property. The two most common forms of consumer bankruptcy areChapter 7 bankruptcy and a Chapter 13 bankruptcy.

Chapter 7 is known as liquidation bankruptcy. In a Chapter 7 bankruptcy, the individual liquidates, or sells, most of the property to pay off their debts. Not all property must be liquidated because there are some exemptions available.

Chapter 13 is known as a reorganization bankruptcy. In a Chapter 13, an individual uses options other than the sale of property to rearrange their finances so they are able to afford their payments. 

An individual’s debts are not discharged in a Chapter 13 bankruptcy. The individual instead keeps their property and establishes a payment plan for their debts. Chapter 13 is often used by individuals who have a higher income and who want to keep their property.

What are Bankruptcy Exemptions?

Bankruptcy exemptions are exemptions that allow an individual to keep property and assets of a certain value after filing for bankruptcy. These exemptions are defined by statutes, both state and federal. Property that is exempt from a bankruptcy may not be sold or seized in order to satisfy an individual’s debts. 

Any individual who files for bankruptcy, either Chapter 7 or Chapter 13, may also file for exemptions. There are, however, limits to the exemptions that apply.

For example, if an individual has equity in their property, a certain amount of that equity may be exempt. Equity is calculated by deducting the unpaid balance on the property from the fair market value.

There are also other factors that affect certain exemption limits. For example, if an individual is married, the exemption limit amounts may be doubled. In addition, if an individual files as a head of household or has a certain number of dependents, certain exemption amounts may be increased.

The exemptions that are available vary from state to state. There are also federally-created exemptions. Some states allow an individual to choose between the state and federal exemptions. Other states require the individual to choose the state exemptions where they reside. The individual filing for bankruptcy may only choose exemptions from one statute, the state or the federal.

It is important to note that certain types of debts may not be discharged, especially if the creditor can convince the court that they should not be. Many times, this includes consumer debt for luxury items. It may be in an individual’s best interests to attempt to settle their debts out of court prior to filing for bankruptcy.

Can Bankruptcy be Settled Out of Court?

Yes, one of the main ways to resolve debt issues outside of a formal bankruptcy process is for an individual to pursue an out of court settlement. Because bankruptcy proceedings are so complex, finding alternatives to filing for bankruptcy have become more appealing.

What is an Out of Court Settlement?

An out of court settlement is a private negotiation between a debtor and creditor. The rules that govern out of court settlements are the basic principles of contract law

There are three main types of out of court settlements:

  • An assignment for the benefit of creditors;
  • A receivership; and
  • An extension and composition plan.

An assignment for the benefit of creditors describes a transfer by the individual to a third party who is chosen by the creditor to sell the individual’s property. The third party will then distribute the agreed to amount of profits and proceeds.

A receivership is appointed by a court. A receiver is a third party that is responsible for overseeing a party in receivership and ensuring that they comply with the agreement.

An extension and composition plan is essentially a compromise contract. It is proposed by the debit and allows them extended time periods until a payment is due or reduces the debt owed.

When Should I Consider an Out of Court Settlement?

An individual can attempt an out of court settlement at any time. However, they are most likely to be successful in cases where:

  • The individual only has a few creditors, all of which are reasonably sophisticated;
  • The creditor or committee that is overseeing the disposition of property and the disbursement of the proceeds is involved; and
  • The debtor is an integral economic force and their continued involvement in the community is economically desirable.

An out of court settlement is essentially a novation. This means it is the replacement of one arrangement for another. 

For example, if an individual has a credit card bill of $5,000, by using that card they have agreed to pay the balance. However, if they can settle this debt out of court, they may be able to pay a lump sum payment which is less than what they owe, replacing the original agreement to pay the $5,000 with an agreement to pay a lump sum to satisfy the debt.

Therefore, it is crucial that every creditor is represented and participates in the settlement efforts. Otherwise, the individual risks of facing subsequent challenges to the agreement by unrepresented creditors.

Are There any Risks in Pursuing an Out of Court Settlement?

The main risk of pursuing an out of court settlement rests with the debtor. An out of court settlement requires negotiations that include a full financial disclosure through regular accounting of all assets.

One of the main concerns for the debtor is the risk that an unethical or overzealous creditor may take advantage of the negotiation process in order to discover and seize assets while refusing to conduct an actual settlement negotiation. In addition, if the settlement attempt fails, the debtor may have to proceed with bankruptcy proceedings after incurring expenses related to out of court negotiations.

Do I Need a Bankruptcy Attorney?

Yes, it is essential to have the assistance of an experienced bankruptcy lawyer for any out of court settlement issues you may have. Whether the negotiation is ultimately successful or not, having an attorney on your side can help reduce any risks of the process. 

Your lawyer will also help protect your interests by preparing all documents in advance and in accordance with the requirements for bankruptcy proceedings. This step will save time and money in the long run in case it becomes necessary for you to file for bankruptcy. Your attorney can also take steps to protect you from the risk that property you disclose will be seized as a result of the negotiation process.

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