The complexity of bankruptcy proceedings has made finding alternatives to filing for bankruptcy both more appealing and more challenging. One of the primary ways to resolve debt issues outside of the formal bankruptcy process is to pursue an out of court settlement.

What Is an Out of Court Settlement?

An out of court settlement is a privately conducted negotiation between each debtor and creditor. The rules of the settlement are governed by the basic principles of contract law.

There are three primary types of out of court settlements:

  • Assignment for benefit of creditors: This describes a transfer by debtor to a third party chosen by the creditor to administer or sell the property and distribute an agreed to amount of profits and proceeds.
  • Receiverships: Receivership is appointed by the court; a receiver is essentially a third party responsible for overseeing the party in receivership and ensuring they comply with an agreement.
  • Extension and composition plans: These are basically small "compromise" contracts proposed by the debtor, where creditors extend time until payment is due, or reduce to debt. 

When Should I Consider an Out of Court Settlement?

An out of court settlement can be attempted at any time. However, it is most likely to be successful if:

  • There are only a few creditors, all of whom are reasonably sophisticated.
  • The creditor committee overseeing the disposition of property and disbursement of proceeds is involved.
  • The debtor is an "integral economic force" whose continued involvement in the community is economically desirable.

An out of court settlement is basically a novation - a replacement of one arrangement for another. Therefore, it is critical that every creditor is represented and participates in the settlement effort. Otherwise, the debtor runs the risk of facing subsequent challenges to the agreement by unrepresented creditors.

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

The primary risk in pursuing an out of court settlement lies with the debtor. An out of court settlement will require negotiations that include full financial disclosure through regular accounting of all assets. A major concern for debtors is the risk that an overzealous or unethical creditor may take advantage of the negotiation process to discover and seize assets and refuse to conclude an actual settlement.

Additionally, if the settlement attempt fails, then the debtor will have to proceed with bankruptcy proceedings after having incurred the expense of out of court negotiations.

Do I Need a Bankruptcy Attorney?

Whether a settlement is ultimately successful or not, an experienced bankruptcy attorney can reduce any risks and protect the debtor's interests by preparing all documents in accordance with the requirements for bankruptcy proceedings. This will save time and money in case it becomes necessary to file for bankruptcy. The attorney can also take measures to protect the debtor from the risk that disclosed property will be seized as a result of the negotiation process.