Can You Settle Business Debt During a Lawsuit? 5 Steps That Must Proceed Together

Settling and Defending Are Not Either/or

In most cases, you can still settle the claim against you and your company. If a lawsuit has been filed against you, you and the other side can still negotiate a settlement, even though a clock is running. It is only important to remember that the negotiations will not halt the lawsuit. In federal court, an answer is due 21 days after “service” (the court papers are delivered to you or your agent) unless the papers are waived; then the time is 60 days after the waiver request was sent. That means you can still be hit with default judgment.

That doesn’t mean you only have 21 days to negotiate with your claimant; it means that there is a hard deadline. You’ll need to submit an answer within the time you have, so that you’ll still be part of any mediation or discussion about a settlement. If you miss the deadline, you could end up losing the case or having a judgment against you that you didn’t realize you had to defend. When a debt is for a fixed sum of money, and you fail to appear, the clerk will enter a judgment against you on the creditor’s affidavit. If you do show up in the case, the creditor must give you at least 7 days’ written notice before any default hearing is held.

So settling and defending are not either/or. Five things have to move at the same time:

• (1) answer the suit,
• (2) set up payments,
• (3) limit the remedies if you fall behind,
• (4) settle the fees,
• (5) close the case correctly.

If you negotiate with a claimant while the case is open, what you say is probably protected by a ”settlement privilege.” Even if something you write or say is relevant, the other side can not use it to prove the basis or the value of the claim. But beware: asking to pay less on a debt you freely admit carries no privilege at all. In federal court, at a pretrial conference, a judge may require you to be present or available to consider settlement.

Negotiating the Time Line for Payments

Settling collection actions is about timing as well as the size of the discount. Even if you get a large discount, the deal can break apart and hurt you if your first payment arrives before your receivables clear. And remember, being late on one installment can turn the rest into an enforceable judgment. The first payment should be due a set time after the signing. Installments should fall on dates when you expect to have money on hand, preferably after you collect from your customers. In seasonal businesses, quarterly payments can make sense. A smaller opening installment, with gradual step-ups by dates you specify can also help. A ”discount for early payoff” is worthwhile because it gives your operation leeway.

What you are settling is not just an invoice total. It may be an open account balance with interest still accruing; it may also affect a personal guaranty. The deal you write up should address each of those points. If several creditors are pressing you at once, negotiate so your payments don’t stack in one or two months, but are spaced out over several months.

A missed payment triggers more than the dunning letters and collection calls. Lenders will often ask for a stipulated judgment they can file on default. Negotiate (as a condition of signing) for a minimum advance written notice and cure period; for more than one cure during a loan or contract period; and for a stipulated judgment only for the unpaid balance, not the whole amount. A stipulation made during the lawsuit can allow a judgment against you just on an affidavit if the conditions are met, so be very careful about what you agree to. In New York, if a stipulation made during the lawsuit says default allows judgment in a set amount, the clerk must enter it on an affidavit of noncompliance, with no further notice to you.

Attorney fees and costs can add a major load to a settlement when not handled right. If the note or credit application had a fee clause, attorneys’ fees could be part of your balance. As a closing matter in any settlement, make sure the language of the settlement clearly says who pays the fees and costs, or leaves each side to pay for its own. Leaving the matter open on paper leaves you open to a second fight.

Closing Matters

Put your settlement in writing and get both sides to sign it. In Florida, a settlement reached in mediation must be written and signed, or there is no deal. Outside mediation, a deal can bind without a signature once essential terms are agreed, but be very careful to control what goes in writing.

The litigation is closed with a stipulation of dismissal, signed by all who appeared. By its terms, it is “without prejudice” unless it says otherwise. Ask for dismissal with prejudice, a mutual release, satisfaction of any judgment entered, and a set date for each. Pay special attention to the closing matters if the debt you are settling was covered by a security agreement. Paying off the debt may not bring the file to a close. The finance company’s file may still carry a Uniform Commercial Code financing statement that says it has a security interest in your property. Name the filing in your debt settlement, and be sure you have specified how and when it will be canceled.

Taxes can still be due on debts forgiven or settled. The IRS generally treats canceled debt as taxable ordinary income. There are insolvency or bankruptcy exclusions, which are claimed on Form 982. The amount canceled is reported to the IRS by the creditor on Form 1099-C, for amounts canceled of $600 or more.

A settlement is good when you’ve got a payment problem: you can’t pay right now, but you believe that with time, you can. When the problem is solvency - too many debts for your assets and income - then debt reorganization may fit better. Bankruptcy, Subchapter V, is another tool. Bankruptcy’s automatic stay generally stops pending lawsuits. Subchapter V, in cases filed since June 21, 2024, has a debt limit of $3,424,000.

Before you put any money into a settlement, test the validity of the papers and the accuracy of the payments credited and owed. Confirm that credits and offsets have been applied and the claim is adjusted. If what’s on paper is mistaken or even disputed, use that as a bargaining point. While negotiating, keep your five tracks running together, so that the papers are closed while your final payment is made.