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Out-of-Court Settlements

There are several ways to cope with an economically troubled debtor.  Sometimes, the creditors may prefer to rehabilitate the debtor through out-of-court settlements.  Generally, this occurs when the procedure of restoration is impossible.

An out-of-court settlement includes the resolution of an argument prior to the key decision by the bankruptcy judge.  To resolve arguments between debtors and creditors, out-of-court settlements include or require negotiations.  These negotiations typically include creditors recognizing a portion of their outstanding balance due as payment in full.  The debtors may sell their resources outside of bankruptcy procedure through a general assignment between the debtor and creditor for the benefit of creditors or, a settlement agreement between creditors and the debtor.

In out-of-court settlements, voluntary settlements between debtors and creditors are preferable.  Voluntary settlements are generally known as compositions agreements and extension agreements.  In a composition agreement, the debtor pays less than total volume of debt.  However, in an extension agreement, the outstanding debt is not paid at the due date and ensures the rehabilitation of the debtor’s business by extending the due date for the debt.  In other words, voluntary settlement is a simple contract between the debtor and creditors to ensure maximum return to the claims of creditors and minimize the economic distress of the debtor.   The major benefits of voluntary out-of-court settlements are:

  • Less time intensive and usually less expensive than an official bankruptcy procedure
  • Less disruption in the performance of debtor’s business
  • Greater confidence of management by the debtor’s business functions
  • Less risk in losing a management team and experienced workforce
  • Greater versatility for income management
  • Better environment for refinancing, capital creation or new credit
  • Sale or rental of resources is less complicated, particularly those out of the common course of business
  • Less probability of decrease in wage and other benefits paid to key workers
  • Better security in confidential business matters

However, the voluntary out-of-court settlements have certain demerits. These include:

  • No protection against secured events or legal loan lenders seeking to use their rights pursuant to written agreements with the debtor
  • No ability to stop action by taxing power
  • Limited abilitgy to stop the federal or state court pending process against the debtor after the agreement inception
  • Inability to decline renting and other complex proprietary agreements
  • No room to accommodate claims of under-secured creditors to avail bankruptcy “cramdown” conditions.
  • No procedure to attack preferential transfers, counterfeit conveyances or attachments of the debtor’s property.
  • No legal method to persuade dissenting creditors to work with settlement.

Voluntary or out-of-court settlements can be initiated either by a debtor or creditors.  The debtor in economical problems can avail attorney guidance for this.  The assigned attorney initiates  a conference with the creditors to discuss the debtor’s economic condition, reasons for the economic crisis, steps adopted to resolve vital problems, the position of secured creditors, suggest payment options or settlement plans, provision for interest on the debt to be settled, any provision of security to creditors, and data regarding continuous business functions, plans and leads.

The significant using of out-of-court settlements is adequate proof of its wide popularity by innovative creditors and lawyers who are dedicated to the law of bankruptcy.  The benefits resulting from out-of-court settlements have been recognized in the Bankruptcy Code Section 305, which allows the Bankruptcy Court to avoid an involuntary case in bankruptcy registered against a debtor if the termination would better serve the interest of the creditors and the debtor.  A well-constructed out-of-court settlement contract between a debtor and an associate body of its creditors stands a good chance of providing its purpose.

Inside Out-of-Court Settlements