Bankruptcy-Proofing Settlement Agreements

Once parties to a legal dispute have entered a settlement agreement, the Defendant may jeopardize the Plaintiff’s ultimate recovery under the agreement by filing for bankruptcy. In order to reduce the risk associated with Defendant’s bankruptcy, the Plaintiff’s lawyer may: (1) Structure the payments so that they do not exceed $5,475 in one 90-day period, as this is the threshold for some preference actions under 11 USC 547. (2) Try to structure the settlement so that most of the payments are made by third parties, or get a third party to guarantee Defendant’s payments. (3) Get the Defendant to represent that, as of the formation of the settlement agreement, they/he/she are/is financially solvent. (4) As soon as possible, take a security interest in Defendant’s (preferably non-exempt) property. (5) Be careful about including broad language releasing all claims in the settlement agreement. Include language in the agreement conditioning the release on Plaintiff’s ability to reap the full economic value promised in the agreement. (6) Beware of novation, which occurs where a settlement agreement converts otherwise non-dischargeable debt, such as that for willful and malicious injury to person or property, into a dischargeable contract debt. In cases where non-dischargeable debt is being settled, have the Defendant specifically admit to the specific charges or other facts that make the underlying obligation non-dischargeable.

Anyone with questions regarding bankruptcy-proofing settlement agreements should contact Jim Shenwick.