Special Settlement Problems When Defendant Claims Poverty or Non-Collectibility

By: Donald L. Swanson

“I’d be happy to pay the million dollars I owe you. The problem is that I have only two of them.”

–A defendant’s claim of poverty and non-collectibility in settlement negotiations.


A defendant’s poverty/non-collectibility claim creates an interesting dynamic in mediation and other negotiations. And that’s true whether the defendant is an individual or a business.

A Study Report

A 2015 study on mediation [Fn. 1] had this to say about a defendant’s poverty claim:

A defendant’s poverty or impending bankruptcy “need not impede settlement if the plaintiff makes or accepts settlement offers” reflecting the reality that plaintiff “is likely to have trouble collecting on a trial judgment”;

The problem with a defendant’s poverty claim is this: skepticism from the opposing party; and

Skepticism is difficult for a defendant to overcome, even when poverty does exist, because supporting information is usually in the defendant’s sole possession, and defendants are reluctant to fully open their books to a plaintiff.

Some Hard Knocks Observations

I’ve had lots of experience, over the years, with poverty and non-collectibility claims in mediation and other negotiations. And I’ve been on all sides of the issue. Here are some observations from lessons learned—mostly the hard way—on the subject:

• When a defendant raises a poverty/non-collectibility claim, the credibility of that claim increases dramatically when that defendant is represented by a bankruptcy attorney;

• Evidence of a large liability to the IRS lends credence to the poverty/non-collectibility claim;

• A financial statement signed by the defendant, to demonstrate poverty/non-collectibility to the plaintiff, can backfire—after settlement, disputes can arise over the accuracy or completeness of the financial statement, substituting a new set of disputes for the resolved ones;

• Defendants need to beware that a plaintiff demanding financial information to evaluate settlement possibilities might also be looking for assets to attach, instead of solely seeking proof of financial condition;

• A common response by defendants to demands for financial information in negotiations is this: “The only time we’ll voluntarily provide such information is in bankruptcy schedules—not before”; and

• Some disputes with a state or federal government cannot be resolved without a signed financial statement—in such circumstances, a financial statement cannot be avoided if the party wants to settle.

Additional Concerns

Claims of poverty and non-collectibility raise concerns of preference and fraudulent transfer exposure in a subsequent bankruptcy.


A Hypothetical: Disputing parties reach a settlement, under which defendant pays money to plaintiff.

A Danger: If the defendant files bankruptcy within 90 days thereafter, a risk exists that plaintiff will be required to return the settlement money to defendant’s bankruptcy estate as a preference under § 547 of the Bankruptcy Code.

Here is how plaintiffs often respond to a preference possibility:

“Take the money and run”; and
Hope that 90 days expires without defendant filing bankruptcy.

It’s difficult to paper over or around a preference problem, because the law looks at practical effects of what happened—not to how the parties describe what’s happening.

Nevertheless, it’s possible for the settlement agreement to provide such helpful things for creditors as:

• That the settlement’s release of defendant will have no force or effect, if defendant becomes a bankruptcy debtor within 90 days after payment of the settlement amount; and

• That all officers and directors or managers of a corporate or LLC defendant agree in writing to refrain from filing a voluntary bankruptcy petition within 90 days after payment of the settlement amount.

–Fraudulent Transfer

Here are two situations where settling plaintiffs can, despite their own good faith, have fraudulent transfer exposure from a settlement in a subsequent bankruptcy.

1. Plaintiff and defendant reach a settlement. Defendant is an individual but uses a corporate check to pay the settlement amount. The paying corporation files bankruptcy thereafter. The corporation’s bankruptcy estate demands return of the settlement payment as a fraudulent transfer, since the corporation paid a debt it did not owe.

2. Plaintiff and defendant reach a settlement. Unbeknown to plaintiff, the settlement is part of defendant’s broader scheme to hinder, delay or defraud creditors. Defendant thereafter files bankruptcy, and defendant’s bankruptcy estate demands return of the settlement payment as a fraudulent transfer, because of defendant’s fraudulent intent.

The statute of limitations on such fraudulent transfer claims is commonly four year under state law. And, if bankruptcy is filed within the four year statute of limitations period, the bankruptcy estate typically has another two years to bring the fraudulent transfer claim. This leaves settling parties in the lurch for a long time.

In bankruptcy, furthermore, the initial transferee can be strictly liable for the debtor’s fraudulent transfer—even if totally innocent and without notice of the avoidable nature of the transaction.


Settlements with defendants claiming poverty/non-collectibility carry special risks and concerns—even when plaintiffs act in complete good faith. Yikes!

Footnote 1: The study is by Daniel Klerman and Lisa Klerman, published in 12 Journal of Empirical Legal Studies, 686-715 (Dec. 2015), and is titled, “Inside the Caucus: An Empirical Analysis of Mediation from Within.”

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