A Small Business in the US Can Out of Court Settle Debts in 2026
Yes. A small business in the US can out of court settle debts in 2026. Many do. An out of court settlement is a private contract. Each creditor agrees to accept less, or to wait longer, for their payments in exchange for agreeing to stop collection. It can be a good option if you have a small number of creditors, mostly unsecured debt, and can accumulate lump sums. It can be a bad option if you have a large number of creditors, a merchant cash advance funder has frozen accounts, or your federal debt has been transferred to Treasury. The bottom line is that an out of court settlement will only bind the creditors that agree to it. There is no automatic stay, no ability to coerce holdouts, and no court to prioritize claims.
Many settlement companies boast of settlements from 30 to 70% of the balance due. One national company touts that clients who complete a program will save 45% on balances prior to fees, and 20% after fees, over a 24 to 48 month period. This is the first thing to do, run the numbers. A creditor’s decision to negotiate will be based upon what it would otherwise receive. This is predicated upon whether the debt is secured, guaranteed by an owner, and how likely it is that the company will close or file for bankruptcy.
The threat of bankruptcy is what gives a workout a stick, so the eligibility requirements matter. Subchapter V is the abbreviated small business Chapter 11. The debt limit for Subchapter V increased to $3,424,000 on April 1, 2025. At least half of the debt must be from a business activity. The House passed H.R. 7730 on September 16, 2026. The Senate passed it on September 28. It would permanently set the Subchapter V limit at $7.5 million. As of early October, 2026, it was waiting for the President’s signature. It would only apply to cases filed after it became law. A business that qualifies for Subchapter V can bind holdout creditors by a plan confirmed by the court. An informal settlement cannot.
Personal Guarantee
A settlement agreement signed by a business will not release a business owner from a personal guarantee unless the agreement expressly states it. That’s why the 2025 settlement of the New York Attorney General with Yellowstone Capital not only wiped out $534 million in merchant debt but also the balances remaining owed by all the guarantors who were defaulted and those merchants who had settled previously. Otherwise, they would still be exposed.
Treated as Taxable Income
Discharged debt is generally treated as taxable income. An “applicable entity”, which includes a bank, credit union, federal agency, or other lender, must send out a Form 1099-C for the cancellation of $600 or more of a debt. But, the income is taxable even if the form is not received. Here is an example from the IRS: I borrowed $1,000 but I made a $400 settlement payment. Thus, my bank can treat $600 as cancelled debt. To exclude forgiven debt from income, you can claim the insolvency exclusion. But, you can only exclude to the extent your liabilities exceeded your assets immediately before the discharge. You file this exclusion on Form 982, line 1b. Once you exclude canceled debt from income, you must reduce certain tax attributes like loss carryovers and basis. Line 1d allows you to make a special election to apply to a debt secured by real property used in your business. This is only available after the bankruptcy and insolvency exclusions.
Preference Claims
Undoing a failed reorganization in a later bankruptcy. Under section 547 of the Bankruptcy Code, the trustee can “avoid” payments on pre-existing debt to a creditor made within 90 days of the bankruptcy filing. This period is one year for “insiders” such as an owner, relative or other business of the debtor. The business is presumed insolvent during the 90 days. The creditor can defend a preference claim by showing the payment was in the ordinary course of business, but the creditor must prove the defense. For business cases filed on or after April 1, 2025, the trustee cannot bring preference claims for less than $8,575. Lump sum payments to some creditors prior to bankruptcy are particularly at risk of avoidance.
Merchant cash advances need to be considered separately as the law has changed in favor of the businesses. Confessions of judgment are signed documents that allow the funders to get a judgment without having to ever sue. On August 30, 2019, New York amended CPLR 3218 and the amended law prohibits the filing of one against a non-resident, or a company that has no place of business in the state. Texas House Bill 700 was effective on September 1, 2025. Texas Finance Code section 398.055 states that confession provisions in sales-based financing contracts are void. Texas Finance Code section 398.056 prohibits automatic debits unless the funder has a first priority perfected security interest. There is a registration requirement for providers which is due on December 31, 2026. The applicability of the Texas law to the contract depends on the date and the choice of law provision in the contract.
Actions by regulators give borrowers a greater degree of leverage when negotiating with providers. Regulators have argued that some cash advances were actually loans with interest rates far exceeding the state’s usury rate. The settlement with Yellowstone was entered on January 16, 2025. Yellowstone judgments were vacated by courts in over two dozen New York counties and the company and two executives were barred from the industry. On March 4, 2026, the court denied a motion to dismiss the Attorney General’s claims against Delta Bridge doing business as Cloudfund and others. A federal jury in the Southern District of New York found against merchant cash advance operator Jonathan Braun in FTC v. Braun. A $20.3 million judgment was entered in February 2024, which included $3,421,067 in redress and $16,956,000 in civil penalties. The FTC claimed that the defendants misrepresented the terms of deals, and took confessions of judgment from businesses.
Unpaid COVID EIDLs. The deadline for direct resolution of EIDLs continues to get shorter. Since September 2025, the SBA has been referring EIDLs in nonpayment status to Treasury’s Cross-Servicing program. Treasury says that it can’t send accounts back. An SBA Inspector General report in August 2025 reported that the SBA had charged off 369,588 COVID EIDLs with original balances of more than $25,000, for a total of more than $47 billion. Once SBA charges off an account, Treasury must take the account unless collection is prohibited by a compromise, discharge in bankruptcy, or the statute of limitations.
For the EIDL borrower, there is no opportunity for a compromise with SBA once the account is referred. Business owners who hire a debt settlement company to make debt relief offers on their behalf have much less federal consumer protection. According to the FTC’s Telemarketing Sales Rule, debt relief companies cannot collect fees from consumers until they settle or change at least one debt. However, the vast majority of the rule does not apply to business-to-business calls. The FTC amended the rule April 16, 2024 to apply only the rule’s prohibition against misrepresentation to business-to-business calls, and specifically declined to apply the remainder of the rule. This means that a company that sells debt settlement services to another company may be able to collect fees upfront. The company still cannot misrepresent its costs or expected results. A business owner must carefully check the contract and verify the time and condition upon which fees are collected and any state registration requirements for the company before any funds are paid.
