When Should I Settle Out of Court?

Going to trial can be lengthy, difficult, and costly, so many lawsuits end up being settled out of court. In fact, of major case categories, tort cases (including personal injury and negligence) tend to have the highest settlement rates, followed by contract cases, employment discrimination cases, and then constitutional tort cases.

One study from the Eastern District of Pennsylvania reported that the highest settlement rate for tort cases was 87.2%.

If you’re considering whether to settle out of court, here’s a breakdown of how it works, including a sample settlement agreement template.

What Is an Out-of-Court Settlement? 

A settlement is an agreement between the parties in a lawsuit that effectively halts the dispute process and any other future litigation (lawsuit). It’s basically a compromise, which is why it’s sometimes called a compromise agreement. The compromise agreement is substituted for the claim by the injured party, and the rights and liabilities of the two parties are then set by the agreement.

Why Do So Many Court Cases Settle Out of Court? 

Going to trial in a civil case against another party—whether you are the plaintiff or the defendant—can be stressful, and settling before the trial may be the best option to save time and money.

Pros Explained

Costs of Litigation. Many court cases are settled just before trial and, of course, a significant amount of money has probably already been spent getting ready for it. This money may go toward:

• Billed time for attorneys
• Costs for investigations
• Depositions
• Court filings

Stress and time. The “stress factor” is different for everyone, but if the case is taking you away from your work and it’s costing you money, or the stress is eating away at you, it might be wise to settle. 

Uncertain outcome of a trial. Jury verdicts are more uncertain than having a judge. For instance, studies have found that juries tend to be more empathetic to defendants in certain situations than a judge might be.

Why spend all that time, money, and effort if there’s a possibility you won’t win the case? You or the other party can appeal a trial verdict, but a settlement ends the dispute and is binding on both parties.

Cons Explained

Claim amounts. Offsetting the uncertainty of the results of a trial is the prospect of a high return in damages to the injured party, especially punitive damages. Since a settlement is a compromise, the damage amounts you receive in a settlement may be lower than you expect.

Getting the claim paid. Even if the two parties can agree on the settlement, it may be more difficult to get the claim paid in full. The plaintiff may have to go back to court to get a judgment (court order) from the court.

Back to court. If the settlement process breaks down, you may end up in court, with all of those costs and time, in addition to the time spent in the failed agreement.

Using Mediation for a Settlement Agreement

As a way to get to a settlement agreement, the parties in a lawsuit can agree to mediation. In mediation, the two parties meet with a trained mediator who works to reach an agreement. At any point in a lawsuit before trial, the two parties can agree to mediate. If they reach agreement, they can put it in writing.

What Is Included in a Settlement Agreement?

A settlement agreement is a contract, so it must meet the terms necessary for a contract, including mutual agreement and consideration (something given by both sides).

The various sections in a typical settlement agreement may include: 

• Names of the parties to the agreement
• An introduction that explains the reasons for the contract, also known as the “whereas” section
• The “no admission of liability” clause that says the settlement doesn’t include an admission of wrongdoing by either party
• A “promise to pay” section that states the settlement amount that one party agrees to pay to the other party
• The invoicing and payment schedule with details on the money transfer
• The "mutual release" clause, which states that both parties agree not to make any claims against the other party

Settlement Agreements and Income Taxes

The IRS counts any income from any source as taxable gross income, and that specifically includes amounts received in settlements. But gross income for tax purposes doesn't include certain types of damages received through the result of a lawsuit or through a settlement agreement.

Specifically excluded from income taxes are:

• Damages for certain discrimination claims and amount paid on account of physical injuries
• Damages received on account of personal physical injuries and physical injuries
• Damages (not including punitive damages) received by lawsuit or agreement, in a lump sum or in payments, on account of personal injuries or physical sickness

Frequently Asked Questions (FAQs)

What's the difference between a settlement and a judgment?

A settlement is an agreement between the two parties in a lawsuit. A judgment is a verdict or ruling by a judge.

If I take a settlement as the defendant, does that mean I'm admitting guilt?

A settlement doesn't usually include an admission of guilt; it doesn't say anyone was right or wrong in the case. A settlement agreement may include a "no admission of liability" clause. In some cases, part of a dispute can be settled, leaving a judge or jury to decide other issues.

Can I use a settlement agreement in small claims court?

If you have a claim in process in small claims court, you and the other party can come to an agreement before the trial date. Be sure to put in writing. If you make the agreement and the claim has been paid in full, notify the small claims clerk in writing to clear the case. If the claim hasn't been paid, you can go to court and ask for more time.