Consumer Law

'Paid in Full' Check Memo

Find out whether your creditor must accept less than what you owe if you write "paid in full" on your check.

It’s not unusual for people who owe money to negotiate down a debt to a lesser amount—and while it’s possible to do so by writing “paid in full” on a check, it won’t work unless you follow additional rules. And even then, the creditor can reverse course later and demand full payment. So, although you might be able to pay less than what you owe using this approach, you’ll have a better chance of enforcing your deal if you document it in a more traditional way, such as by creating a written agreement with the help of an attorney.

Factors You’ll Need to Meet

When you and a creditor agree that you can pay less than the amount you owe, the transaction is called an “accord and satisfaction” and its governed by the laws of your state. According to the Uniform Commercial Code (UCC)—a set of model rules that many states choose to adopt—a “paid in full” check will only extinguish a debt if you meet the following factors:

  • You and the creditor disagree about the claim amount or haven't finalized it.
  • The paid in full statement is easy to see.
  • You pay the amount in good faith.
  • The creditor cashes the check.

If you try this approach on a credit card debt, it’s unlikely to work. Why? Because you probably won’t be able to show that the amount owed is uncertain. You’ll be held responsible for the amount that you charged—a number that’s likely relatively simple to figure out. On the other hand, if you’re working with a contractor and you disagree about how many hours it took to finish a job or the supplies necessary to complete a project, you might be able to satisfy this requirement.

Also, you can’t pull a fast one by writing paid in full somewhere that the creditor wouldn’t expect to look. You must write it in a conspicuous place. You might run into the same problem if you send the check by electronic means.

Finally, it’s important to understand that acting in good faith means that you conduct yourself in a reasonable manner. What constitutes reasonableness will be determined by the facts of the situation. For instance, a court is unlikely to find that you were acting in good faith if you try to settle a debt for $1,000 by paying $10 with a check marked “paid in full.”

The above discussion is based on the UCC. While it's likely to reflect the law of your state, it doesn't apply universally so you should confirm your state law with a local attorney.

The Creditor Can Demand Full Payment Later

Even if the creditor cashes the check, you still might face a potential hiccup. The UCC gives the creditor 90 days to change its mind, return the funds, and demand the full amount. The creditor can also instruct customers to mail all checks written for a lesser amount to a designated place. This provision allows the creditor to make sure that someone will look at it before cashing it.

Another Approach: Agreeing to a Mutual Settlement

Just because writing paid in full on a check isn’t foolproof doesn’t mean that you can’t settle with a creditor for less than the amount owed. Instead, you might want to try reaching an agreement that you can both accept. Not only will this method bring the matter to a more certain conclusion, but it’s more likely that the creditor will follow through on the settlement.

If you decide to use this route, you’ll have a variety of options. For instance, depending on your comfort level, you can:

  • work with the creditor directly
  • retain an attorney to negotiate on your behalf, or
  • hire a reputable debt settlement agency to work out a deal.

Once you reach an agreement, you’ll want to put the terms in writing and have each party sign it. If this isn’t possible, it’s a good idea to document your deal by sending the creditor a letter summarizing the settlement.

Be Aware of Potential Tax Consequences

Settling a debt for less than the full amount comes at a price. Specifically, the unpaid debt amount is considered “income” by the Internal Revenue Service, and it’s likely that you’ll have to pay taxes on that portion. Worse yet, if you negotiate down a significant amount, you might get pushed into a higher tax bracket and find yourself holding a large tax bill at the end of the year.

To ensure that you get the deal you expect, you should consider discussing your financial picture with your tax preparer beforehand.

Questions for Your Attorney

  • How do I settle a debt for less than the full amount?
  • Is writing paid in full on a check an effective way of paying a debt in my state?
  • What type of tax consequences will I face if I successfully negotiate my debt?
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