When a debtor is in enough financial trouble that a creditor gets worried about receiving payment at all, both parties may elect to make an agreement to satisfy the debt(s) at a reduced cost.
This is known as debt settlement, as the creditor is settling for a lesser amount than what is fully owed. This is also referred to as debt negotiation (though the "negotiation" is really the process of getting to a settlement).
Both the debtor and creditor have their reasons for settling the debt at a reduced price:
The person in debt is doing their best to fix their financial situation without having to declare bankruptcy. If they are unable to utilize a debt consolidation or credit counselling service to pay off what's owed, debt settlement is much less damning to their long-term credit than going bankrupt; and because the debt is satisfied, ends harrassment for payment from the lender and the other unpleasantness that comes from overdue bills.
For the creditor, accepting a debt settlement proposal means they will normally receive more than they would were the debtor forced to go into bankruptcy, and can even save them money over using collection agencies and/or attorneys trying to collect the full amount. It also means they'll receive payment sooner than later.
Many debt management companies use a combination of both debt settlement and consolidation efforts when possible, reducing individual debts before consolidating them into one debt at a lower interest rate.
