Praise be to Allah.
Haraam wealth is of two types:
- That which is haraam in and of itself, which is wealth that is taken without consent, such as wealth that is stolen, seized by force or plundered. This is haraam to the one who takes it, and to the one to whom it is passed on, if the latter is aware of the situation, because the prohibition concerning it has to do with the wealth itself, because it is the property of the one who was wronged and must be returned to him. As for making use of it and benefiting from it, that is sharing in the wrongdoing and sin.
So if the wealth is haraam in and of itself, it is not permissible for him to pay off the debt with it, and it is not permissible for you to accept it.
- That which is haraam because of the manner in which it was acquired. This is wealth that is taken with consent in return for a haraam action, or by means of a haraam business deal, such as the fee of a singer or musician, or money resulting from riba-based transactions, such as bribes and interest, money paid for alcohol or drugs, and the like.
This wealth is haraam only for the one who acquires it, according to some scholars, and it is not haraam for the one to whom it is passed on by permissible means, such as a gift or maintenance.
See the answer to question no. 289442.
If the one who acquired this wealth has repented, and is in need, it is permissible for him to take from it as much as he needs, and it is permissible for him to pay off his debt with it.
Based on that, if the debtor does not own anything except this haraam wealth, there is nothing wrong with him paying off his debt with it, and there is no blame on you for accepting that.
What appears to be the case from the question is that he does not currently possess this haraam wealth; rather he wants to commit sin in order to pay off his debts. If that is the case, according to what we understand, then it is not permissible for him to do that, and it is not permissible for you to call on him to do that. Rather you must give him more time, if he is indeed in financial difficulty, because Allah, may He be exalted, says (interpretation of the meaning): “And if someone is in hardship, then [let there be] postponement until [a time of] ease” [al-Baqarah 2:280].
Shaykh Muhammad ibn ‘Uthaymeen (may Allah have mercy on him) said: One of the things we learn from this verse is that it is obligatory to give one who is in difficulty more time, until he becomes well-off, because Allah, may He be exalted, says: “then [let there be] postponement until [a time of] ease.” So it is not permissible to demand that he pay off the debt or to ask him for what is owed.
End quote from Tafseer Soorat al-Baqarah (3/391).
And Allah knows best.