Why would they not pay taxes on interest earned?

The damages are the suit claim, or are they property damages covered by insurance? In other words, literal damage?

You don't report or not report income based on what is on a 1099-NEC. You do it based on facts and circumstances. Remember, if this customer was a private citizen and not a business, there is never a 1099-NEC issued, even if your client makes $3 million. They still report that income as income. 1099-NEC is informational, not a tax filing form.

The attorney doesn't know tax regulation.

If a client is on cash basis, they already incurred the costs. Labor and materials would have been on the tax form for the year incurred. If that didn't happen, that's an amendment condition. The income is considered income in the year received.