How Does a Bankruptcy Affect a Lawsuit?

Often, I consult with prospective and existing clients who are involved in a lawsuit. Normally, their first question is exactly how a bankruptcy case affects a lawsuit. The answer to that question depends on several factors. First, it must be determined if the debtor (the person filing for or contemplating filing for bankruptcy) is the plaintiff, i.e., the person bringing the lawsuit or the defendant, i.e., the person being sued. This is very important in the bankruptcy context. If the debtor is the plaintiff in a lawsuit, then normally the lawsuit can continue; however, the existence of the lawsuit must be disclosed to the bankruptcy court.

Additionally, the bankruptcy trustee may also have to be joined as a party with the debtor or, in some cases, substituted as the plaintiff in place of the debtor. If the suit is seeking monetary compensation for the debtor, any amount that may be recovered may have to be paid to the bankruptcy trustee to be distributed to creditors of the debtor. Exactly how much of the total recovery that must be paid to the bankruptcy trustee frequently depends on the amount of debts owed and the amount of the recovery. There may be exemption laws that shield some or all of the recovery from the bankruptcy trustee; but, these laws vary significantly from state to state. Therefore, it is crucial to have competent bankruptcy counsel in such circumstances.

Potential Traps and Frequent Scenarios

A potential trap for debtors who are plaintiffs in a lawsuit is the legal doctrine of “judicial estoppel”. It goes like this: Suppose John Doe files a Chapter 13 debt consolidation case to get his finances under control. Later, after his case is filed, he is rear ended on the way to work one morning. He is personally injured, and his car is destroyed. He figures he has a good claim against the driver who hit him, so he goes out and hires a personal injury lawyer to handle the case. He neglects to tell his bankruptcy lawyer about the auto collision, and he doesn’t mention his bankruptcy case to the personal injury lawyer. Later, the lawyer defending the other driver finds out about the bankruptcy case.

In this circumstance, John Doe may be “estopped” from pursuing the injury claim any further. The injury suit may be dismissed, and John Doe may not be able to ever pursue it any further. John Doe has lost his suit no matter how badly he was injured or how good of a claim he had. Further, his bankruptcy case may be dismissed as well. In short, you never want to be on the receiving end of “judicial estoppel”.

What if the debtor is the defendant in the lawsuit?

In this case, the defendant is the person being sued. This is probably the most frequent scenario in consumer bankruptcy cases. Often, a person is consulting with a consumer bankruptcy lawyer because of a lawsuit filed against the person. In such circumstances, the filing of a bankruptcy case automatically stops the lawsuit against the debtor in nearly all circumstances. This happens because of the “automatic stay” that arises in a bankruptcy case from the instant the case is filed. Again, there are some exceptions to the automatic stay that may apply in any given case so it is crucial that competent bankruptcy counsel is available in such circumstances.

What I normally see is the situation where a person is being sued for a debt that they cannot possibly pay. In such circumstances, I usually try to first assess if this person has any legal defenses to the lawsuit. For example, is the debt being sued upon barred by the statute of limitations? Is the party being sued the person who created the debt or is this a case of mistaken identity? What other legal defenses may exist? If there is a viable non-bankruptcy alternative, this is something I discuss with the person. But, in many circumstances, no such defenses exist or the expected cost of the defense far exceeds the person’s ability to pay. In such a circumstance, it is altogether proper to consider filing a Chapter 7 bankruptcy case or a Chapter 13 debt consolidation case. Bankruptcy law usually provides an effective and inexpensive way to permanently resolve a lawsuit. Under Chapter 7 and Chapter 13, the lawsuit is stopped and the underlying debt is eliminated or pared down to an amount the person can afford.

 

If you need assistance in filing for bankruptcy, whether it's Chapter 7 or Chapter 13, contact the law office of Bond & Botes so we can lead you on the right path.