Can I Become Bankrupt Through a Civil Lawsuit?

by Cindy Hill
Litigation can drive a debtor into bankruptcy.

Litigation can drive a debtor into bankruptcy.

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Civil litigation can force you into bankruptcy, but planning ahead with appropriate business structures can blunt the negative impact of litigation by limiting liability. Civil lawsuits may result in a judgment and award of attorney's fees and costs against you, but even the costs of successfully defending a suit may propel you toward bankruptcy. While bankruptcy is usually a choice made by the debtor, there are ways for judgment creditors to force you into bankruptcy.

Civil Litigation Expenses

Engaging in civil litigation can be expensive. If those expenses exceed your resources, a civil lawsuit can lead to bankruptcy. Although the costs of a typical civil lawsuit rarely exceeds $10,000, this may break the bank for many. Factors that may contribute to more expensive litigation include fees for an attorney's time, complexity of the litigation, expert witness or medical records fees, and whether the litigants have economic motivation to drive up the expense of the lawsuit. Complex business litigation between major companies can cost in the millions of dollars. Even if you prevail in a lawsuit, the attorney's fees and costs of litigation can significantly reduce the judgment amount.

Forced Bankruptcy

Bankruptcy is usually a choice made by a debtor, but often the debtor's hand is forced when a creditor files a lawsuit or obtains a civil judgment the debtor cannot pay. In such cases, the debtor may file voluntary bankruptcy if he feels there is no choice but to do so. If you are faced with a large civil judgment or other debts and refuse to file voluntary bankruptcy, your creditors can, in some circumstances, compel you into involuntary bankruptcy. If you have less than twelve creditors, a single creditor -- such as a civil litigation judgment holder -- with a claim exceeding the statutorily-set threshold amount can file an involuntary bankruptcy petition.

Minimizing Risk

You can help minimize your risk of incurring negative impacts from civil litigation by carefully structuring your business to reduce liability. Operating as an LLC rather than sole proprietor can help limit contractual liability and other common business risks. Incorporating and securing appropriate business insurance provides even greater protection against personal liability than an LLC. Vigilance in accounting as well as in hiring, supervision and workplace safety practices can also help minimize the risk of expensive civil litigation that can bankrupt you and your business.

Importance of Pre-Planning

Pre-planning is critical to minimizing the potential for civil litigation leading to bankruptcy. Asset protection strategies must be in place prior to any litigation or legal collection action being instigated, or you risk accusations of fraudulent transfer. Conveying assets to another person or another business entity so that it becomes inaccessible to a creditor or legal opponent, especially if the transfer is made for less than the fair market value of the asset, can be considered fraudulent, and a court can order you to rescind the transaction.