The Effect of Bankruptcy on a Lawsuit

by Patricia Dzikowski

Filing for bankruptcy will stop most lawsuits in their tracks. Whether you file a Chapter 7 liquidation bankruptcy or a Chapter 13 repayment plan, upon your filing, the bankruptcy law automatically prohibits most collection actions against you from going forward. The ban applies to lawsuits that began before the bankruptcy as well as future claims that are based on things that happened before you filed. It generally remains in effect until you receive a discharge or until the court gives the creditor permission to proceed.

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Automatic Stay

The "automatic stay" that goes into effect upon your bankruptcy filing is a temporary injunction, or ban, on collection activity. It stops most garnishments and foreclosure proceedings, car repossessions, personal injury suits, contract actions and collection activities on debt including student loans, taxes, business liabilities, credit cards and medical bills. There are some exceptions. For example, it does not stop child or domestic support actions. It also does not stop a party from defending a lawsuit that you filed and may be limited or not apply at all if you filed another bankruptcy case within the year.

Notice

Although the stay takes effect automatically at the instant you file, as a practical matter, there must be some form of notice given to your creditors so they know to stop collection activity. Initially, when you file for bankruptcy, you must provide the bankruptcy court with a list of all your creditors, including people or entities who are suing you or who have a potential claim against you, valid or not, but have not yet filed suit. The list must include a name and address for each. The bankruptcy court uses this information to send each of these creditors notice of your bankruptcy filing, informing them of the automatic stay. If you are involved in a lawsuit, your attorney will likely file notice of your bankruptcy, called a “suggestion of bankruptcy,” in that proceeding. This notifies parties to the suit that the automatic stay is in place and, in most cases, halts the court action even before the bankruptcy court notice is mailed.

Stay Relief

There are limited situations in which the bankruptcy court will allow a creditor to continue a lawsuit. A formal request, however, must be made by the creditor. If the issue being litigated is just your liability on a contract claim or account, the request will likely be denied. Secured creditors, such as mortgage holders or creditors holding a lien on your vehicle, may be granted relief from the stay to enforce their liens through foreclosure or repossession if you are not making payments. The court also may grant relief to creditors pursuing a claim which is covered by insurance, so that the creditor can have the claim amount determined and collect against the insurance proceeds. Personal injury claims are also generally given permission to proceed outside the bankruptcy court so that the liability and amount of the creditor claim, if any, can be set.

Violations

Violations of the stay are taken very seriously in the bankruptcy court. Violators are commonly brought before the bankruptcy court for sanctions. Sanctions are generally monetary awards covering your actual damages, which are often represented by the attorneys fees you incurred to make the creditor stop. They can be awarded if the court finds the creditor’s actions to be willful. To be willful, a creditor must have violated the stay with knowledge that the bankruptcy was filed and without a good faith belief that some exception applied to his actions. Even if the creditor did not receive formal notice of the bankruptcy, when it comes to violations of the automatic stay, informal knowledge of the filing may be sufficient to support a finding that the action was willful. If the court finds the creditor’s action to be particularly outrageous, punative damages may also be awarded.