After you file a petition for Chapter 7 bankruptcy, the court appoints a trustee to manage your estate -- all of your assets that are not exempt and that can be liquidated (sold) to pay your creditors. In a Chapter 13 bankruptcy, the trustee sets up a repayment schedule, which allows you to make monthly payments over several years on a portion of your outstanding debts. When the process of liquidation or repayment is complete, the bankruptcy is discharged. A discharge legally closes the case and cancels all debts that the law considers "dischargeable."
Workers' compensation laws provide for medical services and cash benefits to workers injured on the job. The laws protect employers from legal liability for the injury, while work comp insurance companies provide benefits according to the requirements of state law governing work comp claims. Workers who have filed a claim have the option to settle it by accepting a lump-sum payment, which ends the insurance company's obligation to provide medical and monthly cash benefits.
Each state has its own laws spelling out which assets are exempt from seizure by the trustee. In most cases, this includes workers' compensation cash benefits, which are considered income. Some states exempt benefits that are paid prior to or during the bankruptcy; other states do not exempt settlements paid before you file for bankruptcy. In all states, the law considers workers' comp benefits to be income in the "means test" that determines whether you are entitled to bankruptcy protection, under either Chapter 7 or Chapter 13. Some state laws do allow a trustee to seize a work comp settlement that you have modified. For example, in California, if you agree to an advance payment on the settlement, or to structured settlement payments from a third party, the money may become "non-exempt" and subject to seizure by the trustee.
State and Federal Exemptions
Some states allow you to choose between state and federal exemptions when filing for bankruptcy protection. However, there is no provision in federal law for the exemption of workers' compensation benefits. Therefore, if you file for bankruptcy, you would have to select the state exemptions in order to protect the workers' comp settlement while the bankruptcy case is open.
After a bankruptcy is discharged, dischargeable debts are cancelled and the trustee has no further claim on your assets, whether or not they are considered exempt by the law. This includes workers' compensation benefits or a settlement amount. The law does not allow the trustee to keep a bankruptcy case open indefinitely in order to seize non-exempt assets, nor does it allow a trustee to seize any asset after the discharge. However, debts like income taxes, child support and federally guaranteed student loans generally are not discharged, and your work comp settlement money can be subject to a garnishment or lien by the IRS or another agency.