Will Filing Bankruptcy Stop a Lawsuit?

People in bankruptcy court

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How bankruptcy will affect a lawsuit depends primarily on the type of lawsuit it is or the type of debt that forms the basis for the suit. It also depends on whether you filed the suit or someone else did. Here’s what you need to know about how bankruptcy works and what’s likely to happen to that lawsuit in bankruptcy court.

Bankruptcy Automatic Stay

Bankruptcy is fundamentally a process that brings order to chaos. It is also designed to provide a level playing field so that powerful creditors can’t overrun smaller less resourceful creditors.

To accomplish these goals, the bankruptcy code includes a powerful tool. When you file a bankruptcy case, an injunction springs into action to police creditor collection activity. It’s called the automatic stay. This injunction prevents creditors from taking action that would make administering a case either impossible or not worthwhile.

Creditors have to stop making telephone calls and sending demand letters. They also have to stop foreclosure actions and attempts to repossess the collateral. But sometimes it doesn't happen immediately

A creditor that wants to continue with the collection action has to ask the bankruptcy court to lift the automatic stay. The same is true for a creditor who wants to start a lawsuit outside of bankruptcy court after the bankruptcy case has been filed. The court can order that the stay be lifted under certain strict circumstances, but only after the bankruptcy judge has had an opportunity to review the case to determine if that action serves the interests of the creditor or the debtor.

When a lawsuit is pending, the parties may or may not have to suspend the suit. Some lawsuits have nothing to do with debts. In other cases, having an outside court continue a case can be more efficient and can benefit the work of the bankruptcy court. Here are some different types of lawsuits and how a bankruptcy case affects them.

Collection of a Debt

It’s no surprise that creditors can be very aggressive in collecting past due balances. One tool in their arsenal is the lawsuit.

The creditor who files a lawsuit is expecting that the court will enter a judgment in its favor, settling any questions about your liability and about the amount you owe. The law gives the judgment creditor some collection powers that the creditor doesn’t otherwise have. For instance, the creditor can use that judgment to seize your bank accounts or garnish your wages—in some states. The judgment will also act as a lien against any real estate you have.

Because this lawsuit concerns a debt, the same subject matter, and jurisdiction as the bankruptcy court, the automatic stay will stop the debt collection lawsuit. One of the parties will file what is commonly known as a “Suggestion of Bankruptcy” in the collection suit. This tells the judge in the collection suit that a bankruptcy case is pending. The judge in the collection suit will cease all activity in the collection suit, at least until the bankruptcy court enters a discharge, which signals the court in the collection suit that the ball is now in the bankruptcy court’s court, so to speak. The state court will usually dismiss the case once the debtor receives a discharge in the bankruptcy court.

Judicial Foreclosure Actions

Many states have a procedure for real estate foreclosures that do not require the lender to file a lawsuit, but in some states or certain situations, the lender must get permission from a court to foreclose on the property. Filing a bankruptcy case will stop a self-help foreclosure. It will also stop a judicial foreclosure.  

Divorce, Child Custody, and Other Domestic Actions

Most lawsuits in family law will not have to be stayed or postponed when a bankruptcy case is filed. Many family court judges will put a case on hold until one of the parties gets an order from the bankruptcy court—often called a “comfort” order—to ensure that moving forward in the family court is proper. The bankruptcy court has little or no interest in domestic relations matters and would never presume to interfere with the dissolution of a marriage or with parental rights.

Child Support and Alimony Cases and Bankruptcy

The family court’s imposition of child support or alimony orders could affect a bankruptcy case because of the effect on the debtor’s resources. A bankruptcy court will often reserve jurisdiction over a property settlement to ensure that the debtor’s resources are not depleted in favor of one creditor—spouse or the soon-to-be ex-spouse. But, even then, bankruptcy courts rarely take issue with a property settlement unless it is way beyond the norm.  

A child support creditor—usually the other parent or a state agency—is subject to the automatic stay similar to any other creditor. There is a difference, however. Any debts you owe for child support will not be discharged in the bankruptcy case. If you file a Chapter 13 repayment plan case, you’ll have to pay off your past-due support by the end of the three- to five-year plan. In a Chapter 7 case, the debt will survive the bankruptcy. The creditor can renew collection activities after the bankruptcy court enters the discharge.

The same holds true for court-ordered alimony and spousal maintenance payments. It can also hold true for many property settlement agreements. You should consult with a qualified bankruptcy attorney to discuss the effect of a bankruptcy case on any property settlement agreements.

Code Enforcement and Nuisance Actions

At times, a local government will find it necessary to file a lawsuit to enforce building or construction codes or to get rid of nuisances such as abandoned houses, overgrown alleys, and dangerous dogs. The bankruptcy court will almost always allow these actions to enforce codes or eliminate nuisances. These suits all involve a government's police power and are in place to safeguard the health and welfare of citizens. The courts may impose fines, but otherwise, these actions have little or nothing to do with the collection of debt, although they could lead to new debt in favor of, for example, the municipality for court costs, repairs, and clean-up.

Evictions and Bankruptcy

Special rules will apply if the lawsuit seeks your eviction. In many states, the eviction court will issue a writ of possession to the landlord. This is similar to judgment, and it grants the landlord certain rights, such as the right to remove your possessions from the premises and change the locks. If the court has not yet issued the writ of possession, the automatic stay will stop the eviction unless the landlord certifies that illegal drug use is involved or the property is endangered. If the court issued the writ before you filed your bankruptcy case, the bankruptcy would not protect you unless your state has laws that allow you to catch up on your payments.

Criminal Cases

Just like code enforcement and nuisance suits, criminal cases are a part of the local government’s police powers. The bankruptcy court and the automatic stay will not interfere with any court cases, for example, involving murder or robbery.

The issue is not as clear cut with cases involving money or property, such as bad checks and fines. In general, they can be determined this way: If the goal of the lawsuit is to reimburse the government for a monetary loss, the case is subject to the automatic stay. An example is a highway toll case, where the government is little more than a creditor trying to collect a debt. If the case is primarily seeking to punish you because you broke the law, the case is not subject to the automatic stay and can go forward. For example, you are being prosecuted for writing bad checks. Even though you might have to make the check good as a part of your sentence, the primary purpose of the action is to prosecute a crime.  

Even here, the issue can become more confusing when the office of a government prosecutor is charged with a duty to collect on bad checks. Some offices have staff that does nothing but act as collectors on behalf of people and companies that took a bad check. The prosecutor has no intention of taking the person who wrote the bad check to court. Even though this is clearly a debt collection activity, most bankruptcy courts won’t enforce the automatic stay.

Administrative Actions and Bankruptcy

Many federal agencies have some sort of process for reviewing decisions that affect the populace. Most people are aware of social security and immigration courts. But they’re not the only administrative courts. They can be found in exotic places such as the U.S. Postal Service, the Veterans Administration, and the National Labor Relations Board. Whether actions in these administrative courts will be stayed by the filing of bankruptcy has to be determined on a case-by-case basis. Some actions are principally monetary, while others involve the government’s police powers.

Debtor's Case Against Someone Else

The automatic stay is designed to protect the debtor and the debtor’s property—what we call the property of the bankruptcy estate. For the most part, a debtor can bring an action in another court against a third party without asking the court for permission to lift the automatic stay. But, that may not benefit the debtor in the long run.

Even though the automatic stay may not apply to the debtor’s actions, defendants often have the right to bring countersuits or mount defenses that could potentially run afoul of the automatic stay. No judge will stay or curtail the rights of the defendant while it allows the debtor/plaintiff to move forward unchecked. Therefore, debtors will more often file their suit in the bankruptcy court where it can be overseen and decided by the bankruptcy judge, especially if they’re trying to collect debts to benefit the bankruptcy estate.