Whether bankruptcy will affect a lawsuit depends primarily on the type of case it is and 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
When you file a bankruptcy case, an injunction called an automatic stay springs into action to limit creditor collection activity. An injunction is a court order that requires an entity to either take an action or stop taking an action. 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.
A creditor who 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 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 way to do that is a lawsuit.
A creditor filing a lawsuit expects the court to enter a judgment in its favor, settling any questions about your liability and the amount you owe. A judgment gives the creditor some collection powers that it doesn’t otherwise have. For instance, the creditor can use that judgment to seize your bank accounts or garnish your wages. 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 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. 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 don't 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 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
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 aren't depleted in favor of one creditor. Even then, bankruptcy courts rarely take issue with a property settlement unless it's 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. 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 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 hasn't 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.
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 isn't as clear cut with cases involving money or property, such as bad checks and fines. In general, 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 isn't subject to the automatic stay and can go forward. For example, you're 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.
Administrative court cases, like Social Security and immigration, are decided on a case-by-case basis.
Debtor's Case Against Someone Else
The automatic stay is designed to protect the debtor and the debtor’s property—known as 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 a 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.