Will Filing Bankruptcy Stop a Lawsuit?

Filing bankruptcy can stop lawsuits over debts, but it won't stop others. Getty

How a 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.

The 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 those 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 collateral.

A creditor that wants to continue with the collection action has to ask the bankruptcy court for 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.

Collect 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 case once the debtor receives a discharge in the bankruptcy court.

Judicial Foreclosure Actions

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

Divorce, Child Custody, Child Support, Alimony, and Other Domestic Actions

Most lawsuits in family law will not have to be stayed 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.

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 - the soon-to-be ex-spouse. But, even then, bankruptcy courts rarely take issue with a property settlement unless it is way out of whack.  

A child support creditor (usually the other parent or a state agency) is subject to the automatic stay like 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 like 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 collection of debt, although they could lead to a new debt in favor of the municipality for court costs, repairs, cleaning up, and the like.

Evictions

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 a judgment, and it grants the landlord certain rights, like 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 will not protect you unless your state has laws that allow you to catch up your payments.

Criminal Cases

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

The issue is a little murkier when we talk about cases that involve money or property, like bad checks and fines. In general, we can differentiate them 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. A good example of this kind of case is one over highway tolls. In that case, 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. A good example is a case that prosecutes you 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 get even more confusing when the office of a government prosecutor is charged with a duty to collect on bad checks. Some offices have staff that do nothing but act as collectors on behalf of people and companies that took a bad check. The prosecutor has no intention of taking to court the person who wrote the back check. Even though this is clearly a debt collection activity, most bankruptcy courts won’t enforce the automatic stay.

Administrative Actions

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 like the US Postal Service, the Veterans Administration, and the National Labor Relations Board, Whether actions in these administrative courts will be stayed by the filing of a bankruptcy has to be determined on a case-by-case basis. Some actions are principally monetary, while others involve the government’s police powers.

When the Debtor Wants to Bring a Case Against Someone Else

To this point, we’ve talked about cases filed against someone who files a bankruptcy. Does the automatic stay apply when the debtor files a case against someone else?

The automatic stay is designed to protect the debtor and the debtor’s property (what we call 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 through 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 suits 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.