• Home
  • Bankruptcy in Brief
  • ABC’s of Bankruptcy
  • Considering Bankruptcy
  • True Stories
  • Chapter 13
  • Blog
  • About
  • TOC

Northern California Bankruptcy Lawyer

On The Bankruptcy Soapbox

The Soap Box
  • How bankruptcy works
  • Mortgage Matters
  • Consumer Rights
  • You & Your Lawyer
  • Small Business
  • Family Law

All You Need To Know About Bankruptcy Stay & Pending Litigation

By Cathy Moran

bankruptcy during litigation

When a trial date looms, bankruptcy may look better and better to a defendant.

Bankruptcy can be the emergency exit from a bad situation that is about to get worse.

That’s because every bankruptcy case comes with an  automatic stay .  That’s  a federal court injunction automatically entered when a bankruptcy case is filed, protecting the debtor and his property.

What does that mean, really, when the stay is imposed while litigation is underway?

Stay halts suit against debtor

The stay stops all parties from continuing the lawsuit in any way against the person who has filed bankruptcy.

The stay is in force, whether or not anyone has received notice of the bankruptcy.

Debtor’s counsel usually wants to notify all parties of the filing, long ahead of any notice of the bankruptcy case that may go out from the bankruptcy court clerk.  Some courts have a form used to provide notice to the court of the stay.

If someone goes ahead with actions against the debtor in violation of the stay, those acts are void or voidable.   (In the 9th Circuit, it’s “void”) .  So if a foreclosure sale takes place after the stay is imposed, the sale is void and of no legal effect.

Deliberate actions in violation of the stay expose the actor to damages, including punitive damages and attorneys fees.

The debtor’s damages include attorneys fees to stop the violation and collect those fees and damages.

Bankruptcy stay in Chapter 13 protects co debtors 

If the lawsuit involves a consumer debt, anyone who is jointly liable with the debtor is protected by the stay when the debtor chooses Chapter 13.

A consumer debt is defined as  “debt incurred by an individual primarily for a personal, family, or household purpose.” § 101(8)

Even though the co debtor didn’t file bankruptcy themselves, they get this protection because it’s seen as protecting the debtor as well.

The co debtor stay can be lifted by a motion for relief from the stay if the Chapter 13 plan doesn’t propose to pay the debt in full.

Suit may continue against others

Other defendants in business cases often hope that the bankruptcy of one of the defendants will stop the suit all together.

Sometimes, a filing has that effect for a while, as the trial court and the parties try to sort out what to do next.  But the injunction created by the bankruptcy court actually protects only the debtor.

The suit in a non bankruptcy court may proceed against other defendants.  The debtor may be required to appear as a non party witness in the suit as it resumes, but absent relief from the stay, the debtor is shielded.

Most courts hold that non bankruptcy actions can continue against corporations or other artificial entities owned by the debtor, even though a successful case against the debtor’s corporation may impair the value of the debtor’s asset and therefore impact the debtor’s bankruptcy case.

Trying multi-party actions including the debtor

Strategically, those suing the debtor may want to avoid going forward with the suit, with the debtor’s chair at the defendant’s table empty.  After all, one of the first things we learned in law school was to fill up all the chairs with those potentially liable.

Two options are available.  Litigants can seek to remove the suit to bankruptcy court under 28 U.S.C. 1441 and try the claim in bankruptcy court or the district court.

Alternatively, litigants can seek relief from the automatic stay to try the case against the debtor and his codefendants, under the condition that any judgment obtained at trial be returned to bankruptcy court for enforcement.

Dischargeability not an exception to the stay

Even creditors whose claims are not dischargeable in bankruptcy must respect the automatic stay.  There is no exception just because you know, or hope, that your claim will survive the bankruptcy.

There is a long list of actions not within the scope of the stay, found in subsection b of 362, headed by carve-outs for criminal matters; family law actions for paternity and status; tax assessments (but not collection).

Discharge provides permanent injunction

 The automatic stay terminates when property is no longer “property of the estate”.  The protection of the debtor and his assets, current and future, is replaced by the discharge injunction.

So, unless the claim you are prosecuting before bankruptcy against the debtor is non dischargeable, you are not free to resume suit against the debtor once the discharge is entered.

How to proceed

Most state court judges have been conditioned to hold hard when there is a suggestion of bankruptcy.  Restarting a pending suit against remaining defendants is often facilitated by seeking an order granting relief from the automatic stay, or a “comfort order” that there is no stay that prevents continuation of litigation.

More

Chapter 13 rescues debtor

What to do when you’re sued

When bankruptcy is the right choice

Image courtesy of Geralt and Pixabay

More from the Soapbox

  • Chapter 13 Keeps You In ControlChapter 13 Keeps You In Control
  • The Unexpected Loss When Tax Returns Filed LateThe Unexpected Loss When Tax Returns Filed Late
  • How Your Property Gets Sold In Your Partner’s BankruptcyHow Your Property Gets Sold In Your Partner’s Bankruptcy
  • Protecting Your Co signor When You Can’t PayProtecting Your Co signor When You Can’t Pay
  • Audited? Did You Tell The State Tax Authorities?Audited? Did You Tell The State Tax Authorities?

Filed Under: Consumer Rights

About Cathy Moran

I'm a veteran bankruptcy lawyer and consumer advocate in California's Silicon Valley. I write, teach, and speak in the hopes of expanding understanding of how bankruptcy can make life better in a family's future.

Bankruptcy Basics

About The Soapbox

You’ve arrived at the Bankruptcy Soapbox, a resource of bankruptcy information and consumer law.

Soapbox is a companion site to Bankruptcy in Brief, where I try to be largely explanatory and even handed (Note I said “try”).

Here, I allow myself to tell stories and express strong opinions. We dig deeper into how to consider bankruptcy and navigate a bankruptcy case.

Moran Law Group
Bankruptcy specialists for individuals and small businesses in the San Francisco Bay Area

How Bankruptcy Works

How To Pay For Bankruptcy When You’re Flat Broke

One of the cosmic ironies of our legal system is that it costs money to file bankruptcy. Bankruptcy gets you out of debt only if you have the money to file. The costs of bankruptcy include the filing fee collected by the court; the required credit counseling; and, if you're smart, an experienced lawyer to make sure … Read more

More Posts from this Category

643 Bair Island Road
Suite 403
Redwood City, CA 94063
Phone: (650) 694-4700
Phone: (650) 368-4700

Categories

All content copyright © Moran Law Group. All rights reserved.