They filed for bankruptcy, what can I do?

By Alex Smock

What to know about navigating a case against a defendant in bankruptcy

Imagine you have a personal injury case against the driver of a vehicle, a company that caused your injury while you were working on the jobsite, or the store where you slipped and fell on a wet floor. Then one day, the company files for bankruptcy and your legal case is “stayed”—basically, put on ice until the bankruptcy is concluded.

It’s an all-too-common scenario. While bankruptcy issues are always best brought to the attention of an experienced bankruptcy attorney, here is a brief look at the bankruptcy process and some of the steps a lawyer might take to help you collect as much of your damages as you can from the debtor defendant.

What is bankruptcy?

Bankruptcy is a legal mechanism that permits the discharge of debts by a party to allow them a fresh start while centering comprehensive relief for their creditors.  This may come at the price of the bankruptcy court’s exercise of exclusive oversight of debtor’s property to be distributed to the debtor’s creditors. There are other forms of bankruptcy which may allow the debtor to retain assets while creating a payment plan for her debtors.

Defining Terms

Bankruptcy is a complex area of law that includes terms with bankruptcy specific definitions, which have been defined below to deepen your understanding of the article. 

Debtor: the party that filed for bankruptcy

Creditor: generally, party that has a claim against the debtor that arose at the time or before the court rules on the relief of that party’s claim

Liquidation: the process of selling a debtor’s property with the proceeds to be distributed to creditors (depending on the kind of bankruptcy the debtor may be able to continue their business)

Secured claim: creditor’s claim which holds a right to credit against or sell the debtor’s property to reduce or resolve the amount owed to the creditor; higher priority in distribution of the bankruptcy estate

Unsecured claim: creditor’s claim that is not secured by any collateral and for which there is no priority for payment

Stay: a court order immediately stops substantially all collection and enforcement actions by creditors against the debtor in bankruptcy (also known as an automatic stay)

Motion for relief from stay: motion by the creditor to be brought outside the bankruptcy court to pursue enforcement against the debtor, also known as a stay-relief motion

Superpriority claim: special priority status granted by the court to a claim arising after the filing of the bankruptcy petition, which is typically to cover expenses from the trustee overseeing the bankruptcy proceeding or necessary expenses of preserving collateral

DIP financing priming liens: special kind of loan that receives superpriority status, which assists in financing operations during the bankruptcy case

What tools does bankruptcy grant the debtor?

Upon filing for bankruptcy, the defendant’s assets are protected under an automatic stay, which prevents creditors from beginning or continuing actions against the debtor. When filing, debtors can choose either liquidation or rehabilitation in exchange for the relief from their outstanding debts. Even if the creditor believes that the debtor filed for bankruptcy in “bad faith,” or to abuse the bankruptcy system, the debtor is still entitled to the initial protections provided by the automatic stay until the court lifts it.

What is an automatic stay?

Immediately upon filing for bankruptcy, the debtor is protected by an automatic stay. This tool allows protection against new or further litigation, lien enforcement, and other actions on account of outstanding claims existing against the debtor. Any violations of the stay may be punishable by contempt of court or, in appropriate circumstances, punitive damages. 

If the party who injured me has filed for bankruptcy, can I still pursue my legal claim against them?

Even when the defendant has established bankruptcy, you may be able to seek compensation for your claim. Although the defendant may be generally insulated through the automatic stay, plaintiffs can still pursue claims through a limited set judicial and statutory exceptions.

What is the procedure of pursuing a judicial or statutory exception?

First, the creditor must file a proof of claim within the designated time period. Then, the creditor must request relief from the automatic stay, which can be satisfied by proof of cause. Cause can include many factors including but not limited to undue delay, misconduct, mismanagement, or waste. Generally, motions for relief from stay must be served on all parties who have filed an appearance at the bankruptcy proceeding and requested notice. Under the Bankruptcy Code, the stay is terminated for the party seeking relief 30 days after it is made unless the court orders the stay to continue in effect (§362(e), Bankruptcy Code). Additionally, upon the denial of a stay-relief motion, it is a final, immediately appealable order. In certain circumstances, previous written agreements to enforce the debt, which were renewed after the stay, could remain enforceable. Throughout the bankruptcy proceeding, parties can pursue two kinds of disputes – contested matters and adversary proceedings.

Why would you pursue either a contested matter or an adversary proceeding?

A contested matter can be pursued within the bankruptcy case while an adversary proceeding is a separate case that is associated with the main bankruptcy proceeding. Adversary proceedings are similar to lawsuits outside of bankruptcy courts, but they are still beholden to the umbrella-like authority of the bankruptcy proceeding. Adversary proceedings may permit a creditor to pursue limited issues including preferential transfers, fraudulent transfers, violations of the automatic stay, objections to discharge, and sale of jointly owned property.

Why is it important to file a proof of claim in a bankruptcy case?

Under most provisions of the Bankruptcy Code, it requires creditors to file proofs of claim not later than 70 days after bankruptcy filing to receive a distribution from the bankruptcy estate and join in the administration of the estate. Further, creditors that do not timely submit a proof of claim could be barred from establishing a claim against the estate in its entirety. This proof of claim includes the amount the creditor believes it is owed, and it qualifies as a facial showing of a valid claim and amount. The claim can be either a secured or unsecured claim. However, creditors should understand that filing or proof of claim can subject the creditor to certain consequences, which include providing sufficient evidence to support their claim or risk an unfavorable ruling from the bankruptcy court.   

What legal strategies permit the court to approve the motion for relief from stay?

There are four grounds to obtain relief from the automatic stay: (1) for cause; (2) acts against property; (3) single asset real estate; or (4) acts against real estate. One of the most relevant special circumstances can be accomplished by pursuing damages through the insurance held by the defendant under demonstrated cause. Additionally, the debtor can waive their stay protections; however, the enforceability is still subject to the court’s approval.

How can a creditor satisfy the for “cause” requirement?

Generally, courts have broad discretion to determine if the creditor has sufficient “cause” to grant relief from the automatic stay. However, if the creditor is secured, the court will likely grant relief if there is enough evidence to support the depreciating value of the secured collateral. Aside from this limited exception for lack of adequate protection, the granting of relief is subject to the court’s discretion and the particular facts of each case. The court may grant relief if the debtor wishes to pursue the debtor in a different forum or if the creditor agrees to limit the liability to the extent of the debtor’s insurance coverage.

Why would a debtor agree to a waiver of the stay?

Creditors can pursue waivers of the stay from the debtor. The debtor may agree to a waiver under the condition that the damages will be limited to the extent of the debtor’s insurance policy. This route offers the creditor a path to having their debt satisfied while the debtor is able to dispose of a creditor. However, this waiver still needs to be submitted to the court for approval of removal from the bankruptcy proceeding.

How are debts and claims in bankruptcy prioritized?

There are different chapters in the Bankruptcy Code that provide small variations in distribution. Generally, the Bankruptcy Code embodies the overall principle that the debtor’s limited resources should be equally distributed to all its creditors. However, Congress recognized that the finite amount of compensation to distribute must follow a priority order, which is set out by the Bankruptcy Code. This order allows prioritized creditors to be compensated for their outstanding debt in the prioritized class order via a proportionate share of the remainder of the estate. Congress created prioritized classes including superpriority, secured, priority unsecured, and general unsecured classes.

What is the difference between the different prioritized claims?

Superpriority claims are the first claim to be paid, even before pre-petition secured claims. They are paid in the following order: (1) surcharges against collateral (e.g., costs of maintaining or disposing of collateral that secured a secured creditor’s lien) (2) professional fee carve-out (e.g., fees of bankruptcy professionals) (3) DIP financing priming liens.

Secured claims are the next group to be paid. Secured claims require some collateral of the debtor to be used to recoup the debt. If the amount of the debt is undersecured (exceeds the value of the collateral), the remainder of that debt is considered unsecured in prioritization. A creditor with a perfected pre-petition (before the bankruptcy was filed) security interest in the debtor’s property has priority over all unsecured claims up to the value of its secured collateral.

Priority claims are non-dischargeable debts that receive special status in bankruptcy, which requires the claims to be paid in full event after a bankruptcy discharge is issued.

General unsecured claims are the remaining debts not secured by collateral nor prioritized under the Bankruptcy Code.

What are non-dischargeable debts?

There are debts that cannot be discharged through bankruptcy. Those debts include taxes, student debt, domestic support obligations, willful or malicious injury by the debtor to another entity or to the property of another.

If a plaintiff files a lawsuit against a defendant in bankruptcy, how can creditor meetings allow me to continue to pursue compensation?

After the bankruptcy proceeding is filed and the creditors have been able to submit their claims of proof, the court will eventually hold a Section 341 Meeting of Creditors to allow parties to orally examine the debtor about their bankruptcy schedules, statement of financial affairs, and other matters relating to the bankruptcy filing. This can be a discovery tool for creditors to allow them to determine if the defendant’s assets were improperly concealed or disposed to support an objection for discharge.

If I am unable to receive relief from the debtor, does the stay protection extend to other parties?

Generally, the stay is limited to the debtor and its property. This permits creditors or plaintiffs who are barred from litigation to pursue other legally responsible parties, such as insurance companies that may have indemnified the debtor’s actions.

Don’t let the threat of a defendant’s bankruptcy dissuade you from protecting your rights if you are injured. Contact an attorney as soon as possible to understand your rights and options.

At Arns Davis Law, we have a record of successfully litigating personal injury cases to excellent results for our clients, even in cases where a defendant has declared bankruptcy.