Sometimes in a lawsuit, one of the parties involved (a plaintiff or a defendant) may file a bankruptcy. The filing of a bankruptcy may have significant consequences for the lawsuit.
If a plaintiff files a bankruptcy (depending on the type or “chapter” of the bankruptcy), the plaintiff may lose the ability to continue prosecuting the lawsuit against a defendant. When a plaintiff files a bankruptcy, the lawsuit becomes an asset of the “bankruptcy estate.” Thereafter, in certain chapters of bankruptcy, only the bankruptcy trustee (not the plaintiff) has the right to pursue the lawsuit. Thus, a disadvantage for a plaintiff filing a bankruptcy is that the plaintiff loses the right to control the lawsuit, and the bankruptcy trustee has the exclusive right to settle, abandon or pursue the lawsuit against the defendant.
If a defendant files the bankruptcy, the plaintiff and the court must stop all court proceedings against the defendant, and the plaintiff must get permission from the bankruptcy court to continue to proceed with the lawsuit against the debtor defendant. Further, it may not be worthwhile to do so. If the defendant has no assets, the plaintiff may have no ability to collect a judgment even if the plaintiff wins. Also, many of the claims that a plaintiff may have against a debtor/defendant are debts which are “dischargeable” in a bankruptcy. If a debt is dischargeable, it means that the debtor defendant has no obligation to pay anything, even if the plaintiff wins. Examples of debts that are commonly dischargeable are judgments on claims for negligence and breach of contract. Examples of debts which are commonly not dischargeable are judgments on claims for fraud, assault, fraudulent transfers, or intentional infliction of emotional distress. Even if a plaintiff’s lawsuit involves a claim which may not be dischargeable, a plaintiff will still need to act quickly in a bankruptcy to have the bankruptcy court make a decision that a debt is not dischargeable.
In some cases where a defendant who files a bankruptcy has assets, it may not be necessary or worthwhile to continue pursuing a lawsuit against the defendant. In such cases, a plaintiff/creditor may be able to simply file a “proof of claim” with the bankruptcy court. The debtor or the trustee must then object to the claim. If no objection is filed, or if the claim is allowed, the creditor will paid a certain percentage of the assets in the bankruptcy estate. However, the problem for a creditor is that if there are numerous other creditors and/or if the trustee’s administrative expenses are significant, creditors will only recover a small percentage of the total amount owed.