How a Bankruptcy Stay Affects Civil Litigation

Originally published by Brent Perry.

As a trial date approaches, bankruptcy may look better and better to a defendant. The complex civil litigation process can be daunting and complex, and for corporations, the prolonged process can be unmanageable, chaotic, and lead to long-lasting personal, professional, and financial repercussions. Depending on the lawsuit, a bankruptcy filing could bring much needed order to a case; however – as is true for many legal matters – it will not resolve all parties’ legal or financial problems. For these reasons and many more, it is important to hire quality legal representation for business and commercial litigation that can provide insight and guidance on how a bankruptcy stay will affect underlying litigation.

What a Bankruptcy Stay Means for Corporate Creditors and/or Corporate Debtors

A bankruptcy stay is a federal court injunction automatically entered when a bankruptcy case is filed, protecting the debtor and the debtor’s property. A bankruptcy stay – sometimes referred to as an automatic stay – is a function of U.S. bankruptcy law that occurs automatically with the filing of bankruptcy by a corporation. The stay is a temporary yet powerful benefit for debtors. The purpose of a stay is to immediately halt and/or prohibit creditors from continuing collection attempts from the debtor that filed for bankruptcy. Corporations without the financial means to repay debts can file for bankruptcy to receive relief from creditors by either reducing or eliminating some of their unpaid debts. Through the power of a bankruptcy stay, the debtor gains much needed time to pause for recovery and to manage its finances without answering to creditors.

Typically, a bankruptcy stay suspends underlying civil litigation; however, a creditor does have the option to file a motion with the court to lift the stay so its lawsuit can resume. This is crucial in cases where a corporate debtor attempts to file for bankruptcy to avoid the consequences of its own fraudulent actions correlated to the debt at issue. One example is a corporate debtor using fraudulent information to secure loans or funding, validating the creditor’s litigation, and, therefore, the debt should not be discharged.

The stay’s impact on litigation against the debtor depends on the circumstances of each case. A stay is intended to be beneficial to a debtor by allowing breathing room to organize its financial situation during the pendency of its bankruptcy filing and associated stay. It is crucial that debtors file bankruptcy in good faith and in a timely manner so the creditors cannot thwart associated stays. Through the guidance of a corporate litigation attorney, a debtor can ensure its stay will remain sound and that it discharges its debts accurately.

How Can a Bankruptcy Stay Be Used?

The full impact of a bankruptcy stay on litigation depends on each party’s underlying lawsuit and the actions the debtor and creditors have taken therein. How a bankruptcy stay can be utilized and the impact it could have on litigation hinge on key components of the lawsuit, such as who filed it and that party’s history of previous bankruptcy filings. Additionally, details from creditors – such as the type of assets attempting to be collected and the chapter the bankruptcy was filed under – determine the weight an automatic stay can have on a lawsuit. Key factors the court will consider in determining the severity of the impact of a bankruptcy stay on existing litigation include the following – however every lawsuit is unique:

Type of Collection Attempt Being Made

Not all collection attempts are the same. The types of collection attempts being made can impact the length of time a stay governs collection attempts as well as the amount of debt to be repaid, if any. Creditors can take action against a debtor entity or that debtor entity’s property. In most cases where a creditor is attempting to collect from a corporate debtor, the automatic stay will remain in place until the debtor receives a discharge. Once a debtor receives a discharge, collection attempts by creditors can legally resume on any debt not included in the discharge. If a debt is discharged, the bankruptcy stay bars its creditors from ever attempt to collect the debt.

The power of a bankruptcy stay also depends on whether the creditor seeks to collect collateral property. Collateral property consists of items governed by agreements between a borrower and a lender. Collateral property is often put up by borrowers to secure a loan; to the lender, the collateral property serves as security on the loan should the borrower fail to meet repayment requirements. Even when a debtor files bankruptcy, that filing does not affect a lender’s entitlement to the value of the collateral property or the property itself. In this case, a debtor must file a statement of intention to either surrender the property used as collateral, reaffirm its original debt, or redeem the value of the collateral property to repay lenders.

Serial Bankruptcy Filers

A debtor that files multiple bankruptcies within a short time period may be considered a serial filer. Depending on the serial filer’s actions and the number of times it has filed for bankruptcy, a court will determine whether to order a stay. If a serial filer has filed three or more bankruptcies within a one-year period, a stay will not be automatic at the time of its third filing. Serial filers who find themselves in this position need to take additional legal action to remedy the first two filings before a stay can be put in place for the third. For debtors who have filed twice in a one-year period, a stay will take effect but only for a limited time – typically 30 days unless additional action is taken to prove extended time is necessary.

Violations of Bankruptcy Stays

Creditors that ignore and violate court-ordered stays violate bankruptcy law. Even creditors whose claims are not dischargeable in bankruptcy must respect the automatic stay. While simple timing and/or a lack of awareness of a bankruptcy stay can cause creditors to unknowingly make collection attempts and thus violate the law. In other cases, creditors are aware of a stay and choose to continue collection attempts. The collection attempts could include discontinuing services, filing liens, or levying property. Debtors do, however, have legal rights against creditors that willfully violate a bankruptcy stay. Depending on the case, a creditor could even be required to compensate the debtor for punitive damages, attorneys’ fees, and compensatory damages incurred.

Houston Bankruptcy Attorneys

Although filing for bankruptcy can prove beneficial to debtors, it is still regarded as a last resort; however, with quality legal representation, debtors can avoid unnecessary and costly, drawn out legal proceedings and focus on rebuilding their finances. It is crucial that debtors select counsel experienced in handling civil litigation involving bankruptcy. Without doing so, debtors could find themselves in an even worse financial situation. If you have questions regarding filing bankruptcy or how a bankruptcy stay could impact your case, contact the Houston civil litigation attorneys of Burford Perry to discuss your case.

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