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The Impact of Bankruptcy on Liability Claims and Lawsuits

The term “liability claim” is indeed very broad but it commonly means that one party is seeking money (damages) from another person. This is typically due to negligence, breach of contract, or through a personal guarantee on a promissory note.

Car accidents, slip and fall cases, product liability cases, and breach of contract in a business immediately come to mind. But it could go beyond such situations, to include malfeasance, malpractice, personal or business disputes or just simply failing to perform a service or provide a product as promised. Sometimes, liability claims can be enormous, into the millions of dollars.

While liability claims frequently end up with a lawsuit being filed, that isn’t always the case and they can just linger there for years. A simple demand letter from a creditor stating that you owe a debt based on any number of circumstances is frequently how these claims start.

Often, people are shocked when a liability claim is asserted against them, not ever having contemplated being in such a situation or how it could have even happened. How will I pay this debt, and could I lose everything I own because of it? What will this mean for my future and the protection of my family? These are moments of panic that happen to just about all of us sometime during our lifetime.

It is exactly at these moments in our lives that we should seek out expert advice on how to deal with the problem and to educate ourselves on what options are available.

While filing bankruptcy to resolve a liability claim is sometimes the ultimate answer, it is premature to jump to that conclusion. Creditor and trial attorneys know the law and they usually have a general idea of what bankruptcy is and that just about anyone can file a bankruptcy to get their financial emergency under control, be it a personal bankruptcy or a corporate one.

That said, an analysis of your entire financial picture (be it personal, business, or a bit of both) frequently resolves liability claims through clear and intelligent communication between the parties. After all, creditors normally just want money, and knowing what would happen if the person they are seeking to collect from files bankruptcy is very important and powerful leverage.

The Types of Liability Claims That a Bankruptcy May Discharge

Bankruptcy can discharge many types of liability claims, from auto accidents to business claims. The general rule is that all liability claims (or debts) are dischargeable in bankruptcy unless there is something specific in the bankruptcy statutes that states otherwise. In the bankruptcy world, they call these limitations “exceptions to discharge.”

Some exceptions to a bankruptcy discharge may include debts based on some type of fraud (the creditor must prove it), an injury to a person or their property that was “willful” or “malicious” or restitution ordered in another case. The bankruptcy law also specifically excepts from discharge claims caused by the operation of a motor vehicle while a person is intoxicated from drugs or alcohol. Additionally, most environmental violations or fines are exceptions to discharge. That said, just about every other type of liability claim is wiped out (discharged) in bankruptcy.

Chapter 7 Bankruptcy

A Chapter 7 bankruptcy can wipe out most liability claims that are caused by honest mistakes, miscalculations, and unfortunate circumstances. A big category of liability claims is those resulting from motor vehicle accidents. Perhaps you didn’t have enough vehicle insurance (or no insurance at all!) Chapter 7 bankruptcies can normally wipe out these liability claims and even qualify you to get your driver’s license back (if it was suspended due to a liability claim

Chapter 7 is also very effective in discharging liability claims when there just isn’t enough insurance coverage (or no coverage) for accidents that happen at home, work, or on the road. In some ways, a bankruptcy is a safety net when financial claims are just too much to handle and now threaten your income, your home, and other assets.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy cases include all of the power to wipe out liability claims as in Chapter 7. For a variety of reasons, filing Chapter 7 may just not available or simply too risky to file. Yet, the good news is that a Chapter 13 bankruptcy is just as effective in discharging liability claims and sometimes it is even better.

Each case is very unique and must be analyzed, but Chapter 13 gives a debtor a lot of flexibility to pay back some important debts (perhaps debts that just can’t be avoided, such as child support, alimony, taxes, etc.) while at the same time getting full protection from other debts, including liability claims.

Bankruptcy and Liability Claims for Plaintiffs

Yes, the filing of a bankruptcy petition can be filed and stops the pending action in the lawsuit.

In the vast majority of cases, the answer is yes. There are always some exceptions, but stopping, clearing and wiping-out a lawsuit debt is a very common thing we do.

An allowed claim in a bankruptcy means a creditor has filed a claim with the clerk of the court (stating what they are owed) and it also means that the bankruptcy court as approved (or allowed) the claim.  A creditor must have an allowed claim to receive any payment from the Trustee.

If there is a lawsuit filed against more than one party and that party is the only person filing bankruptcy, there are two possible scenarios depending on which chapter of bankruptcy is filed.

In a Chapter 7 bankruptcy, the other defendant(s) are not protected, and the lawsuit may continue against the other defendants without delay.

In a Chapter 13 bankruptcy, the other defendant may be protected (and the lawsuit stopped) if the lawsuit concerns a consumer debt. If the lawsuit relates to a non-consumer debt (like a business debt) then the other defendant(s) are not protected.  Even if the lawsuit concerns a consumer debt, the plaintiff can ask the bankruptcy court for permission to proceed with the lawsuit or the Chapter 13 debtor could offer to pay the debt back in his or her Chapter 13 Plan.  The debtor would then have an opportunity to object to this request and normally this happens if the plan provides for repayment.

It depends. Credit is a complicated subject matter to study.  There are literally secret calculations used to determine a person’s credit score.  FICO is a private formula by a private company and their formula changes all the time.

So, is a judgment worse than a bankruptcy?  No, not if you are completely broke and your credit is ruined or about to be ruined by too much debt. In that case, bankruptcy is ultimately helpful to the rebuilding of credit.  On the other hand, bankruptcy could be much worse than a judgment if it could be handled in a satisfactory way, such as making arrangements with the creditor.

Every case is so different and the answer you get depends on the circumstances at hand.

Judgments can create liens against a person’s real estate.  That is scary and could be much worse than bankruptcy.

Bankruptcy and Liability Claims for Defendants

Many states, including Nebraska, protect personal injury awards even if a bankruptcy is filed, to the extent reasonably necessary for your support and that of your family. In other words, the award or settlement is not something that the bankruptcy trustee can take from you.

Whether you are at risk of losing your personal injury award depends on the state in which you file or the state or federal exemption laws that apply.  It varies from state to state and it can also vary depending on when you file. By comparison, the State of Iowa does not have a personal injury exemption.  Thus, it is critical to determine what exemptions apply before knowing what is protected.

Absolutely yes!

All assets (including potential or contingent assets) must be disclosed in a bankruptcy petition. Always tell your attorney every little detail so that they can help protect you from severe consequences.

Notify your attorney upfront that there is an actual or potential for a personal injury settlement so the asset is disclosed properly in the bankruptcy petition. The attorney can then provide you with the information needed going forward - such as retaining an attorney for the lawsuit or accepting a settlement.

Each state is different and exemptions to protect your personal injury claim vary a lot. Nebraska provides very generous protections. The worst thing you can do is fail to list this claim on your bankruptcy. Failure to list an asset means that it is entirely not protected.

Most personal injury settlements in Nebraska are exempt, however, in Iowa, the Trustee may claim all or part of the proceeds depending on the settlement.

Outside of bankruptcy, and depending on the state, a creditor may be able to attach, claim or execute upon a personal injury settlement. That said, it isn’t something that is often seen in day-to-day practice, yet it is so important to consult with a knowledgeable attorney regarding this great question.

In Nebraska, most personal injury settlements are exempt. However, in Iowa, the Trustee may claim all or part of the proceeds depending on the settlement. No matter what, you need to disclose this asset on your bankruptcy petition to protect it. There are many different approaches to protecting assets and achieving a good, fair, and legal outcome in most cases.