Bankruptcy Litigation

by Will Newman

People are broadly familiar with the legal process in which a person or a company seeks relief from its debts.  But it may not occur to them how often a bankruptcy is the source of high-stakes litigation.  The rules that govern bankruptcy litigation are so complex that specialized courts handle these cases, with judges—and usually lawyers—who work exclusively on bankruptcy.  Many of the issues involved are interesting.

Why should you continue to read this post about bankruptcy litigation?

  • You just looked at your own bank account, and you’re getting nervous.

  • You’re playing an ultra-realistic game of Monopoly.

  • You didn’t think about bankruptcy court much before and you want to do so for, like, two minutes, maximum.

Bankruptcy Law in Federal Law

Unlike many other commercial matters that can be heard in state court, all bankruptcy proceedings in the United States take place in federal court.  But instead of commencing in the same district courts that hear nearly all other disputes and criminal matters, a debtor commences proceedings in a specialized bankruptcy court.

Like other courts, however, decisions of the bankruptcy are subject to appeal.  In the first instance, appeals from the bankruptcy court go to the district court, the same court that hears other types of cases.  And appeals from any decision of the district court related to a bankruptcy are subject to appeal in the federal courts of appeals and, if it agrees to hear the case, by the U.S. Supreme Court.

The Automatic Stay

Once a debtor commences bankruptcy proceedings, a statute generally requires all other lawsuits involving the debtor and her assets be paused.  This is called the “automatic stay.”  The purpose of the stay is to give the debtor relief from efforts by creditors to collect her assets and to centralize the distribution of her assets in the bankruptcy court.  The stay does not just apply to federal court; it also stops lawsuits in state courts as well.

Creditors may dispute the stay, however, because they do not want interference to their lawsuit or because they want all of the money from the lawsuit without sharing it with other creditors.  It may not be clear that a particular lawsuit really involves the debtor or her property.  And so creditors may argue in the bankruptcy court or in the court hearing her dispute that stay does not apply.

A Trustee Marshals the Debtor’s Assets

Once a debtor declares bankruptcy, the court may appoint a trustee who collects all of the debtor’s assets so they can be distributed to creditors.  The debtor may herself start lawsuits to collect assets that third parties hold that should go to the debtor’s creditors.  For example, if the debtor gave away assets, the trustee may litigate in an “adversary proceeding” to “claw back” those assets so the trustee may properly distribute them to creditors.

Creditors Rights

Once a person or entity declares bankruptcy, creditors will seek to make sure they receive payment from the bankruptcy estate.  Creditors may file a statement of claim, arguing they are entitled to assets from the bankruptcy estate.  And there may be litigation about the legitimacy of those claims.

Whether a Debt Is Dischargeable

At the conclusion of bankruptcy proceedings, the bankruptcy court can release her from her debts and contract claims.  Creditors, however, may challenge some debts as being non-dischargeable, arguing that the debt should continue, even after the debtor declares bankruptcy.  Student loan debts, for example, are usually non-dischargeable, as are debts arising from the debtor’s own fraudulent conduct.  Creditors make these challenges because they still want to get paid and they want the debtor to avoid saying they are free from the debt because of the bankruptcy. The debtor, of course, wants to be free of the debt.  And so bankruptcy court will hear arguments about whether the debt should be cancelled or survive bankruptcy.

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