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What Happens to That Pending State Court Action After Filing Bankruptcy?

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Many bankruptcy debtors file bankruptcy in the midst of being a party to litigation: they have either been sued or are suing someone.   Sometimes the lawsuit is the reason for the bankruptcy filing.  Sometimes other events precipitate the bankruptcy filing (bank levy, wage garnishment, foreclosure, etc).  So what are you supposed to do with the state court litigation?   Depends on whether you are a plaintiff or defendant.  Make an assessment s to what actions can or cannot be taken.  Here are some considerations:

Impact of the Automatic Stay If You Are a Defendant

If you are a defendant who has filed bankruptcy, the litigation (or at least the part in which you are a defendant) is stayed by the bankruptcy filing. The scope and effect of the “automatic stay” is broad.   Note that there are relatively few exceptions to its applicability.  If your case is stayed and you have appeared in the action, you should file and serve a notice of stay (in California there is a judicial council form which you can use) in the court where the litigation is pending.  If you have not appeared, then provide the other party notice of the bankruptcy filing. Unless your case fits within one of the exceptions, the automatic stay prohibits the prosecution of the action against you until the stay terminates or the bankruptcy court makes an order granting “relief from stay” that permits the action to proceed.  Unless the plaintiff’s claim is nondischargeable, you will eventually receive a bankruptcy discharge.  The discharge permanently enjoins the plaintiff from continuing or commencing an action to recover the claim from you as a personal liability. Note that if the plaintiff obtains an order “granting relief from stay” from the bankruptcy court that allows the plaintiff to continue prosecuting the litigation in state court, then special rules govern your attorney, including getting his or her employment approved by the bankruptcy court.

Causes of Action/Claims Are Property of the Bankruptcy Estate If You Are a Plaintiff

If you are a plaintiff or cross-complainant, you need to be aware that the automatic stay does not stay a proceeding that was initiated by the debtor and the cause of action you have been prosecuting is now property of the bankruptcy estate.  The cause of action needs to be scheduled or listed as an asset on the bankruptcy schedules. Your attorney’s continued representation of you will require bankruptcy court approval.   In a Chapter 7 case, the bankruptcy trustee may hire the debtor’s pre-petition counsel as “special counsel”.  In a Chapter 13 case, you may be allowed to prosecute the cause of action but the court will take note of any recovery and may factor it into the Chapter 13 plan process. The failure to schedule a claim or cause of action can become a problem for a debtor who assumes that there is no continuing duty to inform a bankruptcy trustee after a Chapter 7 case is closed.  The cause of action in question must have been “administered” by the trustee otherwise the cause of action is never abandoned back to the debtor.  If the cause of action results in a monetary recovery later on and it was not scheduled, the trustee may be able to collect the proceeds long after the bankruptcy case is closed All of these issues deserve further discussion. Be sure to contact a certified bankruptcy specialist like David A. Arietta. Call the office at (925) 472-8000 with any questions.