Lawsuits By The Debtor During Bankruptcy

It is common knowledge that the Bankruptcy Code stays collection actions “against the debtor,” including lawsuits. When a bankruptcy case is filed, a temporary injunction is automatically and immediately issued against all creditors that freezes all pending lawsuits against the debtor. However, the bankruptcy automatic stay does not prevent debtor lawsuits against a creditor or another party.

While debtor’s lawsuit is not stayed by the bankruptcy laws, the question arises as to whether a Chapter 7 debtor can prosecute the lawsuit. Recently the Sixth Circuit Court of Appeals clarified that only the trustee can file suit in connection with a Chapter 7 debtor’s pre-petition cause of action, unless the action is first abandoned. When a bankruptcy case is filed, a debtor’s lawsuit becomes property of the bankruptcy estate and the debtor is no longer the owner of the lawsuit. Consequently, only the Chapter 7 trustee can prosecute the action; the debtor has no standing to pursue it unless the trustee first abandons the lawsuit and it is no longer property of the bankruptcy estate.

When a lawsuit continues either by or on behalf of a debtor in bankruptcy, there is nothing that prevents a party from defending itself. However, counterclaims against the debtor are generally suspended during the debtor’s bankruptcy. This can create an inequitable situation where the plaintiff can zealously attack while the defendant’s counterclaims are frozen. Consequently, courts differ on the approach to this situation, and a court may encourage a party to apply to the bankruptcy court for relief from the automatic stay. Modification of the automatic stay “for cause” may permit a counterclaim or lawsuit to proceed against a debtor in bankruptcy.

If you have a potential lawsuit that has either not been filed or is pending in a state or federal court, speak with your bankruptcy attorney about the matter. Your interest in the case must be disclosed to the bankruptcy court and trustee. Your bankruptcy attorney can discuss the lawsuit with the trustee and determine whether the trustee wants to become involved in this action. In many cases, the trustee will abandon the interest and the debtor can continue his or her lawsuit.