Bankruptcy and Its Impact on Related Litigation

In simple terms, bankruptcy is a term for a federal court procedure to help individuals and businesses erase their debts and repay their creditors. A bankruptcy filed in a federal court can have a ripple effect on other ongoing litigation in both federal and state court, as well as potential future litigation.

If a party is involved in litigation in a state court, federal law provides that the state court action is stayed upon the filing of a bankruptcy petition. A bankruptcy stay, in essence, halts the case and future proceedings. The stay begins the moment the bankruptcy petition is filed, preventing creditors from continuing collection activities. While not an exhaustive list, this stay applies to the commencement or continuation of a judicial proceeding, as well as any action to collect, assess, or recover on a claim against the debtor that arose before the commencement of the case, affecting those cases wherein the claim arose prior to the debtor filing bankruptcy. This includes all actions including personal injury cases against the petitioner. While there are ways to have the stay lifted, the stay can cause a potential standstill in all litigation involving the individual or company who filed for bankruptcy.

A bankruptcy stay also raises issues relating to claims by co-defendants. What about their claims for indemnification? Often times insurance policies will contain what is called a self-insured retention (“SIR”), which requires the insured to pay for their defense and indemnity or a judgment up to a specific amount. What if there is a SIR in the policy? Are attorneys handling the case required to file as creditor to the company for their legal services? Be sure to follow along for the next part of our 4-part series answering these questions and outlining some of the ripple effects that bankruptcy can have on other litigation.

If your business is involved in litigation with a bankrupt party, or has potential claims against a party contemplating bankruptcy, please contact Joseph V. Leone, Joshua A. Filzer, or Stephen M. Hennessy or call us at (732) 545-4717.