You can prevent a threatened lawsuit against you or your business, or resolve an ongoing one, by filing bankruptcy.
Business Disputes and Litigation
A business, especially one on shaky ground already, can be brought to its knees by a lawsuit, or the threat of a lawsuit, against the business or business owner.
Business disputes leading to litigation can take every possible form. Examples include simple collection actions by creditors, contractual disputes with a major customer, enforcement action by a governmental regulator, and fights with the business’ co-owners or investors.
Filing bankruptcy can become necessary when either the opposing party wins a judgment against the business and/or the owner, or the business runs out of money to pay the attorney fees and other costs of litigation. If the business is already hurting financially, the judgment can push it over the edge. Or the financial and emotional costs of the lawsuit, or sometimes even just the threat of a serious lawsuit, can be enough to persuade the business owner to throw in the towel and close down the business.
So what’s the effect of filing bankruptcy on the business dispute and/or lawsuit?
Litigation Immediately Stopped by the “Automatic Stay”
The “automatic stay” is the federal law that stops virtually all collection actions by creditors or claimants against the person filing bankruptcy. The “automatic stay” legally stops creditors from taking any new collection action against you, and from continuing any action. So it prevents lawsuits from being filed or from continuing.
The “automatic stay” is, as the name indicates, automatic with the filing of the bankruptcy case. It is imposed simultaneously at the filing, without a judge needing to sign an order. The automatic stay requires your adversary to at least take a pause in his efforts against you. Those efforts can’t continue without a court order from the bankruptcy judge. Often the bankruptcy filing persuades your adversary to do nothing further against you, to not ask the judge for that permission to proceed.
Why Most Business Disputes End at Your Bankruptcy Filing
This immediate stop to any litigation usually ends up being permanent for one primary reason—your adversary is trying to get you or the business to pay something, but that alleged obligation will be discharged—legally written off permanently—in your Chapter 7 case. There’s no point for your adversary to get a court to give it a judgment about an obligation you owe if that obligation is just going to get wiped away in bankruptcy.
Why Debt Discharge Is Not Often Disputed
Bankruptcy law does allow your creditors (including those with alleged claims of any kind) to try to object to the discharge of their debts or claims. But these formal objections are relatively rare, for two reasons:
1. They are difficult for a creditor to win and prevent the discharge of the obligation. The legal grounds for objections are relatively narrow, generally requiring intentional misrepresentation or fraud on your part. Most standard business debts and obligations can be discharged. Debts are assumed discharged in the law unless the creditor can prove to the bankruptcy court that those narrow fraud-related grounds are met. Instead of just proving the existence of a valid debt or claim, as in a conventional lawsuit, now the creditor has to provide convincing evidence that you engaged in certain specific bad behavior, such as fraud in incurring the debt, embezzlement, larceny, fraud as a fiduciary, or intentional and malicious injury to a person or property. These circumstances often don’t apply at all to your situation, and even if they might they are difficult to prove.
2. When you file bankruptcy, in the process you often provide the creditor with persuasive information that it is wasting its time and money to pursue you further. In your bankruptcy documents you present to the court and to your adversary information about your finances that usually show that you genuinely have nothing worth chasing. As a result most creditors accept that pursuing you further would be not be worthwhile.
If you are dealing with a business dispute or lawsuit while you are shutting down your business, filing a Chapter 7 “straight bankruptcy” case will:
immediately stop virtually all lawsuits against you and/or your business, either temporarily or permanently;
permanently stop most lawsuits by legally discharging (legally writing off) the debt or the disputed claim; and
provide strong practical disincentives for your adversary to keep pursuing you after your bankruptcy filing even when it may believe it has legal grounds to do so.