A Chapter 7 “Straight Bankruptcy” Can . . . Help You Avoid or Escape Litigation When Closing Down Your Business

Ongoing litigation, or the threat of it, against you and/or your business, usually dies with your bankruptcy filing.

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A Chapter 7 case can help by:

  • immediately stopping most litigation against you and/or your business, at least temporarily;
  • permanently stopping most litigation by legally discharging the disputed claim; and
  • providing strong disincentives for your adversary to keep pursuing you after your bankruptcy filing.

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This series of blogs is about the benefits of filing a bankruptcy case when closing down your business. The reality is that businesses are often closed as a consequence of litigation, or the threat of litigation, against the business or business owner. These disputes can take every possible form—by way of example, simple collection actions by creditors, contractual disputes with customers, enforcement action by governmental regulators, and fights with other business owners or investors. A bankruptcy often becomes 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. The business is often already on the ropes, and the judgment, or just the financial and emotional costs of the lawsuit, or sometimes even just the threat of one is enough to persuade the business owner to throw in the towel and close down the business.

The question is: what will happen to the dispute and/or litigation against you and/or the business?

Litigation Immediately Stopped by the “Automatic Stay”

The automatic stay legally stops creditors from taking any new collection action against you, and from continuing any action, including litigation. It is imposed simultaneously with the filing of your bankruptcy, 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, and often persuades him to do nothing further against you.

Why Most Disputes Will End at Your Bankruptcy Filing

This immediate stopping of collection and litigation usually ends up being permanent, for a number of reasons.

Your adversary is usually trying to get you or the business to pay something, and that alleged obligation is discharged—legally written off permanently—in your Chapter 7 case.  

Bankruptcy law does allow any of your creditors (including those with alleged claims of any kind) to try to object to the discharge of their debts or claims. But these objections are relatively rare, for two reasons:

1. They are difficult for a creditor to win. The legal grounds for objections are relatively narrow. Debts are assumed discharged unless the creditor can prove to the bankruptcy court that those narrow grounds are met. Instead of just proving the existence of a valid debt or claim, as in a conventional lawsuit, 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.

2. The creditor is faced with practical indications that it is wasting its time and money to pursue you further. In filing bankruptcy, you present to the court a rather detailed set of specific information about your finances. You are able to be questioned by the creditors about those documents and about anything else relevant to the discharge of the debts. When these reveal that you genuinely have nothing worth chasing—which is almost always the case—most creditors accept that pursuing you further will do them no good.

The Exceptions:  Disputes Not Be Stopped by Your Bankruptcy Filing

There are two sets of exceptions: 1) when you are not protected by the automatic stay; and 2) when a creditor challenges the discharge of its debt or claim. These will be addressed in the next two blogs. 

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