Can My Business Be Sued While Going Through Bankruptcy?

 When a business files for bankruptcy, it may experience a temporary sense of relief from creditors and other parties who are seeking to recover debts. However, many business owners wonder whether the protection provided by bankruptcy is enough to shield their business from lawsuits during the bankruptcy process. The short answer is: it depends. While bankruptcy does offer certain protections, there are still circumstances under which a business could be sued, and there are specific legal processes to consider.

In this article, we will examine whether a business can be sued during bankruptcy, the protections provided by bankruptcy, the potential exceptions, and the actions a business can take to mitigate the risk of lawsuits during this process.

1. The Automatic Stay: What It Means for Lawsuits

One of the key protections provided by bankruptcy is the automatic stay. The automatic stay is a provision that immediately takes effect when a business files for bankruptcy. It halts most collection activities, including lawsuits, wage garnishments, and creditor calls, allowing the business to focus on reorganizing or liquidating its assets.

How the Automatic Stay Works:

• Prevents New Lawsuits: Once bankruptcy is filed, the automatic stay prevents most creditors from initiating new lawsuits to recover debts. This protection applies to unsecured creditors (such as credit card companies, suppliers, and vendors), as well as secured creditors (such as banks holding liens on property).

• Stops Ongoing Lawsuits: If your business is already involved in a lawsuit when bankruptcy is filed, the automatic stay also stops the proceedings. If a judgment has not been entered, the lawsuit is put on hold. If a judgment has been entered, creditors are generally prevented from trying to collect the judgment while the bankruptcy case is ongoing.

• Applies to Most Creditors: The automatic stay covers most creditors, but there are exceptions. For example, in certain cases, lawsuits related to child support or alimony obligations may continue despite the automatic stay.

2. Can a Business Be Sued After Bankruptcy Is Filed?

While the automatic stay halts most lawsuits, there are specific circumstances where lawsuits can still proceed despite the bankruptcy filing. These exceptions include:

A. Motion to Lift the Automatic Stay

Creditors or other parties involved in lawsuits against the business can file a motion with the bankruptcy court to lift the automatic stay. If the court grants this motion, the lawsuit can continue despite the bankruptcy filing. Creditors may argue that continuing the lawsuit is necessary to preserve their rights, especially if they believe the business has assets or that the bankruptcy will not resolve their concerns.

For example, if a creditor believes that the bankruptcy case is a sham or that they will be unable to recover their debt through bankruptcy, they may seek permission from the court to continue their lawsuit.

B. Fraudulent Activity and Bad Faith

If the business is involved in fraudulent activity or other bad faith actions leading up to or during the bankruptcy, the automatic stay may be lifted. Creditors can argue that the business’s actions should disqualify it from bankruptcy protection. Fraudulent actions, such as intentionally incurring debt with no intention of paying it or transferring assets to avoid repayment, can expose the business to lawsuits even during bankruptcy.

For instance, if a business is found to be hiding assets or engaging in fraudulent transactions to protect them from creditors, it could face lawsuits for fraudulent conveyance or other offenses, even after the bankruptcy filing.

C. Personal Injury or Property Damage Claims

Certain types of claims are excluded from the protection of the automatic stay. Personal injury or property damage lawsuits may proceed during bankruptcy if the lawsuit was filed before the bankruptcy case and involves issues related to the business’s operations. For example, if someone is injured at a business location or there is damage to a product or service provided by the business, those claims could continue even if the business is undergoing bankruptcy.

However, if the claim is related to the business’s financial obligations (such as unpaid debts), the automatic stay will generally apply.

D. Claims for Taxes or Government Enforcement

The automatic stay does not apply to all legal claims. Claims for certain tax obligations or government enforcement actions (such as regulatory fines) may continue during bankruptcy proceedings. For example, the IRS may still pursue collection efforts for unpaid taxes, and regulatory authorities can enforce penalties for violations of laws, even if the business is in bankruptcy.

• Tax Liabilities: In some bankruptcy cases, a business may seek to discharge certain tax liabilities, but other tax claims (such as payroll taxes or fraud penalties) may not be subject to discharge. The IRS can continue its efforts to collect taxes during the bankruptcy process, which may involve ongoing lawsuits.

• Regulatory Enforcement: Government agencies may continue enforcement actions for violations of health, safety, environmental, or other regulatory laws. Bankruptcy does not shield the business from these types of lawsuits.

E. Post-Bankruptcy Legal Claims

Even after the bankruptcy case is closed, certain claims may arise that are not covered by the discharge or may be excluded from bankruptcy protection. For example, if a business enters into a new legal contract after bankruptcy and fails to honor it, the other party may file a lawsuit seeking compensation.

3. What Happens If a Business is Sued During Bankruptcy?

If your business is sued during bankruptcy, it’s essential to respond appropriately to protect your interests. Here’s what could happen and how to handle it:

A. Bankruptcy Court’s Involvement

When a lawsuit is filed during bankruptcy, the bankruptcy court will be the ultimate authority on whether the lawsuit can proceed. The court will consider whether the claim is subject to the automatic stay or whether there are exceptions that justify lifting the stay. In some cases, the court may decide that a claim should be allowed to proceed to ensure justice for the injured party or that the lawsuit is essential for the protection of creditor interests.

B. Legal Defense

While the bankruptcy court may pause a lawsuit, the business may still need to prepare a defense if the lawsuit is permitted to continue. Legal counsel will be crucial in navigating the complexities of the bankruptcy process while addressing the lawsuit's claims. The business will need to work with both bankruptcy and litigation attorneys to ensure proper representation in court.

C. Impact on Bankruptcy Proceedings

If the lawsuit is allowed to continue during bankruptcy, it could significantly impact the overall bankruptcy case. For example, if the business is ordered to pay a judgment, this could affect the reorganization plan in a Chapter 11 bankruptcy or reduce the proceeds available for creditors in a Chapter 7 liquidation. Similarly, the financial burden of the lawsuit could hinder the business’s ability to recover or settle its debts, complicating the bankruptcy process.

4. Strategies to Protect Against Lawsuits During Bankruptcy

To minimize the risk of lawsuits during bankruptcy, businesses can take several steps before, during, and after filing for bankruptcy:

A. Seek Legal Advice Early

Consulting with a bankruptcy attorney early in the process is critical. A legal expert can help assess the situation and provide guidance on whether bankruptcy is the right option, how to protect the business from lawsuits, and how to comply with the bankruptcy code. Additionally, your attorney can help you prepare a strategy for handling any lawsuits that may arise during the bankruptcy process.

B. Resolve Debts and Legal Issues Before Filing

If possible, resolving outstanding debts and legal issues before filing for bankruptcy may help minimize the risk of future lawsuits. This could involve negotiating settlements, paying off certain creditors, or taking steps to avoid fraudulent transactions that might lead to legal complications later.

C. Communicate with Creditors

Open communication with creditors and other parties involved in lawsuits can sometimes help resolve disputes outside of court. In some cases, creditors may agree to hold off on pursuing legal action if they know the business is in bankruptcy and attempting to reorganize or settle debts.

5. Conclusion

While bankruptcy does offer important protections for businesses, including the automatic stay, it does not offer absolute immunity from lawsuits. Depending on the type of lawsuit and the circumstances, a business may still be sued during bankruptcy. The key to navigating these challenges is working closely with legal counsel, understanding the nuances of bankruptcy law, and ensuring compliance with both the bankruptcy code and other legal requirements. By taking these steps, a business can better protect itself from the legal risks that may arise during bankruptcy proceedings and move toward a resolution that benefits both the business and its creditors.