The Effect of Bankruptcy Filing on Creditor’s Litigation in New York

It is not uncommon when our firm is involved in litigation against a debtor, that the debtor files for bankruptcy protection. In the United States, bankruptcy law is federally governed, and a debtor in the New York metropolitan area would file for such protection in the United States District Court for the Southern District of New York or United States District Court for the Eastern District of New York. The Southern District governs filings in Manhattan (New York County), the Bronx, and Westchester County, while the Eastern District covers filings in Brooklyn, Queens, and Long Island.

There are several different types of bankruptcy filings, depending on whether the debtor is an individual or a corporate entity. In addition, a debtor may file for liquidation, under which all eligible debts are discharged, or reorganization, in which the debtor submits a plan to make partial payment of their debts over a scheduled period of time. Not all debts are eligible for discharge under a bankruptcy filing. While this blog is not intended to be a comprehensive bankruptcy primer, debts such as child support obligations and student loan obligations are not dischargable under current bankruptcy law. When necessary, we consult and recommend specialized bankruptcy counsel with whom we work in concert.

By law, when a debtor files for bankruptcy protection, all litigation and collection efforts from the creditor must cease. This is known as the “automatic stay.” The automatic stay provides protection to the debtor from all pending lawsuits, collection of all judgments, and communications with respect to delinquent obligations. For example, one of our clients had an income execution relating to a judgment that we had obtained against the debtor. After several years of collecting a portion of the judgment through the income execution, the debtor filed for bankruptcy protection. Our firm was required to inform the sheriff’s office that the debtor had filed bankruptcy, and the income execution was closed. Once the judgment was discharged by the Court, we were legally prohibited from further collection of the judgment, much to our client’s dismay.

Another one of our clients filed for bankruptcy several years ago. After his debts were discharged by the Bankruptcy Court, he received notice that a lien had been placed on the shares of a cooperative apartment by the judgment creditor. By law, such a lien is impermissible. Our firm contacted the creditor’s firm and obtained a release of lien and removed the judgment from our client’s record.

When a debt is secured by property, such as a car loan, house loan, or any debt for which there is a security interest, another option is available to creditors. A creditor may make a motion in the Bankruptcy Court, requesting that the Court “lift the stay” as to the collateral. What this means is that the creditor will be allowed to enforce their rights as to the property which was pledged as security for the debt. For example, if the debtor has a car loan, and then files bankruptcy, the creditor may ask the Court to lift the automatic stay as to the car, so that the car may be repossessed by the creditor. This legal remedy may be applied to any type of property which is pledged as security for a loan. The Court, under certain conditions, may give the creditor permission to proceed against the loan’s collateral, while continuing to protect the debtor against collection efforts.

Of course, there are many other legal issues which can arise when a debtor files bankruptcy during litigation. We recommend consulting with our firm to discuss the legal actions which are permitted, and which are forbidden by the federal bankruptcy code.