If you bring a lawsuit or have the right to bring one against someone for a personal injury case, that's considered an asset during your bankruptcy case. Just like other assets, this may be protected by a bankruptcy exemption. If the potential personal injury reward isn't protected or fully protected by an exemption, the nonexempt portion of the award can be used to pay off your creditors as part of your bankruptcy case.
Written by Attorney Curtis Lee.
Updated June 8, 2022
If you have the right to file a lawsuit against someone, that right (sometimes called a “cause of action”) is an asset. That’s true even though there aren’t any guarantees that you’ll receive money from the case. And because it’s an asset, it’s something you need to disclose to the bankruptcy court.
This article will explain why it’s important to disclose this asset and cooperate with the bankruptcy trustee. It will also cover whether you can keep money from your lawsuit (and how much).
How To Disclose Your Lawsuit to the Bankruptcy Court
When you file bankruptcy, you have to list your ongoing lawsuit in response to Question 33 on your Schedule A/B. If a lawsuit hasn’t yet been filed, you’ll list the potential cause of action instead. You’ll also need to list the lawsuit in response to Question 9 on your Statement of Financial Affairs.
If you’ve already received money from your lawsuit — such as winning at trial or agreeing to a settlement — then things are a little different. In this situation, the funds themselves are the asset. Whether you keep the money depends on what form it’s in. Cash sitting in a bank account will be treated differently than proceeds from an annuity, for example. Another factor is if any bankruptcy exemptions apply to your lawsuit proceeds.
Why It’s Important To Disclose This Asset
It’s important to disclose your interest in a lawsuit or cause of action. Failure to do so can have serious consequences. For instance, if you don’t list this asset on your bankruptcy forms, the court could dismiss your case without discharging your debts.
Also, if you tell the bankruptcy court that you don’t have a claim against someone else, this can be used against you in the other lawsuit. If you intentionally exclude your potential cause of action on your bankruptcy schedules, the defendant in the other lawsuit can argue that you shouldn’t be allowed to pursue your lawsuit against them. In other words, you can't say one thing to one court and the opposite to another court.
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Lawsuits Under Chapter 7
In Chapter 7 cases, your creditors are entitled to certain assets that exist when you file bankruptcy. Except for limited circumstances dealing with inheritances, you can keep any assets or property that you receive or become entitled to receive after you file bankruptcy. This is part of what getting a fresh start is about.
This means if you get in an accident after your Chapter 7 bankruptcy has been filed, you can keep all of the money from the resulting lawsuit or settlement. But it doesn’t mean that simply waiting to file your lawsuit allows you to keep this asset out of your bankruptcy estate. It's the date you obtain the right to sue (such as the day of the accident) that matters, not the date you file your lawsuit.
Things get a little more complicated if your lawsuit isn’t due to an accident. This is because it’s easy to miss the fact that you have the right to file a lawsuit. As a result, you might inadvertently fail to list the potential lawsuit in your bankruptcy filings. If this happens, the bankruptcy court might still conclude that based on the circumstances, you had a legal cause of action that should have been disclosed to the bankruptcy court. How the court makes this determination depends largely on state laws and the details of your situation.
As long as this was an honest and reasonable mistake, the court probably won’t dismiss your case or otherwise punish you for failing to disclose the lawsuit. But the court will add the cause of action to your bankruptcy estate.
Lawsuits Under Chapter 13
In Chapter 13 bankruptcy, certain "after-acquired property" gets pulled into the bankruptcy estate. After-acquired property could be money, a potential lawsuit, or personal items that you receive after you file Chapter 13 but before you complete your repayment plan and get a discharge. Some Chapter 13 repayment plans take up to five years to complete. Because of this, it’s not uncommon for Chapter 13 filers to experience a change in their financial situation while their bankruptcy case is in process.
So if you have an accident after you file bankruptcy but during your repayment plan, the money you’re entitled to receive may need to be turned over to the bankruptcy trustee. If this happens, it becomes important that you make sure your medical providers have their liens in place (more on this below). If the liens aren’t created, you could potentially lose any money you get from your lawsuit but still have to pay back the unpaid medical bills that weren’t discharged during the bankruptcy process.
Medical Liens To Pay Your Medical Bills
If your cause of action relates to an accident, make sure you talk to your personal injury attorney about medical liens. If you don’t have a lawyer, talk to your medical providers about them. Medical liens help make sure you can get treatment for your injuries while ensuring your medical providers get paid.
Medical liens work by placing a hold on the money you win in the lawsuit. This makes it possible for your doctors to essentially “call dibs” on the money generated by the lawsuit. This allows them to get paid without worrying the bankruptcy court will take the money instead.
If you don’t have a medical lien, the trustee could distribute the funds from your accident lawsuit to your creditors instead. In this case, your medical providers wouldn’t get any money from your lawsuit to pay for your medical expenses. And you’d be responsible for paying for your treatment because charges incurred after you file your bankruptcy aren’t included in your Chapter 13 repayment plan. Without the money from the lawsuit, you’d have to repay the debt on your own.
This is why it’s extremely important to make sure that you have a medical lien in place. In some states, these liens get filed with a local recorder’s office and become public record. But not all states require a formal lien to be recorded.
Bankruptcy Exemptions To Protect Money From Lawsuits
Even if you don't have the money from a pending or potential lawsuit yet, you still have to list your lawsuit in your bankruptcy documents. But that doesn’t mean you’ll lose all of the money from the lawsuit. As mentioned, current or potential lawsuits are assets. Bankruptcy law includes exemptions to protect some or all of your assets.
Federal bankruptcy exemptions protect up to $27,900 received as the result of a personal bodily injury (with some exceptions). Federal bankruptcy exemptions also protect:
Payments you receive to compensate you for lost future earnings, at least to the extent necessary to support you
Payments you receive due to the wrongful death of certain individuals to the extent necessary to support you
All payments you’re entitled to receive under a crime victim’s reparation law
If you are in an “opt-out” state (one that doesn’t use federal exemptions), you have to look to your state's exemptions to determine whether the money you get from a lawsuit is protected. Some states have explicit exemptions for that purpose. Others have wildcard exemptions you can use to protect various types of assets, including money from a potential lawsuit. Yet others have no protections at all, not even for funds you’ll receive due to an injury you sustained.
If you plan to file bankruptcy while there’s a potential lawsuit that could lead to you recovering money, you’ll need to remember a few other things. If you have a lawyer to handle your bankruptcy case, they’ll most likely make arrangements for you. But if you’re handling the bankruptcy process on your own, here are two more things to think about.
Keeping Your Lawsuit Attorney
If you have an attorney helping you with your lawsuit, make sure you talk to them about your bankruptcy. In some cases, the trustee might take over your case and continue the lawsuit on behalf of your creditors. In other cases, it might make more sense for your lawsuit attorney to stay involved since they’re the person you’re comfortable with and they know the facts of your case.
If you do want your lawsuit attorney to continue working on your lawsuit, you’ll need the bankruptcy court’s permission. You can get that by asking the court to appoint your lawsuit attorney to continue handling the case. The best way to do this is by having your attorney contact the trustee as soon as possible. Your attorney can alert the trustee of the pending claim and tell the trustee they’re willing and able to stay on the case.
As long as your attorney is appointed by the court, they’ll get paid for the work they put in. If your lawsuit includes potential compensation for personal injuries, your attorney will probably work on a contingency fee arrangement.
Cooperating With the Bankruptcy Trustee
Even if your cause of action isn’t protected by any exemptions, it’s still important that you cooperate with the trustee. This includes working with the trustee when they try to recover money from the lawsuit and give it to your creditors. Being uncooperative with the trustee is one of the easiest ways to put your discharge at risk. In other words, a strategy of “if I can’t have the money, then neither can the creditors” isn’t a good idea.
Generally speaking, you can keep money that you receive from a lawsuit during a bankruptcy case if it’s protected by bankruptcy exemptions. If you recover more money from the lawsuit than is protected by exemptions, you’ll likely have to hand over the excess amount to the bankruptcy court.
The most important thing to remember is that you get plenty of benefits from a bankruptcy, such as the automatic stay and a discharge of your debts. And if you don’t file bankruptcy your creditors can still reach any funds you receive from a lawsuit. So depending on what you’re dealing with, it may still make sense to file for bankruptcy even if that means you’ll lose part or all of the money from the lawsuit.