It is common in litigation to have numerous parties on each side. If one defendant files bankruptcy, exclusive jurisdiction of all ongoing matters is transferred to the federal bankruptcy court and the action outside of the bankruptcy court is automatically halted (“stayed.”) But assuming there is more than one defendant but only one files bankruptcy, what happens to the rest of the legal action against the other defendants? That question is answered in this article.
When a Co-Defendant Files Bankruptcy: Key Points for Plaintiffs
A bankruptcy filing stops the case against the defendant who filed, but it does not automatically stop the case against everyone else.
- Automatic stay: Filing for bankruptcy triggers a stay under 11 U.S.C. § 362(a) that bars starting or continuing proceedings against the debtor, including enforcing earlier judgments against the debtor or estate property.
- Co-defendants: The stay generally protects only the debtor, so claims against non-bankrupt co-defendants can usually continue.
- Limited exception: A court may halt the whole action in limited cases, such as when the debtor is an indispensable party.
- Your options: You can pursue the debtor in bankruptcy court, and some debts, such as those based on fraud or willful and malicious injury, may be excluded from discharge if you ask the court to decide.
The Automatic Stay:
When a debtor initiates bankruptcy proceedings, an automatic stay immediately goes into effect preventing any actions against the debtor and the debtor’s property. 11 USC §§ 103(a), 362(a). The automatic stay applies in all Chapters of bankruptcy. Further, even if the bankruptcy filing is a sham, the automatic stay still goes into effect. Wekell v. United States (9th Cir. 1994) 14 F3d 32, 33.
1. Application of the automatic stay
Pursuant to 11 U.S.C. § 362(a)(1), the automatic stay prohibits creditors and other parties from commencing or continuing an action against the debtor that was or could have been commenced pre-petition. Additionally, the automatic stay prevents creditors from enforcing a pre-bankruptcy judgment against the debtor or its property, i.e., “any act to obtain possession of property of the estate.” 11 U.S.C. § 362(a)(3).
Although the automatic stay does not prevent the debtor from appealing claims made by the debtor, the debtor may not appeal claims against him while the automatic stay is in place. Parker v. Bain, 68 F.3d 1131, 1137–1138.
Know Your Options
A Defendant’s Bankruptcy Raises Hard Questions. You Do Not Have to Sort Them Out Alone.
When one defendant files for bankruptcy, it can leave you unsure what happens next to your claims and to the other parties in the case. SS&R Law Corporation helps California clients understand where their case stands and what options they have. Schedule a consultation and talk it through.
Schedule a Consultation2. Application to third parties
However, the automatic stay does not protect nonbankrupt third parties even when the codefendants are closely related to the debtor. U.S. v. Dos Cabezas Corp. (9th Cir. 1993) 995 F.2d 1486, 1491 (“the automatic stay does not extend to actions against parties other than the debtor, such as codebtors and sureties.”) California courts have held that bankruptcy of one defendant in a multidefendant case does not stay the proceeding as to the other defendants. Queenie, Ltd. v. Nygard Int’l (2nd Cir. 2003) 321 F3d 282, 287; In re Miller (9th Cir. BAP 2001) 262 BR 499, 503-504 & fn. 6; Fortier v. Dona Anna Plaza Partners (10th Cir. 1984) 747 F2d 1324, 1329-1330.
However, courts have made exceptions where the debtor is an indispensable party to the pending action. In these instances, the court may issue an injunction to stay the entire action. United States v. Dos Cabezas Corp. (9th Cir. 1993) 995 F2d 1486, 1491, fn. 3. Generally, an indispensable party is a party that must be included in the instant action in order for relief to be granted.
3. Penalty for violating automatic stay
Should an individual willfully violate the stay, the debtor, if injured, shall recover actual damages and possibly punitive damages. 11 U.S.C. § 362(k)(1).
Co-Defendant Bankruptcy: Common Questions
The case against the defendant who filed is halted by the automatic stay, and the claims move to the bankruptcy process. The other defendants are generally not protected by the stay, so the case against them can usually continue. Their role in the dispute may shift once the bankrupt party is no longer participating.
The automatic stay takes effect when a bankruptcy petition is filed. Under 11 U.S.C. section 362(a), it bars starting or continuing proceedings against the debtor, enforcing earlier judgments against the debtor or estate property, and acts to take estate property. It lasts until a court ends it or the case is closed, dismissed, or ends in a discharge.
Generally, no. Courts have held that the stay does not extend to codebtors, sureties, or other defendants in a multi-defendant case, even when they are closely connected to the debtor. The stay is aimed at the person who filed, so claims against the remaining defendants can usually go forward.
In limited cases, yes. A court may enjoin the whole action when the bankrupt defendant is an indispensable party, meaning one whose presence is required to grant relief. This is the exception, not the rule, and it depends on the facts of the case and the role the debtor plays.
A willful violation can carry real consequences. Under 11 U.S.C. section 362(k)(1), an individual injured by a willful stay violation can recover actual damages, costs, and attorney’s fees, and punitive damages in appropriate circumstances.
Possibly, but the claim goes through bankruptcy court. A debt based on fraud or willful and malicious injury may be excluded from discharge under 11 U.S.C. section 523, but you must ask the court to decide, and the deadline is generally 60 days after the first date set for the creditors’ meeting.
Tactics:
Keep in mind that it is possible to continue the claim against the bankrupt who denies liability in an adversarial proceeding in the bankruptcy forum. See our article on Bankruptcy. Further, if the debt was predicated on nondischargeable claims (intentional wrong doing, for example) bankruptcy protection may be denied for that debt and that argument should be advanced in that forum.
A typical and appropriate reaction of a plaintiff receiving notice of bankruptcy of a single defendant in a multi defendant action is to dismiss that party from the action and proceed independently in the bankruptcy forum for that particular claim. The remainder of the case against the other defendants continues in the original forum. Careful analysis of the role of the bankrupt defendant in terms of establishing liability against the other defendants must be made. One may be sure that the remaining defendants will seek to claim that the now “missing” defendant was at fault and they are innocent of any liability.
