If your company is being sued when it files for Chapter 11, the lawsuit stops. As soon as the petition is filed, nothing can move. The automatic stay kicks in, holding your lawsuit on ice. All creditors, lenders, partners, etc. are barred from continuing an action or proceeding against the company – practically all collection activities are suspended. It’s completely stayed, no movement whatsoever.
That does not make the claim go away. But the Chapter 11 will complicate matters for the other side because they will need to obtain an order from the Bankruptcy Court to “get off the automatic stay” so they can actually try to win the case.
So where does the claim end up? Look at it from the plaintiff’s side. If you get your case out of the automatic stay, it gets moved back to the original court where it was filed. Then the case proceeds there as usual. If not, the claim gets lumped in with all the other claims against the company and handled in bankruptcy.
Relief from the Stay
Section 362(d)(1) of the Bankruptcy Code says the judge “shall” grant relief from the stay “for cause.” But what’s the “cause” that makes it okay to let them make the lawsuit go forward? Over the years courts have given the term “cause” lots of different meanings. Some apply a list of twelve factors, or even more. So even though the Bankruptcy Code says the judge “shall” lift the stay, in practice the judge doesn’t always have to lift it. It depends on what you call “cause.” There’s a long list of factors that lawyers like to argue about, but at the end of the day it’s the judge’s discretion that counts. Each request is decided case by case.
A Case Out of Oklahoma
A case out of Oklahoma shows how a judge actually works through this. In June 2013 Choice ATM sued Petrig in federal court in Oklahoma for a declaratory judgment on a commission agreement. In April 2014, Petrig counterclaimed, alleging breach of contract, fraud, fiduciary duty, and unjust enrichment. Trial was scheduled for December 15, 2014. Just 12 days before, Choice asked the court to stay the trial, explaining that it planned to file a Chapter 11 petition. The court granted the motion to stay on December 5. On December 12, Choice filed for Chapter 11, and the automatic stay kicked in. Petrig asked the bankruptcy judge to lift it, to move the case back out to the district court. Choice, for its part, moved to withdraw the district court case without prejudice.
That left a choice. The bankruptcy judge must decide whether to leave the case in the district court or resolve the claims in bankruptcy via estimation under section 502(c). Estimation just determines how much the claim is probably worth. It saves time and money. There is no binding precedent on the applicable test. So the judge asked four practical questions.
- Which forum serves judicial economy?
- What forum will prevent unnecessary expense and delay?
- Will the claim be critical to the reorganization?
- Does the claim require expertise beyond the bankruptcy court?
All four answers pointed the same way. The motion was denied, and the claims stayed in the bankruptcy case.
On judicial economy, the trial in district court had not yet started. The discovery the parties had already taken could be used in bankruptcy court too. In other words, even if the lawsuit remained stalled, its subject matter and evidence would be available for estimation. Estimation could be expedited. There would be no redundancy or delay or duplication. It would be cheaper than trial.
On cost, the picture was much the same. Discovery and pretrial motions had been done but Choice had not yet started to prepare for trial; Choice knew a month in advance that it would file bankruptcy before trial, and thus there was no need for Choice to prepare for trial. Less expense and delay for everyone.
The third point carried the most weight. If allowed in full, Petrig’s claims would be the largest claims against the estate. If the biggest claim against your company is still up in the air, you don’t have a handle on the risk. You don’t know what you are dealing with. Estimating it fits the twin aims of Chapter 11: preserve the business as a going concern and maximize value of the estate for creditors. A long, expensive trial in another court does neither. It’s inefficient. It’s the opposite of cost-effective. Doing a quick estimation is less burden on management, less expense to the estate. The claims are critical to the reorganization, which made it all the more important to keep them in the bankruptcy case.
Finally, Petrig’s claims were a contract and fraud dispute, the kind of thing bankruptcy judges handle all the time. In the court’s view, the skill required to estimate the claims does not require any special expertise beyond the competence of the bankruptcy court. The judge closed by pointing to section 502(c) itself. Congress intends bankruptcy courts to resolve all claims, including contingent and disputed claims, quickly and thereby preserve the going-concern value of the debtor and its creditors.
What Does That Mean for You
What does that mean for you? The lesson is that filing Chapter 11 will not make a lawsuit go away. A Chapter 11 filing is not an end-run to avoid a lawsuit. What it does is keep the lawsuit from moving forward until a court decides whether the claim is better handled outside bankruptcy or not. In the right case, it can also make the other side’s claims subject to a quick estimation. The Choice ATM factors give a sense of when that is likely: a trial that has not started, discovery that can be reused, a claim big enough to shape the reorganization, and issues a bankruptcy judge can handle. It’s hard to predict in any particular case how a judge will decide, but this case should provide some guidance.
