So, the defendant filed for bankruptcy … what’s next?

So, the defendant filed for bankruptcy … what’s next?

By: Amy Geise, Omni Bridgeway
With contributions by Deirdre Carey Brown, ForsheyProstok LLP

A company is pursuing a high-value claim against a defendant. The case is strong on the merits, and a substantial recovery appears to be in the offing.

That is, until the defendant files for bankruptcy.

For many plaintiffs and their counsel, a bankruptcy filing by a defendant can be a daunting prospect. Potentially substantial resources, including additional counsel, may be required to navigate the process. Some plaintiffs may be intimidated into settling their cases for pennies on the dollar or abandoning claims altogether.

But plaintiffs with high-value claims who approach the process strategically can achieve a strong recovery. Plaintiffs should evaluate whether to seek to dismiss the bankruptcy case as a bad faith filing or whether the bankruptcy venue provides advantages for pursuing their claims.   

Litigation finance can be a critical component of this strategy. By obtaining non-recourse funding, a plaintiff can create a strategy that lowers its out-of-pocket costs, reduces its risk, and provides access to the best possible counsel to navigate the bankruptcy process as a judgment creditor—thereby maximizing the potential recovery.

Under 11 U.S.C. § 362, a bankruptcy petition operates as an automatic stay on "the commencement or continuation" of most legal actions against a debtor in possession. Plaintiffs—now creditors of the debtors’ estate—should carefully observe the automatic stay, as there may be serious consequences for violating it.

Faced with this abrupt halt, plaintiffs, who are typically eager to proceed with their claims, often file a motion asking the judge to lift the stay to allow them to continue their case. Not surprisingly, debtors routinely oppose these motions.

A bankruptcy court has several options in responding to a motion to lift a stay. The court may grant the requested relief and allow the case to proceed in its original forum; it may deny the motion altogether, leaving the automatic stay in place and preventing the plaintiff from proceeding; or it may deny the motion without prejudice if it is deemed premature. In addition, parties may seek to remove the case and continue it in federal district or bankruptcy court as an adversary proceeding. In this instance, the removing party files all case information from the trial court with the notice of removal. The case then proceeds in the new forum and a federal or bankruptcy judge takes control of proceedings. If a plaintiff wants to challenge removal, it can ask the bankruptcy court to abstain from exercising jurisdiction and remand the case.

It may seem counterintuitive, but a bankruptcy court can provide an attractive forum for plaintiffs to resolve a case. Disputes tend to resolve more quickly in bankruptcy court because dockets are fast-tracked. Additionally, settlements are commonplace, partially because bankruptcy judges encourage efficient resolutions when cases threaten to drag on. Sometimes, another sitting bankruptcy judge may even mediate the case.

While plaintiffs proceeding against a debtor may need to accept a discount on their claims, the bankruptcy process also provides some security and certainty. Plaintiffs gain real insight into a debtor-defendant’s financial ability to satisfy a judgment. In addition, once a judgment is obtained, debtors-in-possession and fiduciaries are obligated to pay according to the bankruptcy code, thus helping to relieve potential collection headaches.

If parties to litigation decide to settle their claims in bankruptcy, they must comply with the procedural requirements of Rule 9019 of the Federal Rules of Bankruptcy Procedure. A debtor defendant can only settle a case with Bankruptcy Court approval. Under Rule 9019, typically the parties file a motion outlining the settlement terms, describing why it is in the debtor’s best interest, and asking the court to approve the settlement. The motion may draw objections from other creditors or stakeholders in the case. Standing to object is quite broad in this context. 

If a settlement is contentious, the 9019 process may resemble a “mini trial,” complete with pre-hearing discovery and an evidentiary record before the judge. However, if a settlement is not contentious, it can be approved expeditiously, as Rule 9019 only requires 21 days' notice for the court to approve settlements. In larger bankruptcy cases, the Debtor may file a motion setting forth a settlement procedure which further streamlines the process.

Plaintiffs should also monitor a debtor-defendant’s bankruptcy case to ensure that the proposed process will not adversely impact their rights in other ways. Plaintiffs usually choose to file a proof of claim to reserve their rights against the debtor, although a proof of claim does not ensure payment in any sum certain. Plaintiffs should be aware that filing a proof of claim could be deemed to be consenting to the jurisdiction of the bankruptcy court.

Additionally, plaintiffs should track any Chapter 11 plans proposed by the debtor. A debtor may seek to discharge or otherwise impair pre-petition litigation claims in its plan.  A plan may also include a plan injunction prohibiting any further litigation unless leave of court is obtained.  If a plaintiff fails to participate in the plan process, it may end up bound by such unfavorable treatment post-confirmation.

Plaintiffs whose disputes end up in bankruptcy are well-advised to supplement their litigation counsel with an experienced bankruptcy lawyer. Unfortunately, this comes with an added price tag, which may seem particularly unpalatable in the face of a bankruptcy. Litigation funding can help ease this burden by providing nonrecourse capital to help pay attorneys' fees of both litigation and bankruptcy counsel.  The non-recourse nature of dispute finance means that a funder receives a return on its investment only out of recoveries from the case.

During the underwriting process, funders conduct extensive due diligence into potential investments, which often inures to the benefit of the plaintiff seeking funding. Omni Bridgeway’s team includes subject matter experts in various areas of law, including bankruptcy, intellectual property, and insurance. This expertise can help a plaintiff value its claims and determine the best strategic path forward.

Plaintiffs need not give up on potentially lucrative claims if a defendant files for bankruptcy. Though they will face new challenges, they may be able to turn the bankruptcy to their advantage. Support from a litigation funder can help them do so.

To learn more about Omni Bridgeway’s litigation funding capabilities, visit our Company Insights. While there, explore our recent podcasts, blog posts, and videos. Or contact us for a consultation to learn more about the ways we can help you pursue meritorious claims.