Employee Bankruptcy and Lawsuits

When you file for bankruptcy under any chapter of the Bankruptcy Code, all of your assets become “property” of the bankruptcy estate and becomes subject to administration by the bankruptcy court in which you file. Therefore, if you file for bankruptcy protection at any time after your employment claim arises, your interest in any pending lawsuit also becomes property of the bankruptcy estate, which includes “all legal or equitable interests of the debtor in property as of the commencement of the bankruptcy case.” The relevant date for bankruptcy purposes is when the claim arises – when the event or events at work occurred that are the subject of your lawsuit – not when you actually file your administrative claim or lawsuit itself.

The consequences of your bankruptcy filing can be dramatic. Filing a bankruptcy petition literally robs you of any standing to direct the course of your employment lawsuit – and the authority to receive directly the proceeds of any monetary award obtained in the litigation.

Instead, the bankruptcy court and any trustee appointed by the court to administer your assets have the authority to determine:

• Whether to pursue a cause of action;
• The rate(s) at which any attorney will be compensated for the representation; and,
• Whether and upon which terms to settle the litigation.

Your attorney must obtain the bankruptcy court’s approval to be retained as “special counsel” to pursue the litigation. Needless to say, your attorney may not be eager to continue representing you if there is a chance that he or she will not be retained by the bankruptcy trustee and/or receive the compensation agreed upon when you signed an agreement for representation. That is why you need to inform your attorney immediately, if you have not done so already, once you file for bankruptcy, so that your attorney can take the appropriate steps to be hired by the trustee to continue pursuing your case.

The Bankruptcy Court requires debtors to identify all of their assets on their bankruptcy schedules in order to give the trustee and all creditors the opportunity to decide how to “administer” the bankruptcy estate. 

This means that when you file for bankruptcy, you must disclose, under penalty of perjury, “all suits and administrative proceedings to which the debtor was or is a party within one year immediately preceding the filing of the bankruptcy case.”  Additionally, you must disclose “contingent and unliquidated claims of every nature,” and equitable interests.  You also are obligated to estimate the value of the claims, which you should do in consultation with your employment attorney.

Therefore, any charge pending before the EEOC or any state office of human rights, or other state or federal agency administrative proceeding, as well as any claims pending in any court must be disclosed.

A trustee, with the court’s approval, may decide to wait to receive funds from a pending claim and distribute the proceeds to the debtor’s creditors, or she may decide to “abandon” the claim, at which time any proceeds would go directly to the debtor. In many cases, the trustee will determine that the claim is too speculative or will take too long to prosecute, and therefore will not hold up the timely resolution of the bankruptcy case, and will elect to abandon the claim. Whether the trustee pursues the claim on behalf of the bankruptcy estate and its creditors is up to the trustee’s discretion, but must be determined under the court’s supervision.

Where, however, the trustee does not abandon the claim, the proceeds of the litigation must pass through the bankruptcy estate for distribution to your creditors. If any excess funds are available after all creditors have been paid, the trustee will disburse the remaining funds to the plaintiff/debtor.

If you fail to disclose your employment claim to the bankruptcy court, you cause a predicament for your employment attorney and seriously jeopardize the potential value of your case.

The failure to disclose your claim to the trustee or to the court interferes with the trustee’s and the court’s ability to determine whether to “administer” or “abandon” it. Property of the estate that is not abandoned and that is not administered in the case remains property of the bankruptcy estate. 

A hundred-year old case describes the basic principle followed by bankruptcy courts:

It cannot be that a bankrupt, by omitting to schedule and withholding from his trustee all knowledge of certain property, can, after his estate in bankruptcy has been finally closed up, immediately thereafter assert title to the property on the ground that the trustee had never taken any action in respect to it. If the claim was of value … it was something to which the creditors were entitled, and this bankrupt could not, by withholding knowledge of its existence, obtain a release from his debts and still assert title to the property. 

Courts have found that the creditors should have the opportunity to share in the fruits of any recovery you receive. It does not matter whether you acted in bad faith: courts allow for the possibility of honest error when you come forward offering to share the fruits of the recovery with your creditors.

All states have a list of assets that are exempt from becoming part of the bankruptcy estate, and chances are your workers’ compensation is one of those assets. However, due to complicated nature of some states’ bankruptcy laws, it is best to ask your bankruptcy lawyer about the laws in your state. For example, in California if your workers’ compensation settlement has been modified, like when you receive an advanced payment on the settlement, then your workers’ compensation may no longer be exempt.