What Happens to Collections Lawsuits When I File for Bankruptcy?

 

It is common for those filing for Chapter 7 or Chapter 13 bankruptcy to have already been sued for collections in Michigan state court.

Depending upon the specific debt and creditor involved, a collections lawsuit is typically filed 30-90 days after the debt becomes delinquent and is referred to a collections attorney by the creditor, the creditor’s collection agency, or the creditor’s “subsequent assign” or “assignee.”

That last type of entity is a debt buyer or aggregator such as Midland Funding or Portfolio Recovery or others. Frequently, collections lawsuits in Michigan are filed with captions of this sort: “Midland Funding LLC, Assignee of Citibank, NA.”

It may be, in fact, that the receipt of summons and complaint for contractual breach and damages in a collections matter is the trigger for a decision to consult with a Michigan bankruptcy attorney.

The primary fear is, of course, wage garnishment or bank account garnishment.

These are reasonable fears to maintain when you have been sued for collections.

In Michigan, the outcome of a successful collections lawsuit is a court-ordered money judgment. This is the award for the damages the creditor is alleged to have suffered due to your contractual breach in (allegedly) failing to repay money borrowed.

A creditor holding a money judgment must then “execute” in order to get it paid.

A money judgment in Michigan can be executed in the following ways:

 

• Wage garnishment;
• Bank account garnishment;
• State tax refund garnishment;
• Seizure of assets;
• Judgment lien perfection.

 

Of these, wage garnishment and State of Michigan tax refund garnishment are by far the most common. And routine.

In Michigan, a garnishing creditor can take up to 25% of each and every paycheck you receive until the judgment is fully repaid—including the creditor’s attorney fees and costs as ordered by the court.

For most people, garnishment is an unsustainable disaster, given that a shocking percentage of American households are 1 paycheck loss away from homelessness.

Thus, if you are being sued for collections on a debt that you actually owe (if you don’t, that is the subject of another blog post yet to come) and are not sure how to respond to it, you not only can consult a bankruptcy attorney—but should.

The bankruptcy attorney you consult will, with very few exceptions, have good news for you regarding your collections lawsuits. This will be true regardless of whether you have just received a summons or whether the case has already resulted in a judgment.

What will your bankruptcy lawyer tell you? Read on to learn more.

 

Bankruptcy Filing and the Automatic Stay Against Collections

 

First, your bankruptcy lawyer will tell you that the filing of a Chapter 7 or Chapter 13 bankruptcy will stop a state court-based collections lawsuit dead in its tracks.

This is true regardless of whether the lawsuit is still pending or whether it has gone to judgment.

Why?

The moment that you file a Chapter 7 or Chapter 13 bankruptcy case, a “master injunction” known as the Automatic Stay Against Collections is activated.

This Automatic Stay requires that all actions to collect any debt from the filing debtor must cease for the duration of the bankruptcy case.

Once you receive your Chapter 7 or Chapter 13 discharge, the Automatic Stay expires—but only because the permanent Discharge Injunction is then granted, stopping all pre-filing collections forever (with exceptions).

The Automatic Stay will put a stop to a lot of creditor-driven activity that you might not think it would, such as the withholding of school transcripts until a tuition bill is paid. It certainly puts a stop to the activity it exactly should, such as collections lawsuits or money judgment execution such as wage garnishment.

Any creditor that violates the Automatic Stay is liable to you for damages itself. If a creditor does not cease attempting to garnish your paycheck after you file Chapter 7 or 13 bankruptcy, your bankruptcy lawyer will file a motion for contempt and sanctions in the US Bankruptcy Court.

Did you note that “US” at the front of “Bankruptcy Court” there?

That’s why the Automatic Stay is so effective at stopping collections activity. Bankruptcy is a Federal legal process, while most collections lawsuits are filed in Michigan (or other) state court.

Federal law preempts state law once a bankruptcy is filed.

The Automatic Stay cannot be “contracted around” in a contract. It cannot be ordered aside by a Michigan district, circuit, court of appeals, or Supreme Court judge.

It is a powerful tool to have in your pocket.

So that sounds good. You hire a bankruptcy lawyer, who then files a Chapter 7 or Chapter 13 bankruptcy for you.

What happens next?

 

Orders of Administrative Closing and Collection Lawsuits

 

What happens next will largely occur behind the scenes—in your bankruptcy lawyer’s office.

The moment you file your bankruptcy case, you will receive a case-number from the Bankruptcy Court as well as a one-page document called a Notice of Commencement, or Notice of Filing, with that case-number on it.

Your lawyer will then complete and file with the state court in which the collections lawsuit has been filed something called an “Order of Administrative Closing Due to Bankruptcy Filing.” The Notice of Filing will be attached.

Your lawyer will also serve a copy upon the creditor or creditor’s lawyer who filed the collections lawsuit, along, perhaps, with a strongly worded cease-and-desist letter.

Upon receipt, the state court will close the collections lawsuit down “administratively.”

This means that the case is closed and that the creditor cannot proceed with the action. However, it is not a decision on the merits.

In other words, an administrative collections case closure does not mean that you did not owe the money or that the creditor did or did not have the right to demand collection from you.

These issues will never be litigated. If you wanted a day in court to argue, for example, that a plaintiff debt-buyer “lost the note” or lacks standing to sue you, you needed to hire a lawyer to defend the lawsuit on the merits rather than filing for bankruptcy.

Instead, the case is simply closed, and the Michigan state court judge (very) happily tosses the file off of his or her docket.

Should you, for any reason, fail to receive a discharge in your bankruptcy case, however, this also means that the creditor who filed the collections lawsuit can move to have it reopened in order to pick up where it left off when the bankruptcy was filed.

The Order of Administrative Closing will state this explicitly.

If the case had resulted in a judgment before the bankruptcy is filed, the plaintiff creditor is also under an “affirmative” obligation to release any garnishment order.

The Michigan state court will not necessarily do this just because it closes the case administratively.

The creditor must file a Release of Garnishment with the court—which the court will then order released. It is then up to the court and its process servers to serve a copy of that Release order out to your employer, your bank, or the State of Michigan Department of Treasury in order to let them know not to send money from your paycheck, bank account, or state tax refund to the garnishing creditor.

Creditors often take a leisurely amount of time doing this. They must often be reminded to do it by your bankruptcy lawyer. Occasionally, they fail to do it until and unless a motion for contempt is filed with the Bankruptcy Court.

Even when the creditor complies quickly with this obligation, the court itself often bottle-necks the process.

“Accidental” garnishments are possible.

Any funds that are garnished after the case is filed must be returned in full.

How fast will this happen? Let’s just say we wouldn’t advise that you hold your breath over it.

It is, for all of these reasons, simply better to get your bankruptcy case filed before it goes to judgment, given the opportunity to do that.

What happens when a creditor ignores the act that the collections case is closed?

Again, your bankruptcy lawyer warns them a few times (Eastern District of Michigan bankruptcy judges like this) and the files a motion for contempt and sanctions.

 

Collections Lawsuits and Bankruptcy: The Bottom Line

 

The bottom line is that, if you are dealing with a collections lawsuit, it is well worth taking the time to at least discuss the issue with a bankruptcy lawyer.

While it may be that, for unrelated reasons, a bankruptcy is not recommended for you, you will at least learn why and enjoy the opportunity to discuss the situation with an objective professional in a confidential environment.

Your neighbor, your co-worker, your spouse, and Google are all terrible places to seek legal advice.

Attorney Walter Metzen is a Board Certified Bankruptcy Expert who will offer you a thorough discussion of your options when faced with a collections lawsuit.

Contact us now to schedule your free initial consultation.