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Practical Bankruptcy: Encouraging the Dismissal of a Business-Ending Lawsuit

If a lawsuit against your small business is driving you to close the business, filing bankruptcy will likely get rid of that lawsuit forever.

A lawsuit against your sole proprietorship business can drain money, time and focus away from the business. Especially if your business is already in financial trouble, that litigation can push you over the edge into ending the business. But once you’ve decided to do that, and to deal with the financial fallout of the business closure by filing bankruptcy, where will that leave the lawsuit? Will it continue into your bankruptcy case?

Usually ongoing litigation against your business (or against you involving your business) ends when you file bankruptcy. Here’s an illustration of how this plays out.

Bankruptcy Stops Litigation

Harry & Sally, husband and wife, have been doing business for the last 8 years as a retail hobby supply store. They could not pay their primary inventory supplier’s invoices on time, so the supplier sued them for payment. In its lawsuit the supplier demanded payment for the amount past due. Its lawsuit also alleged that Harry & Sally misled the supplier a year earlier when, on its request, they filled out an allegedly incomplete updated financial statement.

The day before Harry and Sally were to be deposed (asked questions under oath) in this lawsuit, they filed a joint bankruptcy case.

The first thing that bankruptcy filing accomplished is that it immediately stopped the lawsuit by their supplier. So Harry and Sally did not have to attend their scheduled depositions.

Discharge of the Debt

Harry and Sally were warned by their attorney that their debt to the inventory supplier would NOT be discharged (leally written off) if that supplier formally objected to the discharge by the deadline to do so. They expected to get an objection, considering how aggressive that creditor had been in the lawsuit, and especially considering that it seemed to believe it had valid grounds for objection

But that deadline—60 days after the day Henry and Sally went to their “meeting of creditors”—came and went without the supplier filing an objection.

Disincentive for Creditors to Complain

Harry and Sally found out that there were very practical likely reasons why their former inventory supplier did not try to make them pay their debt even though it seemed to think it had legal grounds to do so (the alleged incomplete updated financial statements which supposedly induced the supplier to continue providing them credit):

1. A creditor’s objection on the discharge of a debt is difficult for a creditor to win. The legal grounds are quite narrow. The creditor must prove to the bankruptcy court that those narrow grounds are met, NOT just that you legally owe the debt. In Harry and Sally’s situation, for example, the inventory supplier must not only show that they legally owe the debt, and that information they provided in the updated financial statements was inaccurate and/or incomplete. The supplier must also establish that the Harry and Sally intended the inaccuracies to fool the supplier into extending more credit, and in fact those inaccurate statements were what the supplier relied on in extending the credit.

2. The supplier was faced with practical evidence that it would be wasting its time and money to pursue Harry and Sally any further. The bankruptcy documents that Harry and Sally presented to the court under penalty of perjury revealed that they genuinely had nothing worth for the supplier to chase. As a result, at this point the supplier accepted that pursuing Harry and Sally any further would do no good, and so they decided to not bother filing an objection.


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