Lately, we are seeing more and more legal battles already underway in the civil Courts when a person enters bankruptcy. These cases are often complicated, highly stressful, and deeply emotional.
Because bankruptcy law is incredibly technical, it requires a Bankruptcy Trustee (often working alongside an experienced insolvency lawyer) to carefully navigate the issues, options and associated challenges. What happens to a Court case depends entirely on who started it and whether the assets in question would require the involvement of a Bankruptcy Trustee.
Scenario 1: A Creditor Started the Court Case Against the Debtor
If a creditor (someone who is owed money) was already suing the debtor before the bankruptcy started, the next steps depend on whether the money owed is classified as a “provable debt” or a “non-provable debt.”
- Provable Debts (Most Common)
- What it means: This includes normal financial debts like unpaid loans, credit card bills, and certain maintenance payments.
- What happens to the lawsuit: It stays (pauses) immediately. By law, the creditor cannot continue suing or trying to force against the debtor to pay unless a Court gives them permission. Instead, the creditor’s only option is to lodge their claim with the Trustee (called a “Proof of Debt”). If there is sufficient money available to pay a dividend to creditors, they will get a share.
- Non-Provable Debts
- What it means: This includes Court fines, penalties, certain student loans, or claims for unliquidated (unquantified) damages (where a Court hasn’t yet decided on a specific dollar amount for a dispute not tied to a contract).
- What happens to the lawsuit: It keeps going. The creditor can continue their lawsuit during and after the bankruptcy. Because this debt sits outside the bankruptcy, it could potentially even trigger a second bankruptcy down the road if the debtor still can’t pay.
Scenario 2: The Debtor Started the Court Case Against Someone Else
If the person who went bankrupt was the one suing someone else, the law divides these cases into two categories: Personal Rights and Financial Assets.
- It’s a “Personal Right” (The Debtor Keeps the Case)
If the lawsuit is a “Personal Right”, it does not belong to the Trustee. The debtor can continue the Court case on their own.
Common examples of a “Personal Right” include:
- Lawsuits for personal injury or physical harm done to the debtor or their family
- Lawsuits regarding the death of a spouse or family member
- Challenging a Will or inheritance
Note on successful claim: If the debtor is successful with a “Personal Right” lawsuit, depending on the situation, the money might be legally protected, it might be taken by the Trustee to pay creditors, or it might count as income that requires the debtor to pay a contribution to their bankrupt estate.
Note on unsuccessful claim: If the debtor is unsuccessful with a “Personal Right” lawsuit and the Court makes an order for the debtor to pay the costs of the defending party (adverse costs order), then the costs payable by the debtor could result in a subsequent bankruptcy for the debtor.
- It’s a Financial Asset (The Trustee Takes Control)
If the lawsuit is about money, property, or business contracts, the right to sue becomes an asset that legally transfers to the Bankruptcy Trustee. The debtor loses control of the case.
When this happens, the lawsuit is automatically paused (stayed), and the Trustee has a strict 28-day deadline to make a written election to the Court:
- Option A1: Step in and take over the lawsuit
- (Option A2: Assign the action to another party)
- Option B: Drop the lawsuit entirely
If the Trustee does nothing within 28 days of being notified, the law assumes they have abandoned the case.
How the Trustee Decides What to Do
To protect everyone involved (especially the creditors and the debtor), the Trustee will obtain and review all the legal documents and decide on the best financial path. They will usually look at three options:
- Find Funding: Obtain money from creditors or third parties to pay for legal advice to see if the case is actually winnable and then to step in and takeover the lawsuit
- Sell the Lawsuit: “Assign” (sell) the right to sue to another party in exchange for a financial benefit to the bankrupt estate
- Weigh the Risks: Weigh up whether the cost of fighting the case in Court is worth the potential payout
With over 23 years of experience in Bankruptcy administrations, including administering multiple matters with many complex legal Court proceedings, please feel free to contact our Registered Bankruptcy Trustee, Alan Ma, on 02 9633 3333 to discuss any potential bankruptcy appointments.
