Should You Believe the Threat of Bankruptcy?

By Douglas P. Cushing

Collection efforts in any venue are often met by a defendant's threat of "I'll file bankruptcy" as the first (or ultimate) defense. What is the best response to that position?

A lender and its law firm in a California case found out the hard way. First Select, Inc. ("First Select"), was a creditor of Somkait Leetien, who filed a Chapter 7 bankruptcy on August 18. Five days later, the bankruptcy court clerk sent notice to creditors, including First Select. Five days after that, First Select sent its file to counsel to file suit in state court, which the law firm did promptly, and completed service on the defendant on September 5. Allowing for a lender to process notice and keep its attorneys advised, no one was in trouble then.

The day after service, September 6, debtor's counsel twice called the lender's attorneys. This was to no avail, as no attorney returned the call. A paralegal did take the message regarding the bankruptcy filing. Debtor's counsel demanded by fax that the filing in the state court either be dismissed or placed on hold by September 20. Although neither First Select nor its attorney responded to debtor's counsel, a motion to dismiss was filed on September 29. Was that appropriate and timely action? It was not to the United States Bankruptcy Court, the District Court for the Southern District of California, or the Ninth Circuit Court of Appeals! Eskanos & Adler, P.C. v. Somkiat G. Leetien, 2002 US App 23144 (9th Cir 2002).

Debtor's counsel was notified of the state court dismissal on October 3, the same date First Select and its law firm were sued for violating the automatic stay under Bankruptcy Code Section 362. As all three courts determined, that was not enough. First Select and its attorneys were jointly held responsible for sanctions. Even though the case was dismissed, the simple acts of returning telephone calls or confirming in writing that the case would be dismissed were ignored, leading to the imposition of sanctions.

Protecting your position does not require waiving a valid claim. Request documentation of the bankruptcy filing or go on-line to verify the filing. It takes a day or two to verify whether a defendant has filed bankruptcy. If so, Section 362 mandates no further action in the collection case. Dismissing the pending case is not required. If a co-defendant or a surety source of funds is available, the action may go forward after relief from stay. The critical act is to acknowledge the stay and notify the fact-finder and debtor's counsel that the matter will be put on hold. A bankruptcy filing is grim news to a creditor, but a judgment for sanctions, the attendant publicity for violating the stay, and the cost of litigating in bankruptcy court and/or district court, or an appellate court, cannot be worth the emotional satisfaction of "pouring it on."

Be smart. If you receive notice of a bankruptcy filing and you are not represented, get counsel. If you are represented, alert your lawyer and make certain that you don't compound the problem by failing to respect the stay and keep the other side advised.

This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

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