What Happens to Collection Actions When a Debtor Files Bankruptcy (lawsuits, wage garnishments, etc)
Updated: Mar 19
If your wages are being garnished or you’re facing the threat of having your car repossessed, the Bankruptcy Code provides an instantaneous and broad-sweeping prohibition against all types of collection actions via the automatic stay.
There are several purposes to the automatic stay, each of which provide relief to the debtor (and as explained below, creditors as well). First, the stay gives the debtor a breathing spell from creditors. Second, the stay allows for an orderly distribution of assets to creditors thorough the bankruptcy process, based on what assets, if any, the debtor has that are available for distribution (note separate blog posts on a debtor’s exemptions the debtor may claim on certain assts).
Without the automatic stay, things would be messy. There could be a rush to the courthouse to get a judgment from the debtor. This way, creditors will get whatever distribution they are entitled to from the trustee based on the bankruptcy code’s distribution scheme.
When a debtor files bankruptcy, the automatic stay immediately goes into effect. The stay takes effect regardless of whether a creditor had notice of the bankruptcy filing. The automatic stay generally bars all collection actions against the debtor and property owned by the debtor (for example, the debtor’s bank accounts, vehicle or home).
So, if a creditor has started the foreclosure process and scheduled a foreclosure date, that foreclosure cannot go forward if the debtor files bankruptcy before the sale occurs. So long as it’s one minute before the sale, any sale after the bankruptcy is void. Similarly, wage garnishments and vehicle repossessions cannot go forward while the stay is in place.
To ensure the effectiveness of the automatic stay, the Bankruptcy Code has created penalties to be imposed on creditors for violating the stay. Any collection action taken in violation of the stay is void – which means legally it did not happen. A creditor who knowingly violates the stay may get sanctioned by the court in the form of monetary fines or an order to pay the debtor’s attorneys’ fees incurred to bring the matter to the bankruptcy court’s attention.
Moreover, there are certain types of collection actions that are not impacted by the automatic stay. A list of such actions can be found at 11 U.S.C. § 362 (b). Click here to read the list in its entirety. The most common exception to the stay involves domestic support collection proceedings against the debtor.
When Does the Stay Terminate?
This does not mean that the automatic stay remains in place permanently. Generally, a creditor can ask to have the stay lifted as to its claim if the creditor can show:
It has a lien against the asset; and
The asset is losing value during the bankruptcy and the creditor is not being adequately protected from such loss in value.
An example of a stay lift request could be a car lender with a lien against the debtor’s car. A car is a depreciating asset that losing value over time. If the debtor stops making payments on the car loan ,the lender can ask the court to lift the stay, or get an order forcing the debtor to compensate for the depreciation in the lender’s collateral (typically in the form of regular monthly payments on the car loan).
Also, the stay will automatically terminate when the debtor gets her discharge. You can understand why if you understand the main goals of the automatic stay (again, breathing spell and orderly distribution to creditors). The stay terminates on a debtor’s discharge because: a) the debtor would have received her breathing spell; b) the creditor claims have been dealt with in the bankruptcy; and 3) the relief the debtor gets from the discharge.
So, even though the stay terminates, judgment creditors cannot continue to pursue lawsuits or garnishments against the debtor because the discharge injunction bars such collection activity.