Are Proceeds From Lawsuits Exempt From Bankruptcy?

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Filing for bankruptcy can eliminate your liability for most judgments resulting from lawsuits, but what happens when you're expecting to receive compensation from legal claim? Whether or not you get to keep the money depends on a number of factors. Here's what you need to know about filing for bankruptcy when you have a legal claim or cause of action pending.

Timing is Everything

How your legal claim is handled depends on the date the incident occurred, not when you're expected to receive your payout. The court considers any cause of action that may lead to you acquiring cash or assets to be part of your bankruptcy estate. If the incident that lead to the lawsuit occurred prior to you filing the suit or anytime within the first 180 days after you submit your bankruptcy petition to the court, it must be disclosed in your bankruptcy papers.

For example, you file bankruptcy and a month later you are involved in an accident. You will need to amend your paperwork to include the lawsuit filed or settlement offered in connection with the incident regardless of when you expect to receive the money.

Bankruptcy Type

The type of bankruptcy you file will also determine how the legal claim is handled. In a chapter 7 bankruptcy, the trustee liquidates all of your assets to pay your creditors. However, both the federal and state bankruptcy laws have exemptions that allow you to retain certain property or the cash equivalent. Depending on where you live, the proceeds from lawsuits may be partially or completely exempt from collection by the trustee.

For example, the federal government allows you to keep up to $22,975 of a personal injury award. If you receive a judgment for $100,000, the trustee will give you the exemption amount and distribute the rest to your creditors. If anything is left over afterwards, you'll receive the balance.

Other exemptions include:

If the amount you are expected to receive exceeds the amount of your exemptions, the trustee will take over your lawsuit or claim. You, the trustee and your attorney will work together to determine the best course of action to take in the lawsuit that will maximize the amount of money you receive from the claim. The trustee will take and disburse the funds once the case is resolved.

Things are completely different in a chapter 13 bankruptcy. In this type of bankruptcy, you pay off your creditors by making monthly payments. You retain complete control over how your legal claim is handled. However, you will have to report any funds you receive from the claim once a resolution is reached. Any funds left over after exemptions have been accounted for must be paid to your creditors.

Keeping More of Your Money

If you think your legal claim will result in you being awarded a significant amount of money, you may be better served by negotiating directly with your creditors to pay off your debts rather than file for bankruptcy.

For instance, if you expect to get $600,000 but your debts only amount to $500,000, you could contact your creditors and offer to pay half to three-quarters of the amount owed. You'll pay off the debt, protect your credit and keep more of your settlement.

However, if you expect to get a modest amount that may be covered by available exemptions, then you may want to proceed with the bankruptcy case. In either event, you'll want to speak to a knowledgeable attorney from a firm like the Yoder Law Group for advice on the best way to handle your bankruptcy case when you have a legal claim pending.