If you file for Chapter 7 bankruptcy, whether you can keep the money you get (or will get) from a lawsuit judgment or settlement depends on the law in your state. For the most part, you’ll have to give up your lawsuit award or settlement amount unless a particular state or federal law (called exemption laws) specifically says that you can keep the money.
Chapter 7 Bankruptcy and Your Property
In Chapter 7 bankruptcy you can get rid of most (or all) of your debts. In return, you must give up certain property. That property goes to the bankruptcy trustee (a bankruptcy trustee is assigned to each bankruptcy case) who sells it and distributes the sale proceeds to your unsecured creditors. (Learn more about how Chapter 7 bankruptcy works.)
Luckily, you don’t have to give up all of your property. That’s because federal and state laws allow you to keep certain types of property in bankruptcy. These are called exemption laws. Each state has a set of exemption laws. Some states allow you to choose between the state exemptions and a set of federal bankruptcy exemptions. Other states require you to use the state exemptions. (Learn more about how exemptions work. To find your state exemptions laws and learn whether you can use federal exemptions, visit our State Bankruptcy Exemptions topic page.) Thanks to exemptions, most people who file for Chapter 7 bankruptcy give up little, or no, property.
Lawsuits Are Part of Your Property in Bankruptcy
Lawsuit awards and settlements are considered part of your property in bankruptcy (called the bankruptcy estate). But the bankruptcy laws go further: Potential lawsuits and pending lawsuits are also part of your bankruptcy estate. So even if you haven’t yet received money from a lawsuit, the bankruptcy trustee still may lay claim to it.
Common lawsuits include personal injury suits for automobile accidents, slip and fall accidents, and dog bites. Other examples of lawsuits include employment, malpractice, or products liability cases.
Disclosure of Lawsuits in Your Bankruptcy Case
When you file for bankruptcy, you must list all of your property on your bankruptcy papers that you file with the court (called the bankruptcy petition and schedules). Since they are part of your property, you must list all lawsuits in the bankruptcy petition. This includes not only awards from potential lawsuits not yet filed, but also proceeds that you already got, or that you might get in the future.
This disclosure requirement makes sense because lawsuits often involve significant amounts of money, and therefore represent a valuable source of funds for the bankruptcy estate. If you don’t disclose a potential or pending lawsuit, you could run into trouble in your bankruptcy. (To learn more, see What Happens If I File to List Pending Lawsuits in My Bankruptcy Papers?).
Are Lawsuit Awards or Settlements Exempt in Chapter 7 Bankruptcy?
Whether awards or settlements from lawsuits are exempt in bankruptcy varies widely from state to state.
Exemptions for Personal Injury Lawsuits
States that exempt lawsuit proceeds usually limit them to personal injury cases. Of those states, some states exempt all of the settlement and judgment proceeds while others exempt only those proceeds that are necessary for the support of the debtor and family. For example, if you received a $500,000 settlement, some states allow you to keep the entire amount while others determine how much you and your family need to live. If you need $100,000 to live, the bankruptcy trustee receives the remaining $400,000. Other states do not allow for any personal injury lawsuit exemption whatsoever.
Exemptions for Wrongful Death Actions
Many states allow you to keep money from a wrongful death action, particularly if you depended on the deceased for support and you need the money for your current support.
Using a Wildcard Exemption to Protect Lawsuit Funds
If your settlement is not too large and no other exemption applies, you may be able to exempt the settlement through what is called a “wildcard” exemption. A wildcard exemption usually allows you to exempt any type of property up to a designated dollar amount. So, for example, if you receive a lawsuit settlement in the amount of $5,000 and your state has a wildcard exemption in the amount of $8,000, you could use the wildcard to keep your lawsuit award. Not all states have a wildcard exemption, and for those that do, the amounts vary widely.
Federal Bankruptcy Exemptions for Lawsuit Awards
If you live in one of the states that allow you to choose between state and federal exemptions (those states are: Alaska, Arkansas, Connecticut, District of Columbia, Hawaii, Kentucky, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Texas, Vermont, Washington, and Wisconsin), and you choose to use the federal exemptions, here’s what you can keep:
- up to $22,975 for money you got due to a personal injury lawsuit or claim, but you cannot exempt money that reimburses you for pain and suffering or pecuniary loss (pecuniary losses are things that have a specific dollar value, such as medical expenses and lost wages).
- money that you get from a lawsuit to reimburse you for the loss of future earnings that you and your family need for support, and
- in a wrongful death action for the death of someone you depended on for support, any funds you get from the lawsuit or claim that you need for support.
Other Strategies for Repaying Debts When You Get Lawsuit Funds
A large settlement may prove more problematic, however, since any assets over and above the amount allowed by your state’s exemption lists must be turned over to the bankruptcy trustee to liquidate and distribute to your creditors on a pro rata basis. Therefore, with large settlements it may make more financial sense to negotiate with your creditors directly rather than file for bankruptcy protection.
For example, let’s assume that you receive a settlement in the amount of $100,000, and that you owe your creditors $100,000. If you reach a deal with each of your creditors to cut your debt in half, the end result would be that you would keep $50,000. If this is more than how much you’d end up with if you filed bankruptcy, it may be a better direction to go.