If you file for Chapter 7 bankruptcy, whether you can keep the money from a lawsuit settlement or award will depend on state law.
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If you've recently received a lawsuit settlement or award and are considering bankruptcy, you should know that you could lose the funds. Most people don't benefit from filing for Chapter 7 bankruptcy after receiving a large lawsuit settlement. But that's not always the case, and keeping an award or a lawsuit settlement needed for your support is possible.
Your state exemption law determines whether you can protect a lawsuit award or settlement in bankruptcy. If an exemption does not cover it and you file for bankruptcy, you must give it up.
In this article, you'll learn more about lawsuit settlements and bankruptcy, including what can happen to a pending lawsuit in Chapter 7 bankruptcy and when you might be better off exploring bankruptcy alternatives.
How Chapter 7 Bankruptcy Works
If you qualify for a Chapter 7 discharge, you can eliminate most nonpriority, unsecured debts. Some of the debt types most commonly erased include:
- credit card balances
- personal loans
- medical bills
- gym memberships
- amounts owed from rental or lease contracts, and
- home and car loan balances (but you'll need to return the house or vehicle serving as collateral to the lender).
Find out more about debts that get discharged in Chapter 7 bankruptcy.
Property in Chapter 7 Bankruptcy
Because of state exemption laws, many people who file for Chapter 7 give up little or no property. The property most states will allow you to exempt includes:
- household furnishings and clothing
- your retirement account
- some business tools and equipment
- an amount of equity in a home, and
- an inexpensive car.
Nonexempt property, or property not protected by an exemption, is a different matter. You'll turn over assets you can't exempt to the bankruptcy trustee assigned to administer your case. The trustee will sell the nonexempt property and distribute the proceeds to unsecured creditors using the bankruptcy priority claim system.
Disclosing Awards and Lawsuit Settlements in Bankruptcy
You must disclose all property in your bankruptcy paperwork, and lawsuit awards and settlements are types of property.
Here's how it works.
- You'll list all of your property on official bankruptcy forms.
- When you file, your property will get transferred to the bankruptcy estate.
- You'll get to keep anything you exempted properly in your bankruptcy paperwork (more below).
If your state considers a lawsuit settlement or award nonexempt bankruptcy property, you'll lose it in Chapter 7.
What Happens If You Don't List a Settlement in Bankruptcy?
Keep in mind that it's not a good idea to "forget" about an asset. When you fill out your bankruptcy paperwork, you'll sign a form declaring your disclosures true and correct.
If you don't list the lawsuit settlement, the court might believe you're attempting to hide it and view it as bankruptcy fraud. And the consequences of bankruptcy fraud are steep—you'll face up to $250,000, imprisonment for up to 20 years, or both.
Should You File for Chapter 7 With a Pending Lawsuit?
It depends. You must list ongoing lawsuits—even your right to file a lawsuit in the future—in your bankruptcy paperwork. Like other property, you'll need to protect the potential settlement or award value using a bankruptcy exemption. If you can't protect the potential value, you'll likely lose your interest in the lawsuit. The Chapter 7 bankruptcy trustee will assume the management of the litigation.
Can You Exempt Your Lawsuit Award or Settlement in Chapter 7?
Knowing what will happen to your lawsuit award or settlement in bankruptcy before filing is essential. If you learn you'll lose an asset after filing, the bankruptcy court might not let you out of the case.
If you can't exempt the settlement, the bankruptcy court will use the funds to pay off your debt and return whatever remains to you—something you could do on your own without filing for bankruptcy. This result would actually be more expensive because you'd also pay the bankruptcy trustee a percentage of the amount the creditors received.
How to Exempt a Lawsuit Settlement in Chapter 7 Bankruptcy
The exemption status of typical lawsuits, such as personal injury suits for automobile accidents, slip and fall accidents, dog bites, employment, malpractice, or products liability cases, differs in each state.
Personal injury lawsuits. States that exempt lawsuit settlement proceeds usually limit the exemption to personal injury cases (a lawsuit filed to recover money for an injury received due to someone else's carelessness). Some states exempt all lawsuit settlement and judgment proceeds, while others exempt only funds necessary to support the debtor and family.
For example, suppose you receive a $500,000 settlement. Some states will allow you to keep the entire amount, and others will determine how much you and your family need to live. Some states don't have a personal injury lawsuit exemption.
Wrongful death actions. Many states allow you to keep money from a wrongful death action if you depended on the deceased for support and need the funds for your current support.
Wildcard exemption. Suppose your state doesn't offer a lawsuit award or settlement exemption. If your award isn't too large, you might be able to keep it using a wildcard exemption. A wildcard exemption allows you to exempt property up to a designated dollar amount. For instance, if you receive a lawsuit settlement of $5,000, and your state has a wildcard exemption 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, and limitations on the type of property might apply.
Federal Bankruptcy Exemptions for Lawsuit Awards and Settlements
Some states allow you to choose between state and federal exemptions—and using the federal exemption scheme might be a better bet. The federal bankruptcy exemptions offer substantial protection for personal injury lawsuit awards and settlements and a sizeable wildcard exemption.
People who live in one of these places can choose to use the federal bankruptcy exemptions instead of the state exemptions:
- 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
- Wisconsin
You can find the current exemption limits in Federal Bankruptcy Exemptions.
Reasons to Talk With a Bankruptcy Lawyer
If you receive a large lawsuit settlement and aren't sure whether you can exempt it, the best way to find out is by speaking with a local bankruptcy attorney.
Need More Bankruptcy Help?
Did you know Nolo has made the law easy for over fifty years? It's true—and we want to ensure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!
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