Physicians and Bankruptcy

America is the land of second chances. Many years ago, if you could not pay your debts, you could be moved to a debtor’s prison. Even in the US.  

Many Colonial American jurisdictions established debtors’ prisons using the same models used in Great Britain. James Wilson, a signatory to the Declaration of Independence, spent some time in a debtors’ prison while still serving as an Associate Justice of the U.S. Supreme Court. Fellow signatory Robert Morris spent three years, from 1798 to 1801, in the Prune Street Debtors’ Prison, Philadelphia. Henry Lee III, better known as Henry “Light-Horse” Lee, a Revolutionary War general and father of Robert E. Lee, was imprisoned for debt between 1808 and 1809 where he made use of his time by writing “Memoirs of the War”. 

Debtors’ prisons were prevalent throughout the United States until the mid-19th century. Economic hardships following the War of 1812 with Great Britain helped swell prison populations with simple debtors. This resulted in significant attention being given to plights of the poor and most dependent jailed under the widespread practice, possibly for the first time. Increasing disfavor over debtors’ prisons along with the advent and early development of U.S. bankruptcy laws led states to begin restricting imprisonment for most civil debts. At that time growing use of the poorhouse and poor farm were also seen as institutional alternatives for debtors’ prisons. The United States ostensibly eliminated the imprisonment of debtors under federal law in 1833leaving the practice of debtors’ prisons to states. 

Virginia’s debtor prison closed in 1849. 

There are still state laws which allow for imprisonment based on specific debts – such as failure to pay child support. Or criminal justice debt. Or failure to appear for a deposition as part of discovery procedures to locate assets of the debtor. 

But generally, bankruptcy is the tool used to manage intractable debt. 

Bankruptcy is the legal status of a person who seeks protection from the bankruptcy court in order to repay or eliminate debt. 

Bankruptcy is a creature of federal law.  

There are three types. 

• Chapter 7.  Liquidation.  List everything you own and everything you owe.  All assets are subject to liquidation or sale by a Chapter 7 trustee. 
• Chapter 13.  Reorganization (individual).  Repayment of debt based on income.  All disposable income, including proceeds from an injury settlement/verdict, must be paid into the case. 
• Chapter 11.  Reorganization (corporate).  Repayment of debt based on business income. 

Let’s dig in a little more: 

Chapter 7 Bankruptcy: 

A case filed under Chapter 7 is an end game. It’s over.  

A chapter 7 bankruptcy case does not involve the filing of a plan of repayment as in chapter 13. Instead, the bankruptcy trustee gathers and sells the debtor’s nonexempt assets and uses the proceeds of such assets to pay holders of claims (creditors) in accordance with the provisions of the Bankruptcy Code. Part of the debtor’s property may be subject to liens and mortgages that pledge the property to other creditors. In addition, the Bankruptcy Code will allow the debtor to keep certain “exempt” property; but a trustee will liquidate the debtor’s remaining assets. Accordingly, potential debtors should realize that the filing of a petition under chapter 7 may result in the loss of property. 

A chapter 13 bankruptcy is also called a wage earner’s plan. It enables individuals with regular income to develop a plan to repay all or part of their debts. Under this chapter, debtors propose a repayment plan to make installments to creditors over three to five years. If the debtor’s current monthly income is less than the applicable state median, the plan will be for three years unless the court approves a longer period “for cause.” (1) If the debtor’s current monthly income is greater than the applicable state median, the plan generally must be for five years. In no case may a plan provide for payments over a period longer than five years. 11 U.S.C. § 1322(d). During this time the law forbids creditors from starting or continuing collection efforts. 

A case filed under chapter 11 of the United States Bankruptcy Code is frequently referred to as a “reorganization” bankruptcy. Usually, the debtor remains “in possession,” has the powers and duties of a trustee, may continue to operate its business, and may, with court approval, borrow new money. A plan of reorganization is proposed, creditors whose rights are affected may vote on the plan, and the plan may be confirmed by the court if it gets the required votes and satisfies certain legal requirements. 

So, key questions: Are you filing as an individual or business? Will you have the ability to repay some or all debts? Is the business still viable with a clean start? 

What happens if you are a defendant in a professional liability claim, and you file for bankruptcy? 

In general there’s an “automatic stay” of the claim. The underlying case is put into deep freeze.  

The stay applies to all actions to collect money from the debtor.  The plaintiff and his attorney could be subject to sanctions and other damages for violating the automatic stay.  11 U.S.C. § 362. 

• Service: What if you filed a case shortly before the statute of limitations runs and need to serve a defendant who filed bankruptcy?  The bankruptcy code extends the statute of limitations by the later of either 30 days from the expiration of the stay or the actual statute of limitations.  11 U.S.C. § 108(c). 
• Discovery: You cannot proceed with discovery against a tortfeasor in bankruptcy without court permission.  You must file a motion to lift stay. 
• Trial: You cannot proceed with trial against a tortfeasor in bankruptcy without court permission.  You must file a motion to lift stay. 
• Multi-defendant: Where there are multiple defendants, one defendant’s bankruptcy filing will not stay the entire case.  Wedgeworth v. Fibreboard Corp., 706 F.2d 541, 544 (5th Cir. 1983). 

The plaintiff can file a motion to lift the stay and proceed. 

Grounds for lifting stay:  11 U.S.C. § 362(d)(1) 

“Cause”- The stay can be lifted for good cause shown.  Good cause is not defined under the statute, but here are some good reasons.  In re Sonnax Indus., Inc., 907 F 2d 1280 (2d Cir. 1990). 

Insurer will cover the loss, and it will not pose harm to the debtor/defendant’s estate. 

Not allowing plaintiff to proceed will cause harm to the plaintiff. 

Bankruptcy court does not have jurisdiction to liquidate personal injury and wrongful death claims.  28 U.S.C. § 157(b)(2)(B). 

Plaintiff has the right to a jury trial that is expressly reserved under the bankruptcy court (28 U.S.C. § 1411(a)), and bankruptcy courts cannot conduct jury trials without special designation by the district court and the consent of all parties.  28 U.S.C. § 157(e). 

If the plaintiff has a clear injury and is only seeking to recover from the insurance carrier, the court may grant the motion to lift the stay. In that case, the plaintiff is looking at most, policy limits, without attacking the bankruptcy estate. 

If an attorney is trying to go after personal assets plus insurance coverage, it will be difficult for the plaintiff to proceed. Recovering beyond insurance coverage would impact the bankruptcy estate. In addition, the debtor’s debts, such as any liability over policy limits, would likely be discharged. 

A bankruptcy court will generally not try a personal injury case.  

[The bankruptcy court] generally [has] no subjection matter jurisdiction to liquidate personal injury tort or wrongful death claims.  28 USC § 157(b)(5).  Your client/plaintiff has a right to trial by jury, and bankruptcy court judges are not Article III judges.  District court could decide but generally bankruptcy courts think state court judges are best equipped to liquidate injury claims. 

If the plaintiff wants to get paid and maintain his spot in line, he must file a “proof of claim.” 

A proof of claim is a court document that a creditor files to show that the creditor has a claim against the debtor.  Proofs of claims are filed in Chapter 7 cases where there are assets to be liquidated and in all Chapter 13 cases.  Filing a proof of claim within the debtor’s bankruptcy case is important to preserving your claim and in getting paid if there is money to be paid.  The deadline is 90 days from the date of the filing of petition.  If you are able to lift the stay to collect insurance proceeds, then you should withdraw your proof of claim against the debtor. 

Discharge of a Debtor’s Liability. If a patient’s injury/claim is itemized on the bankruptcy petition, the debt will be discharged (wiped out) at the end of the case. There are unusual exceptions which will not be addressed here.  

If the bankruptcy case is dismissed, the case is over and the bankruptcy is removed. All assets in the estate are restored to the debtor. And the plaintiff can go after the defendant in the med mal case.  

Discharge is not the same as dismissal. 

In sum, in a professional liability case, bankruptcy protection incentivizes the plaintiff to limit their action targeting an insurance claim. Assuming there is insurance money to be had. 

What do you think?