Does Filing For Bankruptcy Protect A Business From Lawsuits?

News reports say Purdue Pharma, the maker of popular painkiller OxyContin, is contemplating bankruptcy in response to the many lawsuits (including one filed by Waukesha County) that have named it as one of the parties responsible for the opioid epidemic. Bankruptcy seems to be a common among companies facing big lawsuits, but is avoiding liability really one of the benefits of filing for bankruptcy?

A Common Occurrence

Purdue Pharma is not the first company to consider filing for bankruptcy in the face of potentially crippling liability. The utility company PG&E filed for bankruptcy earlier this year after it was blamed for several devastating wildfires.

Late last year, USA Gymnastics filed bankruptcy in an effort to manage the many claims made against it by gymnasts who allege the organization’s former medical coordinator, Larry Nasser, sexually abused or assaulted them under the guise of medical treatment.

Asbestos maker Johns Manville is credited by many with starting this trend back in 1982, when that company filed for bankruptcy after it was revealed its asbestos products caused mesothelioma.

These businesses and organizations all realized they needed to do something drastic if they wanted answer all the legal claims against them, and perhaps continue to operate. Bankruptcy was their only hope.

Bankruptcy Is A Legal Pause Button

Pretty much everyone is aware that filing for bankruptcy can shield a business from its creditors, but that shield is much more powerful than many people realize.

When a business (or a person) files for bankruptcy, the court issues what is known as a stay. The stay stops all other lawsuits the filer is involved with in their tracks. Creditors cannot collect, adversaries cannot continue discovery, all legal actions are paused. They can only start up again with the permission of the bankruptcy judge.

When a pending or potential legal action might jeopardize a filer’s ability to reorganize under Chapter 11 of the bankruptcy code, and lead the business to shut down, the bankruptcy judge can pull that litigation into the bankruptcy case and work out a solution.

Often, business assets and insurance proceeds are pooled and put into a trust that potential plaintiffs can make claims against. This puts most potential plaintiffs in a better position than they would be in if the company went out of business, or they had to wait until all of the filer’s other creditors were paid off. It also encourages more plaintiffs to come forward since the claims process is typically well-publicized and much simpler than going to court. And it benefits the fieler by reducing the uncertainty of litigation.

Once the uncertainty of costly litigation is dealt with, the filer can use the Chapter 11 process to reorganize and move forward.

A Tough Choice

Businesses who chose to file for bankruptcy when costly litigation threatens to put them out of business are taking a risk. Going through bankruptcy is not easy. It puts intense scrutiny on your business or organization, and forces leadership to make tough choices. However, it may be the best option if litigation costs are mounting.