Consider this scenario: You are defrauded by a company and its CEO.
You sue both in state court and, after three years, a jury awards you millions in damages against both. But as the state court judge is finalizing the judgment, the company files bankruptcy. Does the bankruptcy filing nullify the state court lawsuit? And does the company’s bankruptcy automatically protect the CEO? A recent order from the United States Bankruptcy Court for the Western District of North Carolina tackles both questions – and plaintiffs will like the answers.
Background
Systematic Audio and its manager, Scottie Johnson, spent three years defending a lawsuit in Catawba County. After a three-week trial, a jury found Johnson personally liable for fraud and interference with contract, awarding over $5 million in compensatory damages and more than $16 million in punitive damages. But before the state court judge could enter a final judgment, Systematic Audio filed Chapter 11, triggering the automatic stay on efforts to collect from the company. The company then asked the Bankruptcy Court to extend the stay to collection efforts against Johnson on the theory he was too important to the business to be distracted by litigation.
The Bankruptcy Court Can Allow a State Court to Complete Mopping-Up Operations.
The plaintiffs asked the Bankruptcy Court to lift the stay to allow the state court judge to enter final judgment, rule on post-trial motions, and let an appeal proceed. Bankruptcy Courts will ask a short list of practical questions before letting another court finish its work: Is what’s left mostly a state-law issue that doesn’t call for bankruptcy expertise? Would sending the case back to that court save time and expense? And can the bankruptcy court still prohibit collection efforts so other creditors aren’t harmed?
Here, all three answers favored allowing the state court to wrap up the case. The jury had already decided liability and damages. What remained — entering judgment, spelling out the basis for punitive damages, calculating interest, and deciding fees — was routine state-court business the state court judge was better positioned to handle after living with the case for three years. Starting over in bankruptcy court would have wasted time and money for no benefit. Critically, though, the bankruptcy judge prohibited plaintiffs from trying to collect. The state court could finalize the judgment, but plaintiffs had to respect the automatic stay as to collection efforts and behave like the other creditors in the bankruptcy.
A CEO Can’t Hide Behind a Company’s Bankruptcy Filing.
Johnson also asked the bankruptcy judge to pause or block the lawsuit against him personally. The Bankruptcy Court said no. The automatic stay protects the debtor company — not its owners, managers, or guarantors. Courts extend that protection to an individual only in unusual situations, and “unusual” is a high bar: the individual’s exposure generally has to be a stand-in for the company. The identity of interests has to be so great that the Court concludes that the company and the CEO are one and the same. It does not apply where the individual is on the hook for their own separate, independent, and personal conduct. Johnson wasn’t liable because the company was liable — the jury found he personally committed fraud and interfered with a contract.
The company also argued Johnson was too valuable to be distracted by collection efforts, and that the case proceeding against him would jeopardize the turnaround of the company. He needed to focus exclusively on reorganizing the company. Nice try. The Bankruptcy Court noted that Johnson had been defending the lawsuit for three years, and the company still managed roughly $23 million in sales and $3.4 million in earnings. If the business operated fine during pre-bankruptcy litigation, it could do so now. The Bankruptcy Court considered the prejudice to the plaintiffs, concluding that the hardship to them of extending the automatic stay (after three years of litigation) outweighed any supposed distractions to Johnson. Johnson could always file his own personal bankruptcy to halt collection efforts against him.
The Upshot
If you’re a special assets or workout officer monitoring a borrower that just filed bankruptcy, don’t assume every pending lawsuit is frozen or worse, dismissed. That may be the case for a recently-filed lawsuit or a case involving issues that are the purview of the bankruptcy courts. But if litigation is far along, if it involves specialized state-court issues, or if requiring a “do over” in bankruptcy court would be inefficient, a bankruptcy court may allow it to proceed to conclusion. A plaintiff won’t get special treatment among the other creditors – only the right to adjudicate its claim outside of bankruptcy.
Also, if you’re a lender holding a personal guaranty, a landlord who also sued a tenant’s principal, or a business owner facing a lawsuit alongside your company, this case is a reminder that a corporate Chapter 11 filing is not a personal shield. Bankruptcy protects the entity that filed. Extending that protection to an individual is the exception, and courts look hard at whether personal liability is genuinely tied to the company’s debt or is really driven by that person’s own conduct. The individual bears the burden of convincing the Bankruptcy Court that the exception applies. Until that occurs, you can continue to pursue him or her.
