How to Protect a Personal Injury Claim in Bankruptcy: Is Your Settlement Exempt?

You don’t always have to forfeit your injury compensation to get a fresh start. Learn how injury settlements are treated in bankruptcy.

Bankruptcy laws in the United States are designed to provide relief and a fresh start for individuals who are overwhelmed by debt.

Car accidents and other injury events can add a terrible strain to your finances. It takes time to settle a personal injury claim or lawsuit, and you may be getting to the point of considering bankruptcy.

State and federal bankruptcy laws determine if you get to keep your personal injury settlement, or if some or all of your compensation must be applied to your debts.

Here’s where we discuss how different ways filing personal bankruptcy might affect your injury settlement.

Common Types of Personal Bankruptcy

Bankruptcy in the United States is a legal process to provide debt relief to insolvent businesses or individuals. A bankruptcy action is initiated by filing a petition in Federal Bankruptcy Court.

The person filing the bankruptcy petition is called the debtor, or petitioner. Then the court appoints a trustee who examines the petitioner’s assets and decides what can be used to repay all or a portion of the debt.

As stated by the United States Supreme Court: 

“One of the primary purposes of the Bankruptcy Act is to ‘relieve the honest debtor from the weight of oppressive indebtedness, and permit him to start afresh free from the obligations and responsibilities consequent upon business misfortunes.'”

Individuals may file a Chapter 7 or Chapter 13 bankruptcy.

Under federal law, an automatic stay goes into effect against your creditors as soon as you file bankruptcy. Foreclosure proceedings against your home must stop, the bank can’t repossess your vehicle, and wage garnishments and collection calls must cease.

Chapter 7 Bankruptcy

Lower income debtors are most likely to qualify for Chapter 7 bankruptcy. People file Chapter 7 bankruptcy when they can’t afford to make monthly debt payments and still pay living expenses. Chapter 7 is the most commonly filed type of consumer bankruptcy.

In Chapter 7 bankruptcy proceedings, the debtor asks to be released from their debts.  A trustee is assigned to review the debtor’s assets and determine if the assets may be used to cover some or all of the debts. The trustee can sell your non-exempt property to help pay off your debts.

Secured debts, like mortgage loans and car loans, can be discharged through bankruptcy, but you’ll have to surrender the property that secured the debt, like your home or vehicle.

Unsecured debts, like credit card debt and utility bills, can be discharged. If the debtor’s obligations are discharged, they are protected from further collection actions on the debts.

Medical bills are also unsecured debts, unless the bills are connected to a medical lien against your personal injury settlement.

By law, certain debts cannot be discharged through bankruptcy:

  • Child support
  • Alimony
  • Student Loans
  • Taxes

Chapter 13 Bankruptcy

Sometimes people have too much money to qualify for Chapter 7 bankruptcy. In these situations, the debtor files for Chapter 13 bankruptcy, which is essentially a court-ordered repayment plan.

An advantage of Chapter 13 proceedings is that the court allows debtors to keep their property. You can save your home from foreclosure, and keep your car, with the past-due payments spread over the course of the Chapter 13 plan. However, once you file for Chapter 13 bankruptcy, all your assets become part of the bankruptcy estate, to be managed by the trustee.

The trustee will review your incomes, debts, and living expenses. If you are expecting an award or settlement from a personal injury claim, the compensation will be taken into consideration as part of the overall plan. Chapter 13 payment plans can stretch for three to five years, depending on your income.

You must disclose a potential injury settlement when you file for bankruptcy if the accident giving rise to your injury claim occurred before you filed.

If you were injured while still under a Chapter 13 bankruptcy plan, you must disclose your claim right away. The trustee is required to consider using any income, including your settlement, to help pay off debts. You may need to get approval from the Bankruptcy court for your personal injury attorney to represent you.

In any case, your bankruptcy lawyer, personal injury attorney, and bankruptcy trustee will need to work together to serve the interests of everyone involved.

When Personal Injury Payouts are Bankruptcy Assets

Your personal injury award or settlement counts as an “asset” in your Chapter 7 bankruptcy case when the injury occurred before you filed bankruptcy. It doesn’t matter if you wait to file an injury claim or lawsuit until after the bankruptcy. Your injury payout counts toward the bankruptcy.

Compensation for physical injuries that happen after your Chapter 7 filing is usually yours to keep.

Chapter 13 cases are a different story. Potential compensation for injuries that occurred before or during your Chapter 13 plan become part of the bankruptcy estate.

Full Disclosure is Critical

When filing bankruptcy schedules, be sure to list every possible asset, including potential injury compensation, even if you haven’t been paid yet. Also list every debt you owe, including injury treatment bills that may be secured as a medical lien against your settlement.

Even if you haven’t filed a personal injury claim, if you have a cause of action against a negligent party, you must include it in your bankruptcy paperwork. 

Failing to disclose all your assets in a bankruptcy filing is considered fraud. Federal criminal penalties for bankruptcy fraud include up to five years in prison and financial penalties up to $250,000.

Bankruptcy trustees monitor for monetary awards long after your bankruptcy is concluded.

State and Federal Exemptions for Injury Settlements

It pays to fully disclose all your assets and debts when filing bankruptcy and to work with an experienced bankruptcy attorney. There are Federal and local laws that may protect some or all of the proceeds of your personal injury case, depending on your unique situation.

Exemptions in bankruptcy cases are rules that spare some of your property or assets from being used to satisfy your debts.

Federal bankruptcy exemption for injury settlements, in part: 

“The debtor’s right to receive, or property that is traceable to … a payment, not to exceed $23,675, on account of personal bodily injury, not including pain and suffering or compensation for actual pecuniary loss, of the debtor…”

State Bankruptcy Laws May Vary

Your attorney will know the laws and exemption amounts that pertain to your case, and which ones will help you keep more of your injury settlement. In some states, you are limited to the state bankruptcy laws. In others, you can choose between federal and state exemption laws.

For example, federal bankruptcy code exemptions are not an option in California. However, California provides two options for claiming bankruptcy exemptions: Code 704 exemptions, often used to protect home equity and private property; and Code 703 exemptions, called a “wildcard exemption” for assets that don’t fall into other categories.

In Texas, you can elect to use the federal exemption. However, Texas has very generous exemption rules for bankruptcy, so you might be better off using the state rules.

Your attorney will help you weigh the options available in your state.

Get Help to Protect Your Settlement

Talk to an experienced bankruptcy attorney to help you decide if bankruptcy makes sense for your situation, and what type of bankruptcy may be appropriate. Discuss your potential injury compensation and ask if your settlement will qualify for a bankruptcy exemption.

Most personal injury attorneys offer a free consultation to accident victims. During your initial consultation, tell the attorney if you are in bankruptcy, or considering filing for bankruptcy.

You will need an injury lawyer who knows how to navigate bankruptcy rules while handling your personal injury lawsuit or claim.

Dustin Reichard, Esq. is an experienced attorney with 20 years of work in the legal field. He’s admitted to the Illinois State Bar and the Washington State Bar. Dustin has worked in the areas of medical malpractice, wrongful death, product liability, slip and falls, and general liability. Dustin began his legal career as a JAG... Read More >>