Creditor's Rights in Bankruptcy

When a creditor gets a notice of bankruptcy they must do four things:

• Immediately stop all collection efforts - the Automatic Stay,
• File a claim with the Bankruptcy Court - the Proof of Claim,
• Quickly hire an experienced bankruptcy attorney to evaluate their position and rights, and
• Continue to monitor the bankruptcy case.

The Automatic Stay prohibits creditors from doing anything to collect their debts against either the debtor or property of the bankruptcy estate. Creditors must immediately stop all collection efforts, including telephone calls, billing, or law suits. Due to changes in the bankruptcy law passed in 2005, the effect of the automatic stay will be different if the debtor has filed two or more cases in a short period of time. If you are a secured creditor and the debtor is delinquent in making the loan payments, you may be able to get an order of the Court allowing you to foreclose on the property. This depends on many factors including, but not limited to the kind of bankruptcy, the value of the property, other facts and circumstances surrounding the filing of the bankruptcy case, and other loans against the property.

A Proof of Claim is a form which must generally be filed with the Bankruptcy Court if a creditor wants to share in any distribution from the bankruptcy estate. The Proof of Claim is the creditor's way of advising the Bankruptcy Court that they are owed money, why, how much, and where any recovery should be sent. A filed Proof of Claim is treated, in many ways, by the Bankruptcy Court as if the creditor had obtained a judgment against the debtor. The Proof of Claim form must be support by attaching copies of any contracts or judgments concerning your claim, or a summary of the claim if the supporting documents are too voluminous. The claims of unsecured creditors are low in priority in the bankruptcy distribution scheme and creditors often receive little or nothing on their claims. Nevertheless, a claim should still be filed because the costs of doing so are very low. A significant number of unsecured creditors do not file claims and lose valuable rights as a result. If you have not received a Proof of Claim form from the Bankruptcy Court, you can get one by clicking here

Bankruptcy Court notices will sometimes suggest that you not file a Proof of Claim form until you receive a later notice to do so.  We recommend that you file your Proof of Claim as soon as you learn about the bankruptcy case just in case: (1) you move and don't receive the later notice; (2) you lose your paperwork; (3) you lose motivation to file a Proof of Claim later. There is no harm, damage or penalty for filing a Proof of Claim early.  Do it while you are thinking about it now.

Quickly Hire an Experienced Bankruptcy Attorney to Help You Evaluate Your Rights. Some bankruptcy cases require that creditors act very quickly to protect their rights. Creditors who don't act or don't act quickly may lose valuable rights.

    »     An experienced bankruptcy attorney will be able to get background information about the bankruptcy case on line by accessing the Bankruptcy Court's records if you provide the case number and the State or City where the case was filed.

    »     An experienced bankruptcy attorney will want background information from the creditor about the creditor's history with the debtor to determine whether the debtor has claims which can be asserted back against the creditor.

    »     An experienced bankruptcy attorney will want background information about the claim to determine whether the claim is dischargeable, secured, partially secured, entitled to priority payment, entitled to reclamation rights, entitled to other special treatment under non-bankruptcy law, or has other special characteristics.

    »     An experienced bankruptcy attorney will want background information about the debtor and the filing of the bankruptcy case to determine whether the bankruptcy case was filed in good faith or for an appropriate and legitimate purpose.

The answers to these questions will allow the bankruptcy attorney to explain the creditor's rights and options. The options may include: (1) asking to dismiss the case, appoint a trustee or convert the case to another chapter, (2) filing a complaint to determine whether a claim is non-dischargeable or whether the debtor should be denied a discharge, (3) protecting valuable collateral rights, (4) taking a deposition or examination of the debtor or other parties to get more information, (5) participating in a creditor committee or electing a specific Chapter 7 trustee, or (6) asking permission to complete a foreclosure sale or legal proceedings in another court.  Creditors have many rights which can be lost due to inaction.

Creditors must also evaluate potential risks. Did the creditor receive payment or some other improvement in its collection rights shortly before the bankruptcy case was filed? If so, the creditor may be sued under bankruptcy "preference" laws to recover payments or reverse improvements in position. Preferences are special bankruptcy related legal problems that require expert analysis. Is the claim legitimate or fully earned? If not, any claim may be challenged by the debtor filing an Objection or Motion to disallow or modify the creditor's claim. Objections to claims can be based on any applicable law so another non-bankruptcy lawyer with expertise in the relevant law may be needed to protect the claim. Does the claim involve a lease or guaranteed wage or bonus? If so, the bankruptcy laws cap, or limit such claims.

Continue to Monitor the Case. Significant rights are likely to be lost if a creditor is not paying attention. 

Keep your address current. Notices in bankruptcy cases are sent by first class mail so something as simple as forgetting to let the Bankruptcy Court know about an address change can result in the loss of all rights. If the Bankruptcy Court and the parties do not know where you are, they cannot honor your claim.  If the bankruptcy case is dismissed, you may not know unless you keep your address current.

Monitor and object to Debtor’s plans. If the debtor is in a Chapter 13 or Chapter 11 case, read the proposed plan and understand your rights. Make objections where that is appropriate, particularly if the law says you have rights which are not being respected in the plan. Sometimes plans give creditors important options (usually in Chapter 11 cases) so make sure that you know the options and select the option best for you.

Consider reaffirmation agreements. If you are a secured creditor, consider whether your claim is recourse or non-recourse and how the bankruptcy case affects those rights.  In some cases it may be important to demand that the debtor formally reaffirm the claim. Debtors may be willing to do this when there is a cosigner or guarantor of the debt (such as a family member, friend, or employer) or when the creditor can take the car or other collateral after the bankruptcy case is over. 

Make sure the debtor is meeting all obligations. Debtors don't always do what they are supposed to do - that could be how they got into financial trouble in the first place. Bringing problems to the attention of the Bankruptcy Court may help creditors improve their situation.

Dischargeability of Debts

Some kinds of claims against an individual debtor are automatically not dischargeable. Creditors who have these types of claims do not need to take any action to keep their claims alive after the bankruptcy case is over. A few examples of claims which are automatically not dischargeable are claims for child support, spousal support (also known as alimony), family support, other divorce related debts, student loans, criminal restitution and judgments arising from drunk driving.

Other kinds of claims survive the bankruptcy only if the creditor acts within a very short period of time - 60 days after the first date set for the first meeting of creditors (usually about 90 days into the case). These are claims which arise from fraud, violating a trust, dishonesty, or other intentional "bad acts". To preserve these claims, creditors must file a lawsuit in the Bankruptcy Court asking that the claims be properly characterized as non-dischargeable. Unless this lawsuit is filed, these claims WILL be discharged, so timing is critical. Since these lawsuits can be expensive, you should consult with an experienced bankruptcy attorney about the costs, the chances of success and the collectability of the debt if it is not discharged. 

Eligibility for Discharge

In cases where the debtor may be eligible to receive a bankruptcy discharge, that discharge can be denied or revoked by the Bankruptcy Court for various reasons. Those reasons usually involve bad behavior by the debtor during the bankruptcy case, but can also be due to a debtor's failure to maintain adequate books and records or a debtor's attempts to conceal assets before the bankruptcy case is filed. 

These challenges may be raised only if the creditor acts within a very short period of time - 60 days after the first date set for the first meeting of creditors (usually about 90 days into the case). If the Court decides that the creditor was wrong and gives the debtor a discharge, the creditor may have to pay the debtor's legal fees and costs so it is important to weigh this option carefully.

Corporations, partnerships, limited liability companies and other business entities are not entitled to a discharge of their debts in Chapter 7 bankruptcy cases.  Instead, the assets of those entities are fully liquidated to pay creditors. Even in Chapter 11 cases, the assets of business entities are fully involved in the reorganization process.  As a result, the concept of "nondischargeability" is meaningless in a business entity bankruptcy case.

A Few Words About Preferences

The Bankruptcy Code permits the bankruptcy estate (either a trustee or a Chapter 11 debtor in possession) to reverse certain transactions between the debtor and creditors which took place shortly before the bankruptcy case was filed. The rules are complicated, but they include much more than having to repay recent payments received from a debtor.  Before a transaction can be reversed, the creditor must be sued. The plaintiff will have to show that the creditor received a greater benefit than other creditors, that the benefit was received during the relevant time period and other things as well. The creditor will have a chance to raise certain defenses which are built into the bankruptcy laws. If the plaintiff wins, the creditor's remaining claim may be disallowed by the Court until after the preference is repaid.

The policies behind the preference law are reasonable - to make sure that all creditors are treated equally and to prevent creditors from engaging in a footrace to see which of them can grab the debtor's assets first. In practice the costs of preference litigation and the burdens of losing both create serious risks to creditors and may threaten a creditor's own financial survival. 

If you have received a preference complaint, it should not be ignored. You may have legitimate defenses which, if the plaintiff is reasonable, will result in the case being quickly dismissed. Oftentimes settlements, including payments over time, are also available. It is important that you consult with experienced bankruptcy counsel as quickly as possible.

Debts Arising Due to Divorce

As indicated at the beginning of this section, debts related to a divorce are given special treatment in bankruptcy proceedings. Please go instead to our special topic page about family law matters by Clicking Here