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Debt in America is at an all-time high, with one study estimating that Americans owe $14 trillion in mortgages, credit card bills, student loans, and other types of debt. When a debtor fails to repay their debts in a timely manner it can cause serious hardship to the creditor holding that debt.

Although large creditors like banks or credit card companies have significant amounts of data that allow them to effectively factor the risk of nonpayment into their business plan, many small businesses and landlords do not, putting them at greater risk of defaults that threaten their business.

Some of the biggest risks to creditors arise during bankruptcy proceedings. Bankruptcy allows a debtor to discharge many of his or her debts, often in exchange for partial or sometimes even no payment of the remaining balance. Bankruptcy is a complicated process governed by both state and federal law, so many small and inexperienced creditors are unaware of their rights and often lose out on money they are owed that could have been collected had the proper steps been taken.

The Bankruptcy Code is designed to balance the interest of debtors in getting a fresh start and creditors in receiving payment for the debts they are owed. Thus, even though the Code gives certain protections, like the automatic stay, to debtors, it also grants rights to creditors. Exactly what rights a creditor has depends on the type of debt they are owed and the chapter of bankruptcy the debtor filed under.

How does bankruptcy affect creditors?

The legal situation between creditors and debtors changes dramatically once a debtor files for bankruptcy. Bankruptcy affects the debt collection process, the amount of money a creditor can expect to receive, and the relationship between different creditors.

When a debtor files for bankruptcy, it triggers an automatic stay that prevents creditors from attempting to collect debts; create, protect, or enforce liens; repossess property; or sue for a judgment on debt. Although domestic support obligations like child support or alimony are exempt from the stay, the stay prevents attempts to collect almost every other form of debt.

Creditors who attempt to collect in violation of the stay can be subject to serious penalties, so it’s always a good idea to contact an attorney to figure out the best way to proceed within the bankruptcy. In one case in 2017, a bankruptcy judge awarded a married couple $45 million in damages after their bank violated the automatic stay by foreclosing on their home.

The ultimate purpose of a bankruptcy is to either liquidate the debtor’s assets and distribute them among the creditors, or to set up a repayment plan with the debtor’s disposable income distributed among the creditors over a period of several years. Regardless of the form the bankruptcy takes, it usually ends with the discharge of all eligible debts. This can mean that creditors, particularly unsecured creditors, receive far less than they are owed.

Finally, the bankruptcy code governs the distribution of the liquidated assets or income among the creditors. The debtor does not get to decide which creditors are paid and which aren’t; the court and its appointed trustee are given the authority to make these decisions..

This feature of bankruptcy means that creditors who received payments within 90 days of the filing may be asked to return these payments to the estate for distribution among all creditors. The trustee will request the return of the money to ensure that it is distributed among creditors as required by the bankruptcy code rather than according to the debtor’s preferences. A creditor who receives $600 or more from a consumer debtor or $6,825 from a business debtor within the 90 days before the bankruptcy was filed can (and likely will) be asked to return the money to the trustee.

Although the bankruptcy process can be intimidating, creditors do have certain rights. It’s crucial that any creditor whose debtor has filed for bankruptcy exercise these rights to maximize the payment they receive in bankruptcy. Bankruptcy courts enforce their deadlines strictly, so any creditor whose debtor has filed for bankruptcy should contact a lawyer as soon as possible to determine their rights and options.

Secured and unsecured debt

Bankruptcy has very different effects on secured and unsecured debt. A secured debt is a debt where the creditor has the right to repossess a piece of property, like a house or a car, to guarantee payment of the debt. An unsecured debt is a debt where the creditor has no right to any specific piece of property. Although the automatic stay prohibits collection of either type of debt throughout the bankruptcy proceeding, the bankruptcy system treats secured and unsecured debts very differently.

In general, creditors with secured debts have less to lose in bankruptcy than creditors with unsecured debts. A creditor with a lien on property has the right to receive payment equal in value to the lien. This right takes priority over the rights of unsecured creditors, so as long as the property that secures the debt still exists, a secured creditor will receive payment.

For example, if a debtor owes $5,000 on his car when he files for bankruptcy and the creditor has a lien on the car, the creditor is entitled to have the car sold and receive $5,000 in payment. Alternatively, the debtor and creditor could make a reaffirmation agreement, in which the debtor would agree not to discharge the car loan in bankruptcy and continue to make timely payments in exchange for keeping the car.

Unsecured creditors are in a more precarious situation. Whether the debtor files for a Chapter 7 liquidation or a Chapter 11 or 13 repayment plan, payment is not guaranteed to an unsecured creditor. Thus, unsecured creditors must be active in asserting their rights during the bankruptcy process to make sure they receive as much of what they are owed as possible.

Objections

When a debtor files for bankruptcy, the bankruptcy court will notify all of that debtor’s creditors.

Creditors should examine bankruptcy filings for accuracy and file an objection if they are not included as a creditor or if the debt listed is not the accurate amount owed to them. When filing for bankruptcy, debtors must file detailed schedules listing their assets, income, and debts. These filings are publicly available, and creditors should examine them.

The bankruptcy court will notify any creditors listed on the filing of the impending bankruptcy proceeding. If a creditor is not given notice (usually because the debtor did not list them on the filing), the debt owed to that creditor is not discharged in bankruptcy.

If the schedule understates the amount of debt owed to a particular creditor or differs from the information the debtor provided to the creditor when applying for credit, the creditor should file an objection with the court. An attorney can help review filings and determine the best strategy for objecting.

Creditors also have the right to question debtors in a bankruptcy proceeding. In a Chapter 7 or 13 proceeding, the debtor is required to attend a meeting called a 341 hearing, sometimes called a meeting of creditors. As the name suggests, creditors have a right to attend this meeting and ask questions of the debtor and the debts listed in the bankruptcy filing.

If there are inconsistencies in a debtor’s filings, it is usually a good idea to attend and ask questions. A creditor has the right to be represented by an attorney at a 341 hearing, and an experienced attorney will know which questions to ask the debtor to ensure that their client’s rights are protected throughout the proceeding.

The time for questioning at a 341 hearing is usually short, so the Bankruptcy Code also allows creditors to interview debtors under oath (called a deposition). This is a good option if there are serious inconsistencies in a bankruptcy filing.

Priority claims

Not all unsecured debts are created equal. Once secured debts are paid, the Bankruptcy Code establishes an order in which unsecured debts are paid. Domestic support obligations like alimony and child support are highest-priority unsecured debts. Wages or retirement benefits owed to employees, unpaid taxes, and judgments for injuries due to drunk driving also have priority over other unsecured debts. A bankruptcy lawyer can determine whether an unsecured debt has priority and where it stands in relation to other debts.

For example, if a debtor in a Chapter 7 bankruptcy has $5,000 in assets and owes $3,000 in child support, $3,000 in back taxes to the IRS, and $4,000 in credit card debt, the debtor’s children receive $3,000, the IRS receives the remaining $2,000, and the credit card company receives nothing at all.

The priority of debts and the order in which they are repaid will play a major role in determining whether a particular creditor will receive all, some or any of the debt owed to them. If you’re concerned about whether your debt is considered a priority, you should contact an attorney immediately to discuss your options.

Dischargeable and non-dischargeable debts

Filing for bankruptcy does not guarantee the discharge of all debt. Certain types of debt may remain due after bankruptcy. Some types of debt can never be discharged. Other times, even a debt that would otherwise be dischargeable may not be discharged because of something the debtor did.

A few debts are dischargeable in some chapters of bankruptcy but not others. Certain government fines as well as divorce obligations in the nature of property settlements (i.e. not alimony or child support) can be discharged in Chapter 13 but not Chapter 7.

Some debts are never dischargeable, no matter the debtor’s intent in incurring them. Common examples include:

• Student loans – absent a showing of extreme hardship
• Alimony and child support
• Compensation for willful and malicious injury to another person caused by the debtor
• Taxes

Other debts may not be dischargeable if the debtor incurred them without any intent to pay or if they were for luxury purchases. The law defines luxury purchases as purchases over $725 that are unnecessary for the debtor or their dependents, such as jewelry, vacations, or gifts for family members.

A creditor who believes a debtor borrowed in bad faith or made luxury purchases immediately prior to filing for bankruptcy should contact an attorney. Whether a court believes a debt was incurred in bad faith or for luxury purposes often comes down to arguments presented in court, and an experienced bankruptcy attorney could make the difference between the creditor being repaid or not.

Who should I contact if one of my debtors has filed for bankruptcy?

If someone who owes you money has filed for bankruptcy or is threatening to do so, contact Rosenblum Law for a free consultation. Our bankruptcy attorneys have represented both debtors and creditors, so we understand both sides of the process. Email us or call 888-815-3649.