Bankruptcy Basics for Creditors

By Mike Wilson J.D.

When debtors are unable to pay their debts, they may seek relief by filing bankruptcy in federal court. The three most popular forms of bankruptcy are Chapter 7 (liquidation), Chapter 13 (consumer reorganization), and Chapter 11 (business reorganization).

Automatic Stay: Upon filing bankruptcy, the debtor’s creditors are barred from attempting to collect the debt owed by the debtor. This is known as the “automatic stay.” If you are made aware that the debtor has filed bankruptcy, whether from Bankruptcy Court notices that are mailed to the creditors or otherwise, leave the debtor alone. Debtors injured by willful violation of a stay can recover actual damages, including court costs, attorney fees, and sometimes punitive damages.

Secured creditors (ones with collateral) may ask the Court to lift the automatic stay under certain circumstances in order to enforce their liens against collateral. If you are a secured creditor, your attorney will examine whether this is an option for you. The automatic stay generally does not prevent creditors from collecting from co-debtors who have not filed bankruptcy unless the debtor filed under Chapter 13.

Meeting of the Creditors: Soon after filing bankruptcy, a “meeting of the creditors” is scheduled at which interested creditors and the Bankruptcy Trustee (discussed below) can question the debtor. Creditors should receive notice of the meeting from the bankruptcy court.

Secured creditors often ask about the location and condition of their collateral. Creditors sometimes are investigating fraud or another basis for objecting to discharge of the debt. The Trustee, among other things, is looking for assets, avoidable liens, fraudulent conveyances, and transfers shortly before bankruptcy that preferred one creditor over another.

Filing Claims: Creditors may file “proof of claims” setting forth what they are owed and the basis for the claim. Secured creditors do not have to file proof of claims to preserve their liens, but may wish to file if the amount owed may exceed the value of the collateral, as then the creditor would be partly secured and partly unsecured. In some “no-asset” cases, the Court may send creditors a notice saying it is not necessary to file a claim.

Bankruptcy Trustee: The Bankruptcy Trustee appointed by the Court plays an important role in administering Chapter 7 and Chapter 13 cases.

In Chapter 7, the Trustee liquidates the debtor’s non-exempt assets. However, certain assets will be exempt, although the specifics vary among jurisdictions. Also, secured creditors are paid first from sale of their collateral. If the lien approaches the value of the collateral, or the lien plus applicable exemptions leave no equity, the Trustee will “abandon” the property.

Debtors can “redeem” certain collateral by paying the creditor the value of the collateral, even if less than the debt owed. Since liens generally survive bankruptcy, Debtors sometimes “reaffirm” debts under agreements that allow the debtor to keep the collateral and pay on the debt in a manner agreed to by the creditor.

Chapter 13 allows individuals and sole proprietorships to “reorganize” with a plan that will pay the debts, or a certain percentage, over the course of several years under supervision of the Trustee. Creditors may object to the plan, but the Court may approve the plan anyway under certain circumstances. If the plan is approved, creditors receive payments as provided in the plan. Different classes of creditors may be treated differently under the plan.

Business Reorganization: A trustee is not usually appointed in Chapter 11. Instead, the debtor files certain disclosures and a plan of reorganization that is voted on by creditors whose claims are impaired under the plan. If some creditors object to the plan, the Court determines whether or not to approve it. As in Chapter 13, different classes of creditors may be treated differently under the plan.

In Chapter 11, the Unsecured Creditors Committee has the power to investigate the acts and financial affairs of the debtor. Participation by unsecured creditors is optional. The Committee also can propose a plan of reorganization, ask that a Trustee be appointed to operate the debtor’s business, and take other steps to protect unsecured creditors.

The foregoing is a general discussion of bankruptcy, not legal advice. If your debtor files bankruptcy, seek advice of counsel.

Mike Wilson is an attorney and author. He teaches at Sullivan University in Lexington, KY.

[From Connection MagazineOctober 2003]

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