Every creditor faces the risk that someone who owes them money will file for bankruptcy relief. Whether the debtor is planning to liquidate or reorganize, the initial filing invariably delays creditor recoveries. Upon the filing, an automatic stay takes effect, generally preventing actions to enforce then-existing claims or rights against the debtor or any of the debtor’s property. Creditors eventually may receive some or even all of what they are owed, with secured creditors (eg: lenders, parties holding security deposits) and priority creditors (eg: employees, consumers who have made deposits) having the best recovery prospects. General unsecured creditors (eg: vendors, contract parties) run a greater risk of non-payment. However, not all general unsecured creditors face identical risks of loss.
A fundamental philosophical underpinning of our bankruptcy laws is that a debtor should be given a fresh start. Another is that all like creditors should receive equal treatment in the debtor’s case. An individual debtor generally will receive a discharge of all pre-bankruptcy unsecured debt, without the need to actually pay it off. Unsecured creditors who timely file proofs of claim (or whose claims have been properly scheduled in a Chapter 11 case) are likely to share pro rata in a modest pool of assets and recover far less than they are owed. An attentive creditor may be able to take advantage of exceptions to these rules.
Excepting the Claim from Discharge
Not every obligation of an individual debtor is subject to discharge. Creditors who file and prevail on appropriate “non-dischargeability” complaints get to have their claims share in the general pool, and also are permitted to continue to assert and collect on those same claims against the debtor and his/her post-bankruptcy assets as if the bankruptcy filing had not occurred. Generally claims arising from fraud, embezzlement or larceny are not dischargeable. Similarly, while judgments for post-marital property division may be subject to discharge, claims for domestic support obligations are not. The grounds for denial of discharge as to a particular creditor’s claim must be alleged in a timely-filed complaint and proven in the bankruptcy case.
A creditor who obtained a judgment before the bankruptcy filing may still have to prove that the claim evidenced by the judgment is not dischargeable. Oftentimes, a judgment will not clearly be based on non-dischargeable grounds, such as a judgment for damages on a complaint alleging fraud in the inducement and breach of contract. Similarly, a stipulation settling a lawsuit that included claims about false pretenses or false representations likely will not be enough to establish that the stipulated claim cannot be discharged. By timely filing a complaint to prevent discharge, a creditor holding a pre-bankruptcy judgement or stipulated judgment will be given the opportunity to submit evidence and argue against discharge of the claim. The window for filing such a case is short, 30 days after a notice of the deadline is mailed, often within the first three months of the case. Clearly it is important for a creditor to evaluate its potential rights promptly upon receipt of information about a bankruptcy filing.
Excepting the Debtor From a Fresh Start
Some debtors don’t deserve a fresh start, and the Bankruptcy Code makes that clear. Where a court finds that a bankruptcy case was not filed in good faith, the case may be dismissed, denying the debtor all bankruptcy relief. Alternatively, the court may retain the case so that creditors share in the available assets, but deny the debtor its fresh start. This means that the debtor is not permitted to discharge any debts – all claims are treated as non-dischargeable. Under this scenario, creditors share in whatever assets have come under the control of the court, and retain the right to continue to pursue the debtor until they have been paid all they are owed. Debtors who have lied to the court about their assets, hidden assets, hidden records, or cannot explain major losses of assets or information are most likely to suffer this sanction. While it may feel like vindication, this is generally not the best result for any given creditor, as all claims, not just the particular creditor’s, will survive to be asserted against the debtor after the bankruptcy case.
Pursuing Co-obligors and Guarantors
As a general rule, only an identified debtor is protected by the stay in a bankruptcy case. In individual cases, a co-debtor may be protected for a brief time, if the court finds cause. A creditor who has claims against third parties should take care to monitor the case and oppose the imposition of any “co-debtor stay.” Apart from this limited exception, guarantors and co-obligors are fair targets during the pendency of a debtor’s bankruptcy case, unless they are debtors in their own bankruptcy cases. A creditor who initially opted to enforce its judgment against the debtor, should avail itself of all reasonable recovery opportunities. Moreover, these co-obligors may not be responsible for paying the claims of the debtor’s other creditors, and so may provide a recovery source that has fewer claims against it.
Each bankruptcy case has its own twists and turns, but an alert creditor may be able to turn the debtor’s case to the creditor’s benefit, and thus avoid being foiled by a bankruptcy filing. An experienced creditors’ rights lawyer can help you develop and implement effective strategies when the people who owe you money file bankruptcy.
Thank you for joining us on ClarkTalk! We look forward to seeing you again on this forum. Please note that the views expressed in the above blog do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interest relating to the subject matter covered by the blog. If you have any questions about the treatment of creditors’ claims in bankruptcy, or about other creditors’ rights in bankruptcy, please feel free to email Kimberly S. Winick at firstname.lastname@example.org or to call her at 213.629.5700. For more information about Clark & Trevithick’s Commercial Law and Insolvency practice, please visit our website at www.ClarkTrev.com.