What Are Creditors’ Rights in a Bankruptcy?
Understanding creditor rights in bankruptcy
on November 3, 2022
Bankruptcy is a legal process intended to give indebted individuals and businesses a fresh start.
When a debtor files a bankruptcy petition with the bankruptcy court, an automatic stay is created that protects the debtor from further debt collection or lawsuits.
While bankruptcy focuses on protecting debtors’ rights and eliminating their debt obligations, creditors also have important rights in the process.
This article will explain the rights of creditors in a bankruptcy proceeding.
Once you have a general overview, it’s important to speak with an experienced lawyer about your situation.
“I think just about every lawyer will tell you that the decision to go in a certain direction can never be made soon enough,” says Wisconsin debtor-creditors’ rights attorney Seth E. Dizard.
“Delay is never helpful, and time is the one asset you can’t get back. It’s sometimes unfortunate when potential clients are unaware that certain options that might otherwise be available to them are gone with the passage of time.”
“I know it sounds self-serving to potential clients,” says Dizard. “Lawyers understand the issues, but potential clients cynically think it’s just a lawyer trying to get work. But no, it’s really true that financial legal problems don’t get better with age—they get worse.”
What is Bankruptcy?
If you’re a creditor and the person or business that owes you has filed for bankruptcy, it’s essential to understand what type of bankruptcy they have filed for.
Each type of bankruptcy is named after the section (or chapter) of the U.S. Bankruptcy Code where it is established. For example:
- Chapter 7. Chapter 7 bankruptcy is called liquidation bankruptcy since it involves liquidating (sale of assets) the debtor’s non-exempt assets to pay off creditors. Chapter 7 is the most common type of bankruptcy filing for individuals and businesses.
- Chapter 13. Chapter 13 bankruptcy is a type of reorganization bankruptcy for individuals and sole proprietorships. Instead of liquidating assets, Chapter 13 bankruptcy lets individuals restructure their debt and pay it off over the course of a few years in a repayment plan.
- Chapter 11. Like chapter 13, chapter 11 is a type of reorganization bankruptcy. It is used by businesses (including sole proprietorships, partnerships, corporations, and limited liability companies) to reorganize debt and repay creditors rather than liquidate. Reorganizing debt helps companies remain in business while going through bankruptcy. In addition to regular chapter 11 (which can be expensive and time-consuming), there’s a simplified bankruptcy proceeding in Subchapter V available to qualifying businesses. One of the main eligibility requirements for Subchapter V is the business’s outstanding debt is under the debt limit (currently set at $7.5 million).
Bankruptcy law is primarily a matter of federal law, although state laws are also relevant in determining exemptions.
Exemptions are property the debtor can keep in bankruptcy. There is a federal exemption scheme, and many states also have their own set of exemptions.
When the state has an exemption scheme, it will be used in a bankruptcy case. If the state doesn’t, federal exemptions come into play.
Exempt property typically includes the debtor’s house, debt-free cars, clothing, and essential household goods.
Bankruptcy does not discharge some types of debt, including:
- Child support
- Student loans (unless the debtor can prove undue hardship, which is challenging to do)
The Role of the Bankruptcy Trustee
A key player in many bankruptcies creditors should be aware of is the bankruptcy trustee.
As soon as a debtor files a bankruptcy petition to initiate bankruptcy proceedings, their assets are placed in a bankruptcy estate.
In chapter 7, chapter 13, and some types of chapter 11 (including Subchapter V), a court-appointed bankruptcy trustee administers the bankruptcy estate.
The trustee’s responsibilities in administering a bankruptcy estate depend on the type of bankruptcy a debtor has filed and the facts of the debtor’s situation. For example:
- In chapter 7, the trustee gathers the debtor’s assets, sells the assets, assesses creditor claims, and distributes the assets to creditors according to their priority
- In chapter 13, the trustee reviews and amends the debtor’s repayment plan, collects the debtor’s payments and distributes those payments to the creditors
The bankruptcy trustee ensures that creditors’ claims are heard and satisfied in the bankruptcy process.
What’s the Difference Between Secured and Unsecured Creditors?
Secured creditors have a legal claim to property backing a loan or purchase. The property backing the loan is called collateral.
Collateral can be any property specified in a security agreement. Common types of collateral include a house in a mortgage and a car in a car loan. If the debtor fails to make payments, the secured creditor can repossess the vehicle or foreclose on the house.
Secured creditors may have a judgment lien, a court order authorizing the creditor to take or repossess real estate or other real property to repay debt.
Unsecured debt, by contrast, is debt that isn’t backed by a legal claim to collateral. Common examples of unsecured claims include credit card debt and medical debt.
Though they lack collateral, unsecured creditors can file a legal document called a proof of claim with the bankruptcy court to stake their interest in the debtor’s assets.
However, in repaying creditors through bankruptcy, secured creditors have priority over unsecured creditors. This means that given limited assets to repay debts, secured creditors will get paid first. If assets are left over, unsecured creditors will then get paid.
Creditors’ Rights in a Bankruptcy
Working with the trustee in a bankruptcy proceeding, creditors have the right to:
- Have their questions answered at the meeting of creditors
- Have their claims heard in chapter 7 distribution of debtor’s assets
- Have their claims heard in chapter 13 debt restructuring and repayment plan
- Initiate an adversary proceeding to:
- Contest the discharge of the debtor’s property
- Seek enforcement of repossession or foreclosure
- Contest fraudulent conveyance of property
As with any legal action, creditors need to have legal representation in dealing with debtors and bankruptcy proceedings.
Questions for an Attorney
Fortunately, getting legal advice is not as complicated as many people think. Many attorneys provide free initial consultations to prospective clients.
These consultations allow the attorney to hear the facts of your situation and for you to determine if the attorney or law firm meets your needs.
To see whether an attorney is a good fit, ask informed questions such as:
- What are your attorney’s fees and billing options?
- What legal services do you offer?
- How do I get repaid as a creditor in a bankruptcy?
- What are the deadlines for filing a claim?
- How long does the bankruptcy process last?
- When can I expect to get my share of the bankruptcy estate?
It is essential to approach the right type of attorney—someone who can give you legal help through your entire case. You can visit the Super Lawyers directory and use the search box to find a lawyer based on your legal issue or location.
If you need legal assistance with debtor-creditor issues, consider looking for a debtor and creditor rights attorney. If you are dealing with bankruptcy issues, speak with a bankruptcy attorney.