Someone owes you, or your company, money.  You have been writing letters demanding payment, and maybe you have even engaged a collections agency, or our firm’s department of commercial collection to collect the receivable.

But then you learn that the individual who owes you money has filed for bankruptcy.  What does that mean? What do you do? What are your rights?

As a creditor in Bankruptcy, you do have some rights.  However, the filing of bankruptcy places an Automatic Stay on all actions against a debtor, which protects the debtor and his assets from any collection efforts – including phone calls, bills and lawsuits. Therefore, the very first thing you, as a creditor, have to do is stop all your collection efforts while you evaluate your options.

While the Automatic Stay is in place, you can file a proof of claim with the Bankruptcy Court.  If the debtor has listed you as a creditor in the bankruptcy, as the debtor should, you will receive notice informing you of where to file a proof of claim and the deadline for filing one.  This is a form document that allows you to assert, in the bankruptcy, the amount you claim is owed from the debtor. Once you have filed a proof of claim, you, with the help of an attorney, can evaluate your next steps.  There are many issues a bankruptcy raises for the creditors and a discussion of all of such issues is beyond the scope of this article. Key questions to be addressed include:

1. What type of bankruptcy has the debtor filed? There are three main types of bankruptcies filed by debtors, and your options (and recovery) as a creditor may be dictated by the type of bankruptcy chosen by the debtor. (i) A Chapter 7 Bankruptcy is a liquidation of the Debtor’s assets.  Certain assets will be exempt from the bankruptcy estate and will not be sold, but a trustee will sell the non-exempt assets and distribute any proceeds to the creditors according to the priority of their rights.  After a debtor files for Chapter 7, any wages earned by the debtor belong to it, and are not subject to the claims of the creditors in the bankruptcy.  (ii) Chapter 11 is generally used by corporations or partnerships, but individuals also may file under Chapter 11.  In Chapter 11, the debtor and not a trustee remains in possession of its assets.  The debtor creates a plan of reorganization that may involve repayment of creditors out of future profits, sale of some assets or other corporate transactions to allow the debtor to reposition itself to survive once it emerges from bankruptcy.  This plan of reorganization, once confirmed by the court, provides the terms for repayment of the debtor’s outstanding debts. Creditors may object to the plan for any number of reasons, and often do so, if the plan does not meet certain technical criteria or if it appears to be unfeasible. (iii) A Chapter 13 bankruptcy is available only for individuals with less than $336,900.00 in unsecured debt (and provides a cap on secured debt as well).  In Chapter 13, there is a trustee as in Chapter 7, but the debtor remains in control of the property as in Chapter 11 case.  A Chapter 13 debtor proposes a plan wherein s/he makes payments to the trustee over a period of several years and the trustee distributes such payments among the creditors.

2. Is your debt secured? Determine if you have a lien or a security agreement on real or personal property. If so, you may be able to get relief from the automatic stay in order to protect your security interest by selling the asset on which you have a lien.

3. Is your debt non-dischargeable?  Usually, in bankruptcy, the debtor’s debts are ultimately discharged such that when the debtor emerges from bankruptcy, he gets a fresh start and his old debts are basically forgiven, with the creditors having been paid pennies on the dollars owed.  However, certain categories of debts, including those arising out of fraud or malicious acts, are non-dischargeable, and a creditor of such debts can bring an adversary proceeding in the bankruptcy to assert its rights.  A victory in such a proceeding declaring the debt non-dischargeable preserves the creditor’s right to collect on the entire debt after the bankruptcy, whereas for a debt discharged in bankruptcy a creditor only may end up collecting a small percentage of the amount owed.

Even if your claim is non-dischargeable, you and/or your attorney should monitor the bankruptcy  – you are in the best position to know if you have specific rights to assert and you may know if a debtor is hiding assets or if he is using the legal process simply to thwart your efforts at collection.   This knowledge ultimately may allow you to use various legal devices to attempt to collect more than you otherwise would.

A case filed under the Bankruptcy Code may be dismissed or converted to another chapter, if it does not meet the requisite criteria, or if circumstances call for such a conversion.  As such, it is important to continuously monitor the bankruptcy, as your rights and recoveries, as a creditor, may be impacted by the dismissal of a bankruptcy or by the conversion from one chapter to another.  For example, payments to a creditor may differ drastically from a bankruptcy plan calling for payments over five years to a liquidation where the debtor’s assets are sold at auction and the creditors receive one lump-sum payment.  As a creditor, with knowledge of the debtor and its business, you may be able to assist the trustee in martialling and maximizing the debtor’s assets, thereby maximizing your recovery.

In this economy, with the increasing number of all types of bankruptcies being filed, it is important to know your rights, assert them where necessary and seek attorney advice to protect yourself and your interests. If you are in need of advice, feel free to contact our commercial collection office for help.

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