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Creditor Issues In Bankruptcy

As in the age old notion of yin and yang, such is the same in bankruptcy. For every debtor, there is a creditor. Often times, creditors are exasperated when they receive the notification that one of their debtors filed bankruptcy and they are right to do so. In particular, they are automatically estopped from continuing the legal processes, such as a lawsuit or debt collection attempt. Further, assuming that the Debtor completes his/her bankruptcy, the creditor will be forever enjoined from pursuing its debt against the debtor by virtue of the Discharge Injunction. 1 But not all is lost, because creditors have some rights and options in bankruptcy.

A. Proof of Claim

Occasionally, a debtor will have assets that exceed his/her exemptions, supra. In this situation, the Trustee is compelled to liquidate those non-exempt assets and subsequently distribute the proceeds therefrom to the creditors on a priority basis. Priority Creditor Claims are those debts such as tax debts, domestic support obligations (alimony, child support), and unpaid wage claims. After those claims (if existing) are paid, then the General Unsecured Claimants are paid on a pro rata basis. This creditor class is comprised of debts such as credit cards, medical debts, & vendor debts and generally constitutes the bulk of a debtor’s debt. When the Bankruptcy Trustee announces that non-exempt assets are to be sold, then a creditor should file a Proof of Claim (See Exhibit “A”). Along with this Proof of Claim, supporting documents should be submitted, including account balances, mortgage documents, etc…

B. Objections to Confirmation

Creditors who are wholly beside themselves with the notion that a debtor has filed bankruptcy and expect little payment on their debts (if any) can actually attempt to derail a debtor’s Chapter 13 or Chapter 11 by objecting to the confirmation above. Traditionally, in a Chapter 11 bankruptcy, a creditor objects on the basis that the proposed Plan is not feasible or sustainable because historic financials do not support such a lofty prediction of net revenue. Conversely, a Chapter 13 Objection to Confirmation can be filed under several premises, a more common one being fraud. Often, a creditor will accuse a debtor of filing bankruptcy simply as a means of delaying or evading the creditor and that the bankruptcy filing is in bad faith. If the Court so finds, then the Debtor can be dismissed from his bankruptcy or even converted to a Chapter 7, wherein a Chapter 7 Trustee will assume the investigation and liquidation of the Debtor.

C. Avoidance/Preference Actions

One of the worst aspects of being a creditor in bankruptcy is the concept of avoidance actions, specifically preference actions.2 The concept is simple: Within ninety (90) days of filing bankruptcy, a debtor makes a payment on his/her debtor in excess of $600. In some instances, that is the normal course of business; in some instances, however, it is preferential. Here’s the rationale: the Bankruptcy Code presumes that anyone filing bankruptcy was insolvent within ninety (90) days beforehand. As such, the debtor had little means to pay debts to one, much less all of his/her creditors. When that debtor decides to pay only one or a few of them while the majority of creditors get nothing, our Bankruptcy system feels that is unfair. The creditors receiving money were “preferred” over those creditors that did not receive anything. The Bankruptcy Court presumes that in an ideal world that same amount of money paid to one creditor should have been even distributed to all the creditors. Accordingly, the Bankruptcy Trustee has “clawback” powers, aka Avoidance powers that allow him to demand turnover of those preferred payments.

Many creditors cry foul at the notion that they have to turn over money paid on a debt when they were legitimately owed that money by the debtor and likely are still owed more money by that same debtor. There are some defenses available, such as new value and normal course of business, but the presumption is against the creditor. This is an ironic outcome: we are unfair to one creditor so we can be fair to all creditors.

An experienced bankruptcy attorney can assist you through this process. Arnold & Smith, PLLC has experienced attorneys in the field of bankruptcy and can help navigate the process for you. If you would like to set up a consultation with one of our attorneys, please do not hesitate to contact us.