"Creditors' Rights"
Is Not An Oxymoron

by Joy H. King

Your client is facing bankruptcy -- someone else's! With the continuing increase in filings by both businesses and consumers, it seems almost unavoidable. Through the grapevine or by receipt of a formal notice from the court, your client has learned its client or customer has filed for bankruptcy protection. What can a creditor do to protect its interests? While this article is not meant to be an exhaustive study of the subtleties of bankruptcy practice, it will provide an overview of "do's and don'ts" when your client becomes a bankruptcy creditor.

First, learn about the case and pertinent deadlines; second, timely file a claim for any amounts owed; and finally, seek the advice of an attorney with experience in bankruptcy matters. Bankruptcy is a highly complex, subtle and specialized area of the law. With court approval, anything can happen. Depending on the circumstances of the case and the nature of the debt, experienced bankruptcy practitioners can recommend the proper course of action.

A creditor needs to understand the stature of a debtor before and after filing for bankruptcy protection. Once a debtor has filed a petition for relief, it becomes a capital-D "Debtor" under the jurisdiction of the United States bankruptcy court. An entirely new set of rules applies as to when, how, and why Debtor can use its cash and other assets. Almost all of Debtor's assets are considered property of the bankruptcy estate.

Debtor's estates are within the oversight of the United States Department of Justice through the Office of United States Trustee, which is charged with responsibility of seeing that Debtor's assets are not wasted or misused. In the case of a Chapter 7, or consumer bankruptcy, the U.S. Trustee will appoint a Chapter 7 Trustee, whose responsibility is to maximize the value of the estate and increase the pool of funds available for distribution to creditors. A Chapter 13 bankruptcy requires that Debtor have a regular source of income and adhere to a plan to repay its debts. Chapter 12 is reserved for farm reorganizations. Chapter 11 reorganizations are used by businesses or wealthy individuals whose income exceeds the parameters of Chapter 13.

Over the life of any bankruptcy case, Debtor's assets may be sold, contracts modified, litigation pursued, claims eliminated or paid, a discharge granted (debts are eliminated), or the case dismissed (debts maintained).

The "protection" part of "bankruptcy protection" is known as the automatic stay and protects Debtor from any and all collection actions by creditors. The automatic stay arises immediately when the bankruptcy case is filed; it is memorialized by a rubber stamp reading "Relief Ordered -- Judge X," applied by the court clerk directly after time-stamping the petition. Granted pursuant to 11 U.S.C. § 362(a), the automatic stay prohibits a variety of acts and actions in which a creditor may not engage to collect its debt. A non-exhaustive list of prohibited actions, briefly summarized below, is provided in the Bankruptcy Code. In addition to protecting Debtor from adverse actions by creditors, these provisions seek to maximize the value of the estate and the funds available for distribution to creditors and to insure that no creditor gains an unfair advantage over other, similarly situated creditors.

What A Creditor May Not Do

With regard to collection, a creditor may not:

• Initiate or continue lawsuits or collection actions. Because the outcome of a given lawsuit may have an impact on the estate, both in terms of judgment and costs of prosecuting the case, in effect all pending litigation is stayed upon filing of a bankruptcy petition. Certain litigation that may not directly affect the estate may be allowed to continue upon application to the bankruptcy court for relief from the automatic stay. (This provision does not prohibit litigation initiated within the scope of the bankruptcy case itself.)

• Enforce judgments. Even though a creditor may have a valid judgment granted in its favor before the petition was filed, it may not take action to perfect or enforce the judgment before the bankruptcy case is discharged or dismissed. Similarly, a creditor may not obtain a new judgment against Debtor while the bankruptcy is pending.

• Obtain possession of Debtor's property. Virtually all of Debtor's possessions are property of the estate. This provision precludes repossession and "holding" of any property for repayment of a debt.

• Create, perfect or enforce a lien. As with judgments, a creditor may not seek to impose a lien on property of the estate.

• Engage in any collection action. Letters, calls, use of collection agencies, or even sending a routine invoice may be considered collection action and subject to sanction by the court. Debtor is protected from any and all such action during the pendency of the case.

• Engage in setoff. Cross-debt between Debtor and a creditor may not be used to reduce the amount of the bankruptcy debt.

The automatic stay is comprehensive and precludes virtually all collection activity by creditors. This includes making calls, sending letters or bills (even nicely worded ones), or employing collection agencies or counsel. Any of these actions can result in a finding of contempt against the creditor.

The automatic stay applies only to property of the estate. 11 U.S.C. § 362(b) lists 18 kinds of actions that are not stayed. Further provisions provide limited exceptions, such as the payment of alimony and child support, that may be paid from property that is not "property of the estate" and other exceptions for debts that are not dischargeable. The stay regarding property remains in force until that property is no longer property of the estate. Other stays remain effective until the case is closed or dismissed.

So, What Can a Creditor Do?
File a Claim

First, the debt must be acknowledged to be a part of the bankruptcy case. In its filing, Debtor must provide the court with a schedule of all creditors and the amounts owed to each. If the creditor received notice of the case from the court, the creditor has been scheduled. If not, it will be necessary to file a proof of claim (Form B10, available from the court) establishing the nature and amount of the creditor's claim against Debtor's estate. Even if a debt is scheduled, it is advisable to file a proof of claim to establish the correct information regarding the claim. Proofs of claim are filed with the court and should include copies of any supporting documentation (statements of account, leases, contracts -- whatever created or memorializes the relationship between the parties and enumerates the amount of the claim).

Claims are classified by priority of payment. Some claims, such as taxes, may be eligible to receive a higher percentage payment; some, such as properly secured bank loans, may be paid before others. The usual order of payment is administrative expenses such as operating expenses and professional fees, secured claims such as mortgages, priority unsecured claims such as wages and taxes, and general unsecured claims such as credit card or trade debt. In Chapter 7 bankruptcies, there is often little or nothing left in the estate to pay general unsecured claims.

To insure that all claims against the estate are legitimate or "allowed," Debtor or the trustee will review the filed claims and may seek to modify or eliminate some. Differences may be worked out privately between the parties and result in the filing of an amended proof of claim or a withdrawn claim. A formal objection may be filed seeking to reduce, reprioritize, or eliminate a claim. Common bases for objections include untimeliness, duplication, insufficient documentation, and discrepancies with Debtor's books and records. If a creditor receives an objection to its claim, it must defend the claim, or the court may modify or eliminate the claim. Once a disputed claim is allowed by the court, it is paid pursuant to Debtor's plan, unless payment is otherwise determined by a court-approved settlement.

Participate in the Case

A creditor who receives notice of the commencement of a bankruptcy case (or otherwise finds out about it early enough) may wish to participate in the first meeting of creditors required by 11 U.S.C. § 341. This meeting is the first and best opportunity for creditors to find out about the bankruptcy and Debtor's financial situation and Debtor's plans for repayment of its debts. The date, time, and place of the meeting are determined by the court and are included in the notice of commencement.

Get the Property, or the Claim, Out of the Estate

A creditor may seek relief from the automatic stay. This may allow a creditor to pursue litigation against a third party, such as an insurer, or it may allow the creditor to take possession of specific property that is not necessary to the success of the bankruptcy case. Once property is no longer part of the estate, the creditor may sell it to reduce or eliminate the claim.

A creditor in a Chapter 7 case may ask Debtor to sign a reaffirmation agreement. This exempts the debt from the discharge, and Debtor agrees to repay the debt in full. To be valid, reaffirmations must be signed by both Debtor and the creditor and must be approved by the court.

Other Options

Creditors in Chapter 11 cases have additional options. They may participate in the official committee of unsecured creditors appointed by the U.S. Trustee, or they may form committees with other, similarly situated creditors (such as lenders, bondholders, or asbestos plaintiffs) who work together to protect their mutual interests. Committees allow Debtor to work with a number of similar claims very efficiently. Chapter 11 creditors may also be solicited by claims brokers who will pay the creditor a percentage of the face value of the claim and assume the position the creditor had in the bankruptcy case.

Proposed changes to current bankruptcy law would make certain unsecured debts, such as credit card debt and auto loans, non-dischargeable. At the time of writing, a bill providing for this has passed the House but not the Senate.

Once a creditor has sought legal advice and filed a claim, the key to success is patience. Once a claim is filed and allowed, it will be paid if funds are available. If there are insufficient assets to pay creditors, a notice will be sent. The claim will not, however, be paid immediately after it is filed. Debtors and their counsel are able to move a case to its conclusion much more efficiently if they are not bombarded with inquiries from creditors.

 

Joy H. King, a paralegal with the creditors rights group of Hahn Loeser & Parks LLP, in its Cleveland, OH, office, is secondary for the Cleveland Association of Paralegals. The author thanks Jean R. Robertson, Esq., for her assistance in preparing this article.