Creditors’ Rights in Bankruptcy Filing and Receivership FAQs
1. What distinguishes the three main chapters in bankruptcy?
Chapter 7 bankruptcy filing is available to individuals or corporations and is designed to allow the orderly liquidation of the debts of the bankrupt party. For an individual, the slate is wiped clean of unsecured debt, and secured debt can be modified or re-affirmed so that the individual can essentially start over but retain certain essential assets. For a corporate entity, the Chapter 7 does not discharge debts, as it is presumed that the entity will cease to operate. If the entity resumes operation, then creditors may resume collection activities.
Chapter 11 is designed to provide corporate entities and higher wealth debtors an opportunity to reorganize, restructure their debt and resume their lives over time. Unsecured creditors will generally recover a reduced amount and have the remaining balance discharged.
Chapter 13 is for individuals with sufficient assets to make some level of repayment to its creditors. It is often referred to as a “wage earner” bankruptcy. After the revamping of the Bankruptcy Code, there was some thought that all Chapter 13s would result in at least a partial repayment to general unsecured creditors, but the reality has been that a “zero plan 13” is possible. Such a plan will take care of secured and priority creditors but results in no repayment to general unsecured creditors.
2. What is the automatic stay?
When a debtor files a bankruptcy petition, pursuant to the Bankruptcy Code creditors are barred from any form of collection activities including but certainly not limited to, sending statements, making a demand, contacting principals or employees of the debtor or filing a court action or financing statement. There are exceptions for ongoing criminal cases and the filing of UCC Continuation Statements (to maintain a pre-existing security interest). Violation of the automatic stay can result in having sanctions imposed by the court including significant monetary fines.
3. What is the purpose of a proof of claim?
A proof of claim establishes the legal basis for and amount of the creditor’s claim.
4. What is a preference claim?
A preference action is brought by a trustee or debtor-in-possession (Chapter 11) to recover property (money, land, vehicles) of the bankruptcy party which was improperly paid to or acquired by the creditor. The key elements of a preference are:
- The transfer was made to or for the benefit of a creditor
- For or on account of an antecedent (pre-existing) debt
- Made while the debtor was insolvent (presumed insolvent in the 90-days pre-petition)
- That enables the creditor to receive more than it would have in a Chapter 7 (liquidation)
There are defenses available to creditors, including subsequent new value, ordinary course of business, and contemporaneous exchange, or the existence of a security interest in the collateral.
5. What is a secured claim?
A claim is secured when a creditor holds a secured interest in collateral owned by the debtor. A security interest can be gained via a UCC-1 financing statement, a deed of trust or a monetary security deposit held by the creditor. The key is that the security interest must have been perfected more than 90 days prior to the date the petition was filed or it will be subject to a preference claim.
6. What is an adversary proceeding?
An adversary proceeding is a legal action brought in the bankruptcy court to sort out something related to the bankruptcy filing – a lien claim, dischargeability of a debt, the value of a claim or a preference action. These cases often benefit from the expertise of a bankruptcy attorney.
7. What is the creditor’s meeting (or 341 meeting)?
All bankruptcies include a meeting held by the bankruptcy administrator’s office or the trustee for the purpose of examining the debtor(s) under oath to ensure that the petition and schedules are up to date and accurate. This meeting also provides an opportunity for creditors to ask a fairly limited number of questions of the debtor. If the questions become long and detailed, then the Bankruptcy Administrator or trustee will refer the creditor to a 2004 exam.
8. So, what is a 2004 exam?
A Rule 2004 examination is the bankruptcy court’s equivalent to a deposition. This procedure can be utilized when a creditor believes there are questions to be answered relative to the disposition of property (pre- or post-petition) or other issues having a direct bearing on the conduct of the bankruptcy filing.
9. How do I get my money?
This answer is much more difficult and frustrating. If you are a secured creditor, then the debtor will either pay you in cash during the course of the bankruptcy filing, or surrender the collateral securing your debt to you. Oh, if it were that simple, but the reality is that secured creditors whose collateral is unencumbered or who have a first position interest are relatively certain to recover at least a portion of their debt (depending upon the adequacy of the security).
Those with priority or administrative claims have a stronger possibility of recovery than do those with general unsecured claims. In most Chapter 7 cases, general unsecured creditors will receive nothing under the Bankruptcy Code. Chapter 13 cases can also result in no recovery or can have a payout over a 5- to 6-year period in which the payments may not start for the unsecured creditors until the third or fourth year and may be de minimis.
Chapter 11 is a total wildcard ranging from zero to 100% recovery generally in a shorter period of time. The key to getting paid anything is to pay attention to the directions related to filing a proof of claim. Without that filing, recovery will not occur.
10. What is the difference between a discharge and a dismissal?
A discharge means the debtor’s liability to pay pre-petition debts is erased. Certain debts are reaffirmed and continue, including secured debts such as a mortgage and most car loans as long as the vehicle has not been surrendered. Any unsecured debt is canceled once the discharge is issued and any attempt to subsequently collect that debt can result in substantial sanctions from the bankruptcy court.
If a debtor’s case is dismissed, then it signifies that the debtor did not complete the bankruptcy filing process and therefore is not entitled to the protections given by that court. After a dismissal, creditors can resume collection efforts. A word of advice: Always keep an eye out for a refiling because it is not uncommon for a debtor to have the case dismissed and to turn around and file another one fairly quickly. This only becomes an abuse of the system if it happens repeatedly.
11. What is “receivership”?
Receivership is a state law remedy similar to a bankruptcy filing. A “receiver” is appointed by a superior court judge either on the judge’s own motion or by virtue of a consent motion from the parties to an underlying dispute. The receiver essentially assumes responsibility for the operations and finances of a company that is placed in receivership. The order appointing the receiver contains the powers and duties of the receiver and gives the receiver the right to employ professionals, but sets the rate of compensation for the professionals and provides guidance to the receiver in terms of the receiver’s duty to provide interim reports to the court. The court generally will set a finite period for the receivership, but the parties to the underlying action from which the receivership arose can have that time extended by making a motion to extend to the court.
Oftentimes receiverships are used to wind down a company though they can be used to stabilize a business while principals of that business resolve a shareholder dispute either resulting in a sale of the business or a settlement resolving ownership as between the principals. The receiver submits a bill to the court by means of a motion and the court determines how much the receiver is to be paid and who is to make the payment.
If you are involved in a bankruptcy filing that may require the assistance of a lawyer, please contact the bankruptcy attorneys at Hannah Sheridan & Cochran, LLP, at 919-859-6840.