Creditors' Rights in Bankruptcy

When a debtor files for bankruptcy, certain obligations are imposed on the creditors. First, and most importantly, an "automatic stay" is imposed against all creditors. This means that the creditors are not allowed to engage in any effort whatsoever to collect the debt from the debtor. If you are a creditor, and receive a notice of bankruptcy from a bankruptcy court (presumably because the person filing is one of your debtors), you should immediately stop any collection activities against the debtor. If you need to communicate with them for some other reason, and they have retained an attorney, it's smart to communicate through the attorney.

However, creditors still have a right to recover as much money owed to them as possible. Of course, people don't file for bankruptcy if they're able to pay all their debts. Therefore, creditors shouldn't expect to recover everything that a bankrupt creditor owes them.

Kinds of debt

The rights that a particular creditor has, and what it will be able to collect (if it can collect anything) will be mostly determined by the type of debt the creditor owns. For the purposes of bankruptcy law, there are two basic types of debt: secured and unsecured.

Secured debt is debt which has some type of property attached to it. Suppose that you have taken out a loan to buy a car, and the terms of the loan state that the car can be repossessed in the event that you default on the loan. Your car loan is a type of "secured debt" because the creditor has the security of the ability to repossess the property which the loan financed.

Unsecured debt, on the other hand, does not have any property attached to it. If the creditor wants to collect on it in the event of default, there is no property which that can be seized. Instead, the creditor has to go through a collections agency, or file a lawsuit and hope to get a court order enforcing the debt. However, if the debtor simply doesn't have any money, and the creditor has no right to seize any property of the debtor, a court order won't do much good.

When a debtor files for bankruptcy, it is most often secured creditors who are the first in line in terms of collecting from the debtor. Usually, they are simply entitled to repossess whatever property secured the loan in the first place, which serves to discharge the debt. However, if the debtor wants to, they can enter into a new agreement with the creditor, whereby they agree to continue making payments on the property after their bankruptcy is complete. In exchange, they get to keep the property. This is done most commonly if the property is a car, which the debtor needs to get to and from work. Presumably, once a majority of their debt has been discharged, making the payments will be much easier.

Unsecured creditors are usually at the back of the line when it comes to collecting, and most unsecured debt is dischargeable in bankruptcy. Therefore, they are very unlikely to be able to recover anything.

What to do if a Debtor is Bankrupt

If you receive a notice of bankruptcy from a debtor, you should immediately file a claim with the bankruptcy court. The deadline for this filing is very short, so creditors should act quickly. If a creditor fails to file, they will almost certainly be unable to recover anything.

You should also note that certain types of debts are non-dischargeable. This means that they survive bankruptcy. These debts include:

  • criminal fines
  • most student loans
  • taxes
  • child support & alimony
  • civil judgments resulting from injuries caused by drunk driving

If you are owed money in any of these forms (for example, your spouse owes you child support or alimony), and the debtor is filing for bankruptcy, you should speak with a bankruptcy attorney right away, to ensure that your rights are protected.

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