Creditors’ Rights in Bankruptcy

Where You Need a Lawyer:

(This may not be the same place you live)

At No Cost! 

 What Is Bankruptcy?

Bankruptcy is a legal proceeding which allows a debtor to obtain a discharge from some of their debts or to restructure their debts in order to manage repayment of a portion of them at least.

When a creditor receives notice that a debtor has filed for bankruptcy, the creditor may well wonder if they will ever be able to recover what is owed to them.

How Can a Creditor Recover If a Debtor Files for Bankruptcy?

Creditors have certain protections when a debtor files for bankruptcy. As a condition to discharging certain debts, the bankruptcy system requires that a debtor pay off as many debts as possible. Thus, creditors have a right to get at least a portion of whatever funds are distributed to creditors from a bankruptcy estate. Whether or not a creditor will recover mainly depends on the priority that the law assigns to a creditor’s claim.

The bankruptcy trustee, who is an official of the court responsible for managing a bankruptcy case, has the authority to disburse funds to creditors.

What Determines the Priority of a Claim?

Bankruptcy law determines the priority of a claim. Secured debts have the highest priority in bankruptcy. Secured debts are debts that have collateral attached, such as a mortgage loan or an auto loan. The reasoning is that if a loan is secured by collateral, that collateral can be used to pay off the debt at least to the extent of the value of the collateral.

A creditor whose loan to the debtor is secured by collateral is either paid according to the terms of the loan contract or is allowed to recover the collateral through foreclosure in the case of a mortgage loan or repossession in the case of an auto loan.

Therefore a secured creditor is not as vulnerable to the loss of repayment as are other unsecured creditors.A bankruptcy discharge does not eliminate a lien, or security interest, on a debtor’s property. It only eliminates the debtor’s liability to pay the debt. The lien remains, and the creditor can still foreclose or repossess the property if the loan is not paid. So if a person files for bankruptcy and wants to keep property securing a loan, they must continue making payments to the lender until the debt is paid off. .

In a Chapter 7 bankruptcy, If the bankruptcy trustee sells the collateral, the trustee must fully pay the secured debt before paying any other creditor. In a Chapter 13 bankruptcy, a debtor who wants to keep secured property can achieve that by making the payment owed each month and repaying any arrearages through a three- to five-year repayment plan.

Unsecured debts have the lowest priority. Unsecured debts are debts that are not secured by collateral; examples are credit card debt, utility bills and the like. Creditors with unsecured debts are at risk of receiving little or no payment if the debtor declares bankruptcy.

Some debts, such as student loans and child support payments, have such a high priority that they can never be discharged and even survive bankruptcy. This means that the debtor remains obligated to pay these loans in full even after going through bankruptcy. A bankruptcy lawyer should be able to help a creditor identify what type of debt the creditor has at issue in a bankruptcy and what steps can be taken to collect payment through the bankruptcy process.

Unsecured debt falls into two categories:

  • Priority unsecured claims: These debts cannot be discharged in bankruptcy and, if money is available, the claim will get paid before nonpriority unsecured claims are paid;
    alimony, child support, certain tax obligations, and debts for personal injury claims or death caused by drunk driving are all priority unsecured claims; the debtor must pay these even after a Chapter 7 bankruptcy;
  • Nonpriority unsecured claims: Most of these obligations can be discharged in bankruptcy, except student loans. All priority debts must be paid before these nonpriority unsecured debts can be paid with bankruptcy funds; examples of nonpriority unsecured claims are credit card debt, medical bills, and personal loans.

What Should I Do as a Creditor When I Receive a Bankruptcy Notice?

When a creditor receives a bankruptcy notice, they should immediately stop all collection efforts. This includes phone calls, billing actions and lawsuits related to the debt owed to the creditor. The creditor should then file a claim with the bankruptcy court. The deadlines for filing tend to be short and are strictly enforced, so a creditor should act quickly in order to preserve their rights in a bankruptcy proceeding.

The bankruptcy court will start the process by sending out a notice telling creditors to submit claims on an official proof of claim form. After the deadline for submission of claims has passed, the trustee reviews the claims and determines how much each creditor is entitled to get paid, if anything.

Among the rights of creditors in bankruptcy is the right to object to the debtor’s plan for repayment of their debts and related matters. A creditor has a right to challenge a debtor’s right to a discharge of the creditor’s debt. For example, a creditor might have cause to allege that a debtor committed fraud in some manner.

Secured creditors have additional rights, as well. In bankruptcy, a secured creditor is in a much better position than an unsecured creditor. A lien, for example, entitles the secured creditor to the proceeds from the sale of any property serving as collateral for their claim up to the full amount of the claim.

For example, a trustee might sell real property worth $200,000 owned by the debtor. The debtor might owe only $75,000 to the secured creditor, i.e., the mortgage lender. The trustee is legally required to pay off the secured lender in full before distributing the funds that remain to other creditors. After paying off the $75,000 mortgage, the trustee will distribute the remaining $125,000 to the other creditors according to the rules of bankruptcy priority.

Because of the lien rights, if a secured creditor believes that it is losing money as a result of the trustee holding property in bankruptcy, it can file a motion with the court asking for relief. If the judge agrees to provide the relief requested, the trustee (or debtor) will likely be required to either make payments to cover any potential losses or release the property. The secured creditor is also entitled to the interest on the loan as provided in the contract with some limitations.

Do I Need an Attorney?

If you are a creditor and have just received a notice of bankruptcy, you should contact an experienced bankruptcy attorney. A lawyer will be able to tell you whether your debt is secured or unsecured, priority or non priority, and what you can expect to recover. Most importantly, a lawyer can complete and file a proof of claim for you in a timely manner.

A lawyer will know what other rights you should assert in order to recover as much as possible and how to assert them. If you decide to file a lawsuit an experienced bankruptcy lawyer will be able to help you file your lawsuit in a timely manner.

Save Time and Money - Speak With a Lawyer Right Away

  • Buy one 30-minute consultation call or subscribe for unlimited calls
  • Subscription includes access to unlimited consultation calls at a reduced price
  • Receive quick expert feedback or review your DIY legal documents
  • Have peace of mind without a long wait or industry standard retainer
  • Get the right guidance - Schedule a call with a lawyer today!

16 people have successfully posted their cases

Find a Lawyer