Understanding what can occur during a collection action can be vital in determining which accounts to pursue. One common occurrence is that the debtor files for bankruptcy. So, what exactly is bankruptcy? Bankruptcy is a procedure which allows debtors to reorganize their debts and potentially liquidate certain assets. It also allows a debtor to receive a discharge of certain debts, meaning certain debts do not have to be paid by the debtor. There are several types of bankruptcy filings depending upon the type of entity owing the debt and the amount of the debt owed verses income.
In the consumer collection area, there are two (2) types of consumer bankruptcy filings that may likely be encountered. The first is a Chapter 7 – Liquidation, meaning that the debtor is liquidating any of his and/or her assets that are not excluded per applicable federal and state law. The second, is a Chapter 13 Reorganization, in which the debtor proposes to pay creditors some of what creditors are owed over time (3-5 years.); the debtor will file a Chapter 13 Plan that sets forth how the debtor proposes to do this.
The purpose of filing a bankruptcy is for the debtor to receive a discharge from personal liability for pre-petition debt (debt incurred prior to the date of the bankruptcy filing). The bankruptcy filing provides a stay of any collection actions against property of the debtor’s estate, including wage execution and bank levies, as well as individual creditors seeking payment from the debtor. This means that the creditors cannot continue any collection actions against the debtor while the bankruptcy is pending (i,e., lawsuits, collection letters, calls to the debtor for payment, etc). Once having filed for bankruptcy, the debtor must notify all of their creditors of the filing. If you receive a bankruptcy filing notice, you should immediately stop all collection efforts. From that point on, all communications with the debtor must be through their bankruptcy counsel.
While the automatic stay is in place all collection efforts must stop. If collection efforts continue, monetary sanctions can be imposed by the court. So, instead of getting money from the debtor who owes the creditor money, the creditor will end up having to pay the debtor. This is not a position you want to be in. While the standard for imposing sanctions is generally a “willful violation,” the courts have some discretion as to what monetary sanction to impose, if any, and you can’t un-ring the bell, so once a violation has occurred there is no way to undo it.
A secured creditor can, however, still pursue its secured property by getting Bankruptcy Court approval. The creditor must be a perfected secured creditor, which means the applicable state laws for perfecting the security interest must have been followed (e.g.., notation on the title to a vehicle, properly recording a mortgage or lien, etc.). A motion for relief from the automatic stay may be filed which, once granted, lifts the automatic stay to permit the creditor to pursue its secured property by way of either a replevin action (for a car or other equipment) or a foreclosure (for real property). In general, a motion would be granted if post-petition payments on secured debt have not been made (which is the general standard for relief in a Chapter 13) or if there is no equity in the secured assets (which is the general standard for relief in a Chapter 7).
Since a Chapter 13 is a reorganization of the debtor’s liabilities, creditors must file claims which set forth the amount that the debtor owes, what is referred to as a Proof of Claim. The Proof of Claim should contain the claim amounts owed by the debtor for pre-petition liabilities only. The claims must be filed by a certain deadline established in each case, and it is vital that this deadline not be missed. The Proof of Claim must also state the basis for the debt and include applicable supporting documentation (e.g., a copy of any contract, invoices, copy of the accounting setting forth the amount owed, etc.). There are no Proof of Claims filed in Chapter 7 unless it is an “asset case,” which means that the debtor has non-excluded property that will be liquidated by the Chapter 7 trustee to generate funds to be made available to creditors. It is common for consumer Chapter 7 bankruptcies to have no distributions to creditors. It is always best to file a Proof of Claim in a Chapter 13, even if the creditor agrees with how the debt is listed in the debtor’s Schedules because in failing to do so you may have waived your right to any distribution.
In a Chapter 13, the debtor will propose a plan as to how they intend to repay their creditors, generally over a period of several years. The creditors may object to the plan. Such objections may be if a secured creditor is not fully provided for in the plan or if the debtor is not using all disposable income to fund the plan.
Generally a Chapter 7 may take around four to six months from the petition date (date of filing) to discharge of debts and case closure. A Chapter 13 will take around three to five years from the petition date to discharge and case closure, unless the debtor does not make their plan payments, whereby the case could be dismissed. If the case is dismissed then no discharge is entered and the creditors may continue with any collection efforts for all amounts owed by the debtor.
How does a Bankruptcy End? Once the debtor has made all of the payments required under the Chapter 13 Plan (after the 3-5 year period), a discharge and final decree is entered by the Court. Once this occurs creditors are permitted to pursue amounts owed by the debtor, for all post-petition amounts due. In general, it is best to write off any pre-petition debts. There are some limited situations in which liens would survive the discharge (i.e. condominium liens, money judgment liens docketed against the real property) which could be foreclosed after the bankruptcy case is closed; however, in general, any pre-petition money judgment would be discharged in bankruptcy. This means that the debtor would not be personally responsible for the payment on the judgment.
While many things can occur during a collection and bankruptcy action, knowing how to navigate those occurrences will help a business owner understand which accounts can be collected and when counsel needs to get involved, which ultimately will help you reduce unnecessary attorney’s fees and avoid wasted time.
Allyson Cofran is an Associate and member of Stark & Stark’s Bankruptcy & Creditor’s Rights Group where she concentrates her practice in bankruptcy, replevins and collections. Ms. Cofran frequently counsels cooperative, condominium and homeowners associations in collection matters concerning property owners with post-petition delinquent assessments. Ms. Cofran consults clients on compliance with the Fair Debt Collection Practices Act (FDCPA) and…
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