What rights and remedies does a creditor have in a bankruptcy case?
The Bankruptcy Code is broken down into four sections known as "chapters." The four chapters available to a debtor include Chapter 7, 13, 12 and 11, although most individual debtors file for bankruptcy protection under Chapters 7 and 13. These laws were enacted to give debtors a fresh start by releasing them from personal liability for certain debts. This release is known as a bankruptcy discharge. Once the debtor’s liabilities are discharged, creditors are prohibited from taking any further action against the debtor to collect on those debts.
The manner in which a debtor’s liabilities are discharged depends on the chapter under which the debtor files for bankruptcy protection. The debtor must choose the chapter that provides the appropriate relief and determine whether he or she is eligible to file under that chapter considering the financial circumstances.
Chapter 7, known as liquidation, is designed for debtors who do not have the ability to pay their existing debts. A Chapter 7 proceeding may be started voluntarily by the debtor or involuntarily by the creditors. In a voluntary case, the Chapter 7 debtor is subject to a means test in order to determine eligibility. If a debtor’s income exceeds the median income for the debtor’s family size in the state where he or she lives, creditors have the right to file a motion to the court to have the case dismissed. In an involuntary case, creditors can petition the court to have the debtor subjected to a Chapter 7 liquidation proceeding. Debtors are entitled to contest an involuntary petition.
If the Chapter 7 case is permitted to proceed, the court issues an automatic stay that prevents creditors from collecting on the debts. Instead, the U.S. Trustee appoints an impartial case trustee to liquidate the debtor’s assets to pay the creditors. The debtor is required to submit schedules listing all of his or her assets and debts, and whether those debts are secured or unsecured. A creditor holding a secured debt—a debt that is backed by collateral, such as a house or car—may file a motion for relief from the automatic stay in order to foreclose on the loan or repossess the collateral. The court generally holds a hearing on the motion where the debtor can contest the proposed action.
Unsecured creditors are required to file a proof of claim in order to participate in the distribution, and the debtor has the right to object if he or she disputes the claim. If the case trustee determines that the debtor has no assets, or all of the debtor’s assets are exempt, the trustee will file a "no-asset” report with the court. In a no-asset case, there will be no distribution to unsecured creditors so it is unnecessary for an unsecured creditor to file a proof of claim. Most Chapter 7 cases involving individual debtors are no asset cases.
The debtor may also submit a schedule of exempt property pursuant to federal and/or state law. Depending on the state, exempt property may include the debtor’s vehicle, the equity in the debtor’s home up to a certain amount, certain personal property, and income derived from unemployment, disability, Social Security, and public assistance benefits. If the creditors do not object to the debtor’s exemptions, the exempt property will not become part of the bankruptcy estate and will not be used to pay creditors.
The case trustee sells all of the non-exempt assets and distributes the proceeds to the creditors. After the assets are sold and distributed, any remaining liabilities are discharged, i.e., the debtor is no longer required to repay the debts. However, certain debts are not dischargeable in bankruptcy, including but not limited to certain taxes, student loans, child support, and debts that were not listed on the debtor’s schedule of liabilities. Further, if the creditor can prove that a debt was incurred illegally, e.g., through fraud or theft, the court may deny the discharge. In addition, if the debtor fails to include a liability on the schedule of debts, the unscheduled debt will not be discharged.
Read more about Chapter 7 filings in What Is Chapter 7 Bankruptcy?
Chapter 13 filings are designed for individuals with regular income who would like time to pay off their liabilities. The debtor’s assets are not involuntarily liquidated, however, if the debtor’s liabilities exceed the dollar amount set forth in the applicable bankruptcy statute, the debtor is not liable to file Chapter 13.
Under Chapter 13, the debtor pays his or her creditors pursuant to a court-approved repayment plan. The payments are made from future income over a period of time between 3 and 5 years as set forth in the plan. In the meantime, the debtor is entitled to maintain possession of his or her assets. After successful completion of the repayment plan, the debtor generally receives a discharge of most of the remaining liabilities, however, as with a Chapter 7 filing, certain debts are not dischargeable.
If the debtor is a family farmer or fisherman, he or she may file under Chapter 12, which is similar to Chapter 13 in that the debtor is permitted to repay the debts over a period of time from future earnings. In the meantime, the family farmer or fisherman is permitted to continue to operate the business. However, the eligibility requirements are very restrictive and apply only to those individuals whose income is earned primarily from a family-owned farm or commercial fishing operation.
Chapter 11 involves debt reorganization and is intended for businesses, however, Chapter 11 may be available to individual debtors who are not eligible for Chapter 13 because their unsecured and/or secured debts are in excess of those permitted under Chapter 13. Under Chapter 11, the debtor files a debt reorganization plan along with a disclosure statement that reflects the debtor’s financial circumstances. The disclosure statement enables creditors to evaluate the terms of the reorganization plan.