The Creditors: The Chapter 7 Bankruptcy Process

The Creditors is part 9 of a 10 part series on Chapter 7 bankruptcy and will provide general information regarding bankruptcy under Chapter 7. 

A creditor may take an interest in the case, or may do nothing, depending on the situation. Here are a few examples where creditors may be active:

1. Claims.

All creditors may file proofs of claim with the court clerk evidencing the amount owed them. Creditors in Chapter 7 must file claims only in cases where there will be a distribution to creditors. Creditors will receive a notice advising them to file claims and setting a deadline for doing so.

There is an official form for proofs of claim. See Rules 3001-3005 for rules regarding filing of claims. The proof of claim should state the amount and the type of claim (priority, secured, unsecured), and should provide supporting documentation such as invoices or security agreements.

The debtor or trustee may object to claims as appropriate. Rule 3007. The court may then hold a hearing to determine the validity and amount of the claim.

2. Complaints regarding discharge.

In Chapter 7, some debts are automatically nondischargeable, including student loans, priority taxes, and child support and spousal maintenance. Other debts are nondischargeable only if the creditor proves they fall within an exception to discharge. These include the “bad act” debts, incurred through fraud, false pretenses, false financial statements, false representation (§ 523(a)(2)), embezzlement or larceny (§ 523(a)(4)), and willful and malicious injury (§ 523(a)(6)). In these cases, the creditor must sue the debtor in Bankruptcy Court, seeking an order that the debt is nondischargeable. The notice sent to all creditors at the beginning of the case will state the deadline for filing such complaints, which will be 60 days after the date first set for the meeting of creditors. Failure to file a timely lawsuit within this very short deadline may result in discharge of the debt.

These complaints are brought in the bankruptcy court as adversary proceedings. The Federal Rules of Civil Procedure apply, with certain variations for Bankruptcy Court. The creditor almost always bears the burden of proof, although it may be an easier burden to meet than in state law (e.g., preponderance of evidence instead of clear and convincing for fraud claims).

A creditor, the trustee, or the United States Trustee may also bring a complaint under § 727 objecting to the debtor’s entire discharge. Ordinarily, this type of suit is brought only for an affront involving the bankruptcy process (e.g., false oaths on bankruptcy schedules, hiding of assets, withholding of books and records, inability to account for loss of assets) An order denying discharge is, understandably, devastating for a debtor. The debtor winds up having gone through a Chapter 7 (and thus not being able to do so again for eight years), but receiving none of the benefits. One cannot emphasize enough, then, the importance of both accurate and complete bankruptcy schedules and a pre-bankruptcy examination of the debtor’s financial affairs to make sure of the absence of any potentially offending transfers of assets.

3. Relief from Stay.

If a creditor needs to take some action against the debtor after the date of filing, it must seek relief from the automatic stay under § 362(d). Creditors can get relief from stay only for “cause,” or if the relief concerns property where the debtor has no equity and the property is not necessary for a reorganization.

A secured creditor will likely seek relief if it is not getting the anticipated benefit from the debtor. The debtor may be in default, a foreclosure may be pending, the debtor has little or no equity in the property, and relief from stay is desired to repossess and/or foreclose on the property. In this situation, the creditor will file a motion seeking relief. In the event the motion is opposed, the court will hold a hearing where the issue is typically the value of the property and the ability and willingness of the debtor to make payments.

Similarly, a landlord may seek relief from stay if rent is not being paid and the landlord wants to move forward with a state-court eviction.

A non-landlord unsecured creditor rarely has a basis for relief from stay. Any such motions often have a state-court personal injury claim component. “Cause” may exist where a creditor either needs to liquidate the amount of her claim (e.g., a personal injury suit against the debtor is pending and stayed by the filing, and there will be assets to distribute in the bankruptcy case, making the amount of the claim relevant) or where the stay affects the ability of the creditor to go after a co-debtor or insurance coverage.

4. Reaffirmations.

Secured creditors may seek a reaffirmation agreement from the debtor. This is a new contract entered into postpetition, whereby the debtor agrees to maintain payments and cure any default and the creditor agrees to allow the debtor to keep possession of the collateral. The agreement creates a new obligation that survives the bankruptcy. It potentially exposes the debtor to a deficiency claim in the event of a subsequent default. The debtor must affirm that the agreement is voluntary and does not work a hardship, and either the debtor’s attorney must sign or the court must approve the agreement. Reaffirmations are most often seen with car loans, because the car lender (if the car loan is fairly recent) may demand return of the car in the absence of reaffirmation.

Reaffirmation agreements are not recommended in the case of real property loans. The lender gets no additional rights in the absence of reaffirmation. It will need to go through the foreclosure process with or without reaffirmation. On the other hand, the debtor may be agreeing to additional potential liability for, say, a very significant deficiency judgment, by reaffirming a real property loan. I will almost never sign off on a reaffirmation of a real property secured debt.

The form of a reaffirmation agreement is dictated by Code § 524(k) and other provisions.

Contact the bankruptcy attorneys at Wenokur Riordan PLLC today at (206) 724-0846 to discuss your situation.

This article is intended to provide you with enough detail to give you a good basic understanding of the process, without snowing you under with too much information. Obviously, there are exceptions and nuances to just about everything described in this outline. The Bankruptcy Code, Federal Rules of Bankruptcy Procedure, and reported case law are the primary sources of information. All section references here are to the United States Bankruptcy Code, 11 U.S.C. § 101 et seq. All Rule references are to the Federal Rules of Bankruptcy Procedure.