This article is meant to give an introductory view of bankruptcy practice from the creditor’s attorney’s standpoint. It will survey Chapter 7 and Chapter 13, the two main chapters of "consumer" bankruptcy, i.e., a voluntary bankruptcy petition filed by an individual or a married couple.
Chapter 7 is a liquidation bankruptcy where a Trustee is appointed to take stock of the debtor’s assets and debts and, if possible, sell assets of the debtor to pay unsecured and undersecured creditors. State and federal laws give debtors various "exemptions". These are intended to give the debtor a "fresh start" when he gets a "discharge," or a release from personal liability to his creditors. This is because the Trustee cannot sell exempt property to pay unsecured creditors. If the Trustee sells property in which the debtor has claimed an exemption, the Trustee must pay the debtor the dollar value of that exemption (e.g., $15,000.00 on the residence of a married couple filing jointly).
The mechanics of such a liquidation operate as follows. The debtor must fill out several schedules which list his assets and their estimated value. The schedules must also list all of his creditors and the amounts owed to each. The Bankruptcy Court sends out a notice to all the scheduled creditors informing them of the time and place of a Creditors’ Meeting. All debtors must attend such a meeting. Any creditor may attend and briefly question the debtor. The Trustee will review the schedules, question the debtor, and decide if, after allowing the debtor his exemptions, there are any assets in which the debtor has sufficient equity that it would be worthwhile for the Trustee to liquidate the asset.
Occasionally, the Trustee will find such an asset. If so, he will file a report with the court. Then all creditors will be sent notice that they must file a Proof of Claim to share in the proceeds of the Trustee’s liquidation. This benefits unsecured and undersecured creditors who would otherwise walk away empty-handed after a Discharge Order is entered. After the time for filing Proofs of Claim has expired, the Trustee will then distribute payments to the creditors who filed Proofs of Claim. Sometimes, unsecured creditors are paid only a fraction of what they are owed.
The great majority of Chapter 7 cases are "no-asset" cases. That is, after holding the Creditors’ Meeting, the Trustee often files a No-Asset Report. This says that he has not found any asset in which the debtor has sufficient non-exempt equity such that it would be worthwhile for the Trustee to sell it.
If you represent an unsecured creditor in a non-asset Chapter 7, there is often little recourse for your client. However, various debts, even if unsecured, are not discharged in a Chapter 7. Section 523 of the Bankruptcy Code lists these (e.g., taxes, student loans, alimony, child support, and debts incurred fraudulently). If your client fits into one of these exceptions, you must file an Adversary Complaint laying out why the particular debt is non-dischargeable.
If you represent a secured creditor, you should first review the debtor’s Statement of Intention. This document is filed with the bankruptcy petition and schedules in a Chapter 7. It tells whether the debtor intends to surrender your client’s collateral or retain it. If the debtor intends to surrender the collateral and the Trustee has filed a No-Asset Report, then you should file a Motion to Modify the Automatic Stay.
Section 362 of the Bankruptcy Code protects debtors from the moment they file a bankruptcy petition. Until this stay is "modified" or removed, a creditor cannot foreclose, garnish, send collection letters, call the debtor, etc. However, a creditor may file a Motion to Modify the Automatic Stay. In a no-asset Chapter 7, such motions are routinely granted because one of the grounds for modifying the automatic stay is that (1) the debtor has no equity in the property and (2) the property is not necessary for an effective reorganization. (Sec. 362(d)(2)). Because a Chapter 7 is a liquidation, not a reorganization, the second prong of that test falls away and a Motion to Modify Stay is granted simply for lack of equity.
If the debtor’s Statement of Intention says that he wants to retain the collateral, he must act within 45 days of filing the statement to either redeem or reaffirm the debt. Redemption under Section 722 allows the debtor to keep his property by paying the secured creditor amount of its secured claim or the fair market value of the collateral, whichever is less.
A more common choice for keeping personal property (e.g., a car) is reaffirmation under Section 524(c). Under this section, the debtor and creditor reach an agreement that the debtor will continue to pay the creditor and keep the goods rather than surrendering the collateral and walking away from any liability to the creditor as well. Reaffirmation Agreements often change the terms under which the creditor was originally to be paid. Reaffirmation Agreements must clearly inform the debtor that the agreement is rescindable. These agreements are voluntary on the part of the debtor and must be filed with the court.
In Chapter 13, the debtor files a plan under which he will reorganize and pay his creditors no less than what they would receive in a Chapter 7. A Chapter 13 debtor must be an individual or married couple with regular income. Under the Chapter 13 Plan, the debtor makes regular payments to the Chapter 13 Trustee who, after taking a small administrative fee, will disburse the debtor’s payments to the creditors according to the terms of the plan.
Chapter 13 debtors must submit to examination at a Creditors’ Meeting jut like Chapter 7 debtors. This is often a valuable opportunity for a creditor’s attorney to negotiate with the debtor’s attorney, and perhaps also with other creditors’ attorneys, for a more advantageous treatment under the Chapter 13 Plan. Chapter 13 Plans are often amended after such negotiations.
For example, many Chapter 13 Plans pay secured creditors pro-rata. That is, all Proofs of Claim filed by secured creditors are totaled up and a given creditor will be paid in proportion to the size of its claim versus those of other creditors. You can negotiate with a debtor’s attorney to designate that your client will be paid a "set payment" rather than a pro-rata share. Set payments are paid each month before any payments go to other secured creditors.
If you represent a mortgagee on the debtor’s home, you are given special consideration under Section 1322(b)(2). A debtor can use the long-term debt exception [Sec. 1322(b)(5)] to cure any arrears that existed on the mortgage before the bankruptcy was filed. However, the debtor must continue to make the regular mortgage payments that come due after the case was filed. At the same time, he must pay enough to the Trustee under his plan so that the mortgagee’s pre-petition arrears are cured in a "reasonable" time. (Id.)
The length of time for a "reasonable" cure of a mortgagee’s pre-petition arrears is subject to some case-by-case analysis. However, a debtor must show "cause" for a Chapter 13 Plan to extend beyond 36 months, and it can never run for a term of more than 60 months. [Sec. 1322(d)]. During those 36 important first months, the debtor must pay all his "disposable income" to the Chapter 13 Trustee. This is income which remains after the debtor has provided for the necessary expenses of himself, his dependents and, if applicable, his business.
Any creditor (or the Chapter 13 Trustee) may file an Objection to Confirmation of the debtor’s Chapter 13 Plan. One of the grounds for such an objection is that the Chapter 13 Plan is unfeasible, i.e., that the debtor does not have sufficient income to carry out his Chapter 13 Plan. Another is bad faith, e.g., if a debtor has filed repeated Chapter 13 petitions with no change in circumstances from one case to the next, just to stall creditors. Section 1307(c) also allows some grounds for creditors to file a Motion to Dismiss a Chapter 13 if the debtor, prior to confirmation, "unreasonably delays" creditors or fails to commence payments under his Chapter 13 Plan.
If confirmation of the debtor’s plan is denied, the entire bankruptcy is subject to quick dismissal under Sec. 1307(c)(5). If, however, the debtor’s plan is confirmed, then the Trustee will begin making payments to creditors according to the plan. A creditor must file a Proof of Claim to be paid by the Trustee. The Trustee’s office disburses on a monthly basis. Unsecured creditors often must wait for two to three years before they will see their first disbursement. That is because Chapter 13 Plans generally pay secured creditors before unsecured creditors.
After the debtor’s plan is confirmed, if the debtor does not make regular payments to the Trustee or to a particular creditor as provided in his Chapter 13 Plan, a creditor can file a Motion to Dismiss for Material Default under Sec. 1307(c)(6). The Trustee also often makes such motions.
The Trustee’s motions to dismiss are sometimes coupled with a motion for "payroll control", i.e., that the debtor submit to garnishment of the Chapter 13 plan payments from his paycheck. Debtors are asked at Creditors’ Meetings if they want to voluntarily submit to such orders. If you can convince the debtor to do so at the Creditors’ Meeting, it can assure a steady flow of payments from the debtor to the Trustee, and from the Trustee to your client.
One other significant remedy for Chapter 13 creditors is a Motion to Modify the Automatic Stay. Such motions may be filed at any time during a Chapter 13 if cause exists under Sec. 362(d)(1). One cause for modifying the automatic stay is a lack of "adequate protection" for the creditor. Examples include an uninsured car on which the creditor holds a lien on an asset (typically a car) that is depreciating faster than the lienholder is being paid on it. Such motions are commonly coupled, in the alternative, with Motions to Dismiss under Sec. 1307(c).
John J. Grieger, Jr. is an Associate at Pierce & Associates, Chicago. His practice is limited to Bankruptcy Law. He received his Undergraduate Degree in 1986 from Northwestern University and his Law Degree in 1990 from the University of San Diego.