Creditor Rights in Bankruptcy Proceedings: What Paralegals Need to Know

Creditor Rights in Bankruptcy: A Paralegal's Essential Guide

Bankruptcy law affects both debtors and creditors, and paralegals working on either side of bankruptcy proceedings need to understand how creditor rights are protected and enforced under the Bankruptcy Code. This guide covers the key concepts that creditor-side paralegals must know, as well as the bankruptcy topics tested on the NALA Certified Paralegal exam.

Overview of Bankruptcy Chapters

Before diving into creditor rights, it helps to understand the most common types of bankruptcy proceedings:

• Chapter 7 (Liquidation): A trustee collects and sells the debtor's non-exempt assets and distributes the proceeds to creditors according to the priority scheme. The debtor receives a discharge of most remaining debts.
• Chapter 13 (Individual Reorganization): Individual debtors with regular income propose a repayment plan to pay creditors over three to five years. The debtor keeps their property and makes plan payments from future income.
• Chapter 11 (Business Reorganization): Businesses (and some individuals with substantial debts) propose a plan of reorganization to restructure their debts while continuing operations.

The Automatic Stay

When a debtor files a bankruptcy petition, an automatic stay immediately goes into effect under 11 U.S.C. Section 362. The stay prohibits most creditor collection activities, including lawsuits, foreclosures, garnishments, repossessions, and even telephone calls and letters demanding payment. The stay applies to all creditors, regardless of whether they have secured or unsecured claims.

Creditors who violate the automatic stay may face sanctions, including actual damages, punitive damages, and attorney fees. However, the stay is not absolute. Creditors can seek relief from the stay by filing a motion with the bankruptcy court. Common grounds for relief include lack of adequate protection (the collateral is declining in value and the debtor is not making payments), the debtor has no equity in the property and the property is not necessary for reorganization, and cause shown (such as bad faith filing by the debtor).

Filing a Proof of Claim

To participate in any distribution from the bankruptcy estate, a creditor must file a proof of claim with the bankruptcy court. The proof of claim is a formal document that states the amount and basis of the claim and attaches supporting documentation such as invoices, contracts, account statements, or promissory notes. In Chapter 7 cases, the deadline for filing proofs of claim is typically 70 days after the filing date. In Chapter 13 cases, the deadline is 70 days after the order for relief.

A proof of claim filed in accordance with the Bankruptcy Rules is presumed valid. The debtor or trustee may object to a claim, and the bankruptcy court will hold a hearing to determine the allowed amount.

Priority of Claims

Not all creditors are treated equally in bankruptcy. The Bankruptcy Code establishes a priority scheme under 11 U.S.C. Section 507 that determines the order in which claims are paid from the bankruptcy estate:

1. Secured creditors: Paid first from the collateral securing their claims. If the collateral is worth less than the claim, the deficiency becomes an unsecured claim.
2. Priority unsecured creditors: Paid in order of priority, including domestic support obligations, administrative expenses, employee wages (up to a statutory limit), employee benefit plan contributions, and certain tax claims.
3. General unsecured creditors: Paid on a pro rata basis from any remaining assets after secured and priority claims are satisfied.
4. Equity interest holders: Shareholders or owners receive any remaining value after all creditors are paid, which rarely occurs in practice.

Exceptions to Discharge

Certain debts survive bankruptcy and cannot be discharged, meaning the debtor remains liable even after the bankruptcy case is closed. Important non-dischargeable debts include:

• Domestic support obligations (child support and alimony)
• Most student loans (unless the debtor can prove undue hardship)
• Debts for fraud, embezzlement, or larceny
• Debts for willful and malicious injury
• Certain tax debts
• Debts arising from drunk driving judgments
• Criminal fines and restitution

Creditors holding potentially non-dischargeable debts must file an adversary proceeding (a lawsuit within the bankruptcy case) to establish that their specific debt is excepted from discharge.

Preference and Fraudulent Transfer Actions

The bankruptcy trustee has the power to avoid certain pre-bankruptcy transfers under 11 U.S.C. Sections 547 and 548. A preference is a transfer made to a creditor within 90 days before the bankruptcy filing (or one year for insiders) that gives the creditor more than they would have received in a Chapter 7 liquidation. A fraudulent transfer is a transfer made with intent to defraud creditors or for less than reasonably equivalent value when the debtor was insolvent.

Prepare for Bankruptcy Topics on the CP Exam

Bankruptcy questions on the CP exam test your knowledge of the automatic stay, priority of claims, proof of claim procedures, and exceptions to discharge. Use ParalegalPrep flashcards to drill these concepts. Sign up for your free account to access practice questions, or explore our pricing plans for full CP exam preparation.