Creditor Rights in Bankruptcy Proceedings: What Paralegals Need to Know

Bankruptcy from the Creditor's Perspective

Bankruptcy is governed by federal law, primarily Title 11 of the United States Code, known as the Bankruptcy Code. While much attention goes to the debtor, creditors have important rights and responsibilities in every case. Paralegals who work in bankruptcy or collections must understand how creditors are classified, how they assert claims, and what limits apply to their collection efforts. These concepts also appear regularly on paralegal certification exams.

Who Is a Creditor?

A creditor is any entity that holds a claim against the debtor arising before the bankruptcy filing. The Code defines a claim broadly to include a right to payment, whether or not it is disputed, contingent, or unliquidated. Creditors are generally divided into secured, priority unsecured, and general unsecured categories.

What Is a Secured Creditor?

A secured creditor holds a lien or security interest in specific property of the debtor, such as a mortgage on a house or a purchase money security interest in a vehicle. The creditor's rights in the collateral survive bankruptcy in most cases. If the collateral is worth less than the debt, the secured creditor holds a secured claim up to the collateral value and an unsecured claim for the deficiency (Section 506).

What Is a Priority Unsecured Creditor?

Section 507 gives certain unsecured claims priority and requires them to be paid ahead of general unsecured claims. The common priority categories include domestic support obligations, administrative expenses of the bankruptcy estate, certain wage claims earned shortly before filing, contributions to employee benefit plans, and certain tax claims. Domestic support obligations have the top priority.

What Is a General Unsecured Creditor?

These creditors, such as credit card issuers, medical providers, and trade vendors, have no collateral and no special statutory priority. They share pro rata in whatever remains after secured and priority claims are paid, which is often little or nothing in a Chapter 7 case.

What Is the Automatic Stay?

When a bankruptcy petition is filed, an automatic stay under Section 362 takes effect immediately. It prohibits creditors from beginning or continuing collection actions, lawsuits, foreclosures, repossessions, wage garnishments, and most contact with the debtor. Violating the stay can result in sanctions, including actual damages, attorney fees, and in egregious cases, punitive damages.

Are There Exceptions to the Automatic Stay?

Yes. The stay does not stop criminal proceedings, the collection of domestic support obligations from non-estate property, certain tax audits, or the exercise of police and regulatory powers by governmental units. A creditor may also ask the bankruptcy court for relief from stay, which is typically granted when the creditor lacks adequate protection of its interest in collateral or when the debtor has no equity and the property is not necessary for an effective reorganization.

How Does a Creditor File a Proof of Claim?

To share in distributions, most creditors must file a proof of claim with the bankruptcy court. In a Chapter 7 case, the deadline is generally 70 days after the petition date for non-governmental creditors, and governmental units generally have 180 days. In a Chapter 13 case, the non-governmental deadline is 70 days after filing. A proof of claim states the amount owed, the basis for the claim, and any security. Filing on an official form with supporting documentation gives the claim prima facie validity. In Chapter 11, a creditor whose claim is scheduled by the debtor as undisputed does not need to file unless the claim is listed as disputed, contingent, or unliquidated.

What Is the Creditors Meeting?

Section 341 of the Code requires a meeting of creditors at which the debtor appears under oath and answers questions from the trustee and any creditors who attend. Creditors may use the meeting to ask about assets, transfers, and the accuracy of the schedules. Paralegals often prepare attorneys for these meetings by reviewing the petition and schedules and identifying issues.

Can a Creditor Challenge the Discharge?

Yes, in limited circumstances. A discharge releases the debtor from personal liability on most debts, but some debts are non-dischargeable under Section 523. Examples include domestic support obligations, certain taxes, most student loans absent undue hardship, debts for fraud or false pretenses, willful and malicious injury, and debts arising from drunk driving. A creditor who believes a debt falls within a fraud based exception must file an adversary proceeding within the deadline, which is 60 days after the first date set for the creditors meeting. Missing that deadline typically results in the debt being discharged.

Creditors may also object to the debtor's overall discharge in Chapter 7 under Section 727, for reasons such as concealing assets, destroying records, making false oaths, or receiving a prior discharge within the statutory period.

What Are Preferences and Fraudulent Transfers?

A trustee can recover certain payments made before filing. A preference is a transfer to a creditor on account of an antecedent debt made while the debtor was insolvent within 90 days before filing, or one year for insiders, that allows the creditor to receive more than it would in liquidation. Defenses include contemporaneous exchange for new value and payments made in the ordinary course of business. A fraudulent transfer involves transfers made with intent to hinder, delay, or defraud creditors, or for less than reasonably equivalent value while insolvent, generally within two years under the Bankruptcy Code or longer under state law. Creditors who received these transfers may have to return the property or value to the estate.

What Rights Do Secured Creditors Have in Chapter 13 and Chapter 11?

In reorganization cases, secured creditors are entitled to adequate protection and to retain their liens until paid. A plan may modify certain secured claims, but most mortgages on a debtor's principal residence cannot be modified in Chapter 13. A secured creditor may vote on a plan, and a Chapter 11 plan must satisfy the best interests of creditors test. In Chapter 11, the absolute priority rule requires that senior classes be paid in full before junior classes receive anything when a plan is confirmed over dissent.

Paralegal Responsibilities in Creditor Matters

• Monitor the docket for notices and calendar deadlines for claims and adversary proceedings.
• Prepare and file proofs of claim with supporting documents.
• Draft motions for relief from stay and related declarations.
• Track plan treatment and payments.
• Maintain communication protocols that respect the automatic stay.

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