The bankruptcy process can be challenging for creditors who are now forced
to halt their collection efforts if they do not know what to expect. Focusing
on the three biggest components of bankruptcy will help you understand
the process and protect your interests as a creditor.
In this article, I will discuss the difference between a Chapter 7, Chapter
11, and Chapter 13 bankruptcy filing. Next, I will address the automatic
stay and what steps you must take to avoid a violation of the stay. And
third, I will explain the “Proof of Claim” – what is
it, and when is it due?
Recent changes to bankruptcy laws have reduced the number of filed cases
nationally, yet there are still more than one million cases filed every
year in the United States. Over 100,000 of those cases are filed in California,
so it is clear to us here at Geraci Law Firm that bankruptcy is still
causing frustration for many lenders.
Bankruptcy is a process that allows your borrower to eliminate, restructure,
and/or repay specific debts. Each type of bankruptcy has different rules
that ultimately affect your ability to collect and the time frame it will take.
Chapter 7 Bankruptcy
A Chapter 7 bankruptcy filing is most commonly used by consumers and is
referred to as a “liquidation” bankruptcy. It is called a
liquidation bankruptcy because the Chapter 7 trustee may elect to sell
off all or a portion of the debtor’s non-exempt assets to provide
repayment to unsecured creditors based on their priority. If there are
no assets to liquidate, unsecured debts such as medical bills and credit
card balances will be completely discharged, and certain exemptions exist
under state laws that allow a debtor to keep their primary real estate
However, when the Chapter 7 trustee liquidates a debtor’s non-exempt
assets as part of the bankruptcy proceedings, the creditor that holds
a security interest in the asset will be paid first, with the balance
being distributed among unsecured creditors on a pro rata basis. There
are particular unsecured entities given priority, such as the government,
but for the most part, each creditor will receive a proportionate share.
In most consumer bankruptcy cases, all of the assets will be considered
exempt, and no payments will be made to the creditors. This is the primary
reason that a Chapter 7 bankruptcy is the easiest to file and quickest
to resolution for consumers. If you are a secured creditor, you likely
won’t have to do anything but wait until after the bankruptcy process
is complete and then you can continue your collection efforts.
Chapter 13 Bankruptcy
In a Chapter 13 bankruptcy, debtors who have a regular income are eligible
to file a Chapter 13 so they can restructure their debt. The advantage
is that the borrower is provided the opportunity to retain their property
and repay their debt through a restructured payment plan. Unlike a Chapter
7 where all non-exempt property is sold off to repay creditors, a Chapter
13 debtor submits a plan to the court that details how they will pay off
most or all of their debt via a five-year repayment plan. Typically, pre-existing
loans will not be affected, but a debtor will be required to pay any arrears
on mortgage debt and remain responsible for paying off medical bills as
well as other unsecured debt.
As with a Chapter 7, a Chapter 13 bankruptcy filing will halt the foreclosure
process but will require the consumer to repay the mortgage arrears over
a five-year period. The debtor must submit a 60-month plan that details
how 100% of their income will be distributed month-to-month. For high-income
individuals, it is not uncommon to see them required to repay all of their
unsecured debt. For lower income individuals, they may see their unsecured
debt reduced significantly. The debtor, however, will be required to continue
making their monthly mortgage payments but the Chapter 13 Plan will allow
them to get current on arrears through their repayment plan.
Chapter 11 Bankruptcy
A Chapter 11 filing is a reorganization of debt, typically used for corporations,
LLC’s, or partnerships. Individuals who have a high net-worth or
own multiple pieces of property may also use this type of filing. The
Chapter 11 requires the borrower to propose a reorganization plan and
is often used by debtors to lower interest rates or possibly extend a
loan repayment period.
A Chapter 11 can be frustrating for creditors because it takes longer to
complete and the debtor receives much more flexibility from the court
on their plan of reorganization. Under this type of filing, many borrowers
use their plan to restructure short-term debt into 30-year loans. Under
a Chapter 11 filing, a debtor is called a “debtor in possession”
and allowed to administer his/her/its own case without a trustee. This
can cause increased frustration for lenders and enable the debtor to delay
the process even further.
The Automatic Stay
Regardless of the kind of bankruptcy that is filed, there is one thing
that is constant – the automatic stay. The automatic stay is an
injunction that arises immediately upon the filing of a bankruptcy case.
Although the creditors may not be notified of the bankruptcy filing until
a later date, the stay goes into effect immediately and halts all actions
with regards to collection or enforcement of debt.
If you are a creditor and receive notification from your debtor that they
filed bankruptcy, you should consult an attorney before you have any further
contact with the borrower. The advice can ensure that you are not violating
the stay and help to protect your rights during the bankruptcy process.
The automatic stay may be in place even if you don’t know about it.
For this reason, it is imperative that a foreclosure trustee conducts
a thorough bankruptcy search before conducting a trustee’s sale.
If you do not perform the proper due diligence, you may find that your
sale is void, and you will incur the costs to unwind the transaction.
Judges treat violations of the automatic stay very seriously, and can
impose sanctions on violators or even strip them of their collateral.
There is good news – the automatic stay does not last forever. The
stay is in effect only until any of the following occurs:
- The judge grants your motion for relief from automatic stay
- The debtor’s bankruptcy is discharged and closed
- The debtor’s bankruptcy case is dismissed
Once you determine that an automatic stay is in effect for your borrower,
you have the option of petitioning the court to grant relief from the
stay, permanently lifting the injunction and allowing you to continue
Obtaining a Hearing
From the date of the filing, it may take up to three or four weeks before
you can get a hearing date. Assuming your motion is granted, it can take
a couple more weeks to receive the final order from the court. In general,
it will take about a total of eight weeks for a creditor to challenge
and obtain relief from the automatic stay.
Often, when a client wishes to file a motion for relief, we will reach
out to the debtor’s counsel to ask them to stipulate to the relief
or arrange some repayment plan that would result in the creditor getting
paid off sooner than the court would dictate. A stipulation is a good
way to go if both the borrower and the creditor agree to terms. If not,
then filing for relief from the stay would be an appropriate course of action.
Proof of Claim
In bankruptcy cases, the proof of claim is a way to inform the trustee
exactly how much you are owed from the debtor. Except for Chapter 7 bankruptcies,
where no claim is filed because the debtor has no assets, a proof of claim
is the only way to ensure that you are ultimately paid the correct amount.
After the proof of claim is filed, the borrower is given an opportunity
to object to the claim. If the borrower does not object to a claim, then
the trustee will order the debtor to pay the amount of your claim, regardless
if the debtor’s plan indicates a lesser amount.
A proof of claim is a form that you complete which shows the principal
amount owed, the amount of arrears that is owed, and the interest rate
accruing on the loan. It also requires a creditor to attach documentation
establishing proof of the debt such as promissory note and deed of trust.
A proof of claim should always be filed at the soonest possible date after
you learn of a borrower filing bankruptcy. This claim will promptly inform
the trustee of the amount owed, the validity of the debt, and where to
Bankruptcy can be a frustrating and confusing time for creditors, but a
complete understanding of the process will ensure you the best chance
of full repayment.
If you have any questions or concerns about a pending bankruptcy case,
please do not hesitate to
contact Amy Martinez at Geraci Law Firm to help guide you through the process or call our main
office at (949) 298-8050.