In our current uncertain times, both businesses and individuals are faced with historic economic challenges resulting from unprecedented government shutdowns and public health restrictions. We are experiencing an increase in the unemployment rate that exceeds that of the Great Depression. At the same time, businesses are being forced to make tough decisions about their employees and what to do in regard to their contractual obligations. Individuals are left wondering how to pay their rent or make their mortgage payments and just pay all the bills each month.
It is a near certainty that we will see an uptick in
bankruptcy filings in the coming months. There are some important things to know for those who may need a fresh start. There are also critical things to know for people or businesses who have a claim against someone who may go into bankruptcy or threatening to file bankruptcy.
1. There Are Three Main Types Of Bankruptcy.
Both individuals and corporations can file a Chapter 7
“liquidation” type bankruptcy. This type of bankruptcy essentially requires the person or entity filing bankruptcy (called the “debtor”) to give up their non-exempt assets while at the same time providing relief from almost all of their debts. A “trustee” is appointed to be involved in the process (as with all types of bankruptcy). While there are many laws and rules that must be followed by all parties, it is absolutely critical that the debtor accurately and fully list all of their assets and debts in order to obtain a discharge and a fresh start. Failing to do so may put the potential “discharge,” (as described below) which is the resolution of most types of debts, at risk.
A “creditor” is someone who is owed money by a debtor. For example, a credit card company or the mortgage company. If a creditor thinks that a debtor failed to disclose an asset (such as a second home, an interest in vacant property, a claim in a lawsuit, a foreign bank account, etc.) then the creditor or trustee can take certain action to capture those assets. Additionally, if the debtor acted in bad faith, or is acting in bad faith, the trustee or a creditor can challenge the ability for a debtor to receive a discharge.
A Chapter 13 bankruptcy is commonly thought of as a reorganization for individuals. The debtor proposes a plan for payment of their debts based on a portion of their discretionary income, over a three to five-year period. A plan often pays unsecured creditors (such as credit card companies) pennies on the dollar for what they are owed. This type of bankruptcy is commonly utilized by debtors wishing to save their homes from foreclosure. This is commonly done by curing the amounts owed to the first mortgage company and paying their current mortgage payments as they come due via their reorganization plan. There may also be the possibility of working with the first mortgage holder, through mediation, to resolve issues with the payment default (loan modification process,
Chapter 11 bankruptcy is typically a reorganization-type bankruptcy for corporations and certain high net-wealth individuals. The debtor proposes a plan of reorganization. Depending on their status, creditors may have the opportunity to vote to accept the proposed plan. A Chapter 11 provides a high degree of flexibility for debtors in reorganizing their debts or by proposing a liquidating plan akin to a Chapter 7. In fact, Congress recently authorized a simplified form of Chapter 11 bankruptcy for certain individuals and entities, which is known as a
2. Bankruptcy “Estate” And Proof Of Claim.
Upon filing for bankruptcy, a “bankruptcy estate” is formed that consists of all assets belonging to the debtor anywhere in world. This “estate” includes tangible assets like real property (i.e., a house), and non-tangible assets like money in a checking account, including any income generated by those assets. The “estate” even includes post-filing inheritances that occur within a six-month period following the filing of the bankruptcy. Essentially, anything
a debtor may have an interest in, with some exceptions, is likely to be included in the bankruptcy “estate.”
There are secured creditors (like a first mortgage holder) and unsecured creditors (like a credit card company). If a debtor has a contract with you, or owes you some amount of money, then you may be required to file a “Proof of Claim.” If a creditor is required to file a Proof of Claim and fails to do so then the creditor’s claim may be barred forever. If a creditor files a timely Proof of Claim then the creditor may get some, or all, of the money the creditor is owed. However, debtors can oppose a Proof of Claim if it is improper or not properly supported with
documents showing the creditor’s claim’s basis.
3. Do I Lose All My Assets In Bankruptcy And How Do Exemptions Work?
Not all property of the debtor is taken in bankruptcy to pay the debts of creditors. Exemptions are the way in which a debtor tries to remove an asset from the bankruptcy estate. Certain states, such as Florida, provide a list of exemptions available for a debtor to use. This includes an unlimited exemption on the value of a homestead so long as it meets the criteria for a homestead. The application
of exemptions is very fact specific. All non-exempt assets (unprotected assets) may be sold to raise funds to pay the debts owed to creditors. Florida does not generally permit the use of federal exemptions but other states do. A debtor’s residency over the past 2 years is used to determine which state’s exemptions apply.
The appointed trustee, or a creditor, has the ability to challenge an exemption if it thinks a debtor is improperly trying to shield one or more of its assets. If a creditor has a legitimate legal and factual basis to contest an exemption, then the debtor may have to turn over the asset or make a payment to redeem the asset from the bankruptcy estate. Again, if the trustee or
creditor fails to timely challenge the debtor’s exemptions then it potentially loses that right forever.
If an exemption does not fit the situation, another option available to debtors is to redeem or reaffirm a debt owed to a creditor for a particular asset. This often occurs with a lease for a vehicle. However, a debtor cannot force a creditor to agree to reaffirm the debt. If the creditor is willing, the parties may enter into a reaffirmation agreement that will permit the debtor to keep the asset, such as a vehicle, during and after the bankruptcy. Reaffirming a debt is a very serious legal choice and should be taken with care. The debtor is agreeing to opt out of any protection from
the bankruptcy for that particular debt by reaffirming. (“Redeeming” is where the debtor purchases an asset back from the bankruptcy estate by negotiating terms with the trustee.)
4. Bankruptcy Protection Can Stop Certain Lawsuits And There Is Special Treatment For Landlords And First Mortgage Holders.
One reason many people or companies file for bankruptcy is to stop a pending lawsuit, or to try to prevent a judgment being entered against the individual or corporation (such as a foreclosure lawsuit or a debt collection
lawsuit). Sometimes a bankruptcy is filed shortly after a judgment is entered against them. Upon filing for bankruptcy, the party owed something is generally barred from being able to collect, and if the lawsuit is not finished, the lawsuit itself should stop. This concept is known as an “Automatic Stay.” Typically, an “Automatic Stay” will stay (or stop) any judicial proceedings until the end of the bankruptcy case unless it is relaxed by the bankruptcy court (this is known as “Relief from the Stay”).
If a creditor has a mortgage, lien or other secured interest in an asset then there are specific protections afforded to the creditor. For example, a first mortgage holder’s lien
against the real property will survive the bankruptcy even if the debt itself has been discharged. Creditors such as a landlord, or a mortgage holder, can take certain action to compel compliance with the lease or mortgage and may be entitled to adequate protection from any further default. Further, if the debtor and creditor are in a long-term contract then there are certain rights and obligations of the debtor. If, however, the creditor does not timely and properly assert its legal arguments then the creditor may lose certain rights. As such, it is critical that anyone owed money by a debtor (even if they have a secured interest) hire counsel to represent them in the bankruptcy proceeding from its inception.
5. Not All Debts Can Be Eliminated By Bankruptcy.
The bankruptcy laws are set up to eliminate (or “discharge”) most debts at the end of a bankruptcy case. This is accomplished by the bankruptcy court entering an “Order of Discharge” or an order confirming a plan in a Chapter 11. Corporations, however, do not receive a discharge like individuals in a Chapter 7 but can in a Chapter 11. Of course, there are certain types of debts, such as student loans, child support, alimony, and certain taxes, that are not automatically discharged at the end of a bankruptcy case.
Also, there are circumstances relating to how the debt occurred that can be a bar to the discharge of a debt. For example, a debt that was procured by fraud is not dischargeable. A debt arising from embezzlement, larceny, or a breach of fiduciary may not be dischargeable. Any creditor that wants to challenge whether a debt can be discharged has to file the appropriate filings within a specific time period. Some of these circumstances arise automatically, but others must be brought to the bankruptcy court’s attention by a creditor or the trustee.
If you think that a fresh start in bankruptcy may be an option for you, or if you are a creditor in a bankruptcy case and need to
know your rights, then we encourage you to reach out to knowledgeable counsel with experience in this complex area of the law.