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Creditors’ Rights During a Bankruptcy

Whether you’re in debt and filing for bankruptcy or you’re a creditor whose debts are going to be involved in a bankruptcy proceeding, understanding creditors’ rights during the proceeding are vital.

In some ways, creditors’ rights are limited by bankruptcy proceedings, such as being forbidden to contact debtors or seek collection of debt by an automatic stay. Of course, some forms of bankruptcy, including Chapter 7 and Chapter 11, involve the discharging of debts upon completion of the process.

However, creditors are also given the ability to assert their interests during bankruptcy proceedings. Depending on the size of the debt owed to them compared to other creditors, a creditor may even be entitled to some portion of debt repayment based on the bankruptcy agreement.

You can use the following information to understand creditors’ rights during bankruptcy in general. If you have specific questions, you can refer to an experienced bankruptcy and financial law firms like New Mexico Financial & Family Law. We have experience representing both filers and creditors during bankruptcy proceedings, and we know how to advocate for your rights during the process. Call (505) 503-1637 or contact us online to schedule a consultation and speak with a knowledgeable bankruptcy lawyer near you.

Right to Notice

Once a debtor files a petition for bankruptcy and relief, all of their creditors have a right to be notified by the court. This notice not only serves to warn them about possible debt discharge and a stay on collection actions, but it also gives them the opportunity to be heard in matters that affect their debts.

Right to Be Heard

Once creditors are notified, they should file a claim on debt as soon as possible. You or your attorney will need to file Proof of Claim with the court. There should be instructions on where to send the claim included with the notice you received.

All creditors also have the opportunity to present matters relevant to the bankruptcy case. Common declarations/assertions a creditor may make include:

  • Clarification regarding mistakes or inaccuracies in debts owed and their nature
  • Requests that can affect the creditor’s status or priority in collections
  • Opportunities to form a consensual agreement with the debtor
  • Assertions regarding secured claims that will be affected by the bankruptcy proceeding
  • Notice of malfeasance, criminal activity, or bad faith actions on the part of the debtor that would affect their eligibility for bankruptcy

Automatic Stay

Creditors should be aware that they are forbidden from making direct contact with the debt holder or attempting any collection action under most circumstances once bankruptcy proceedings have begun.

As such, cease all collection actions. Debtors are protected from collections during the bankruptcy process. This is called an automatic stay. In chapter 13, bankruptcy filings, the automatic stay also protects co-debtors.

Priority of Claims

Priority refers to the order in which unsecured claims in a bankruptcy case are paid from the money available in the bankruptcy estate. Claims in the higher priority are paid in full before claims in a lower priority receive anything.

The U.S. Bankruptcy Code establishes the order in which claims are paid from the bankruptcy estate. All claims in a higher priority must be paid in full before claims with a lower priority receive anything. All claims with the same priority are supposed to share debt repayment pro rata (proportionally).

Priority claims are claims that are not secured by a lien and include certain debts, such as unpaid wages, spousal or child support, and taxes are elevated in the payment hierarchy under the Code. Priority claims must be paid in full before general unsecured claims are paid.

Based on their priority, creditors will often be assigned to a particular class. Within a class, creditors share the available funds in proportion to the size of their claim.

Order of Priority for Debts & Creditors During a Bankruptcy

  1. Claims for debts to spouse or children for court-ordered support
  2. Administrative expenses of the bankruptcy
  3. Unsecured, post-petition claims in an involuntary case
  4. Wage claims of employees and independent salespersons up to $4300 per claim
  5. Contributions to employee benefit plan up to $4300 per employee
  6. Claims of farmers and fishermen against debtors operating storage or processing facilities.
  7. Layaway claims of individuals who didn’t get the item they made the deposit on
  8. Recent income, sales, employment, or gross receipts taxes
  9. Commitments to maintain the capital of a bank or savings and loan

Non-Dischargeable Debt

In Chapter 7 bankruptcy and within certain Chapter 11 and Chapter 13 agreements, debt may be “discharged,” meaning the debtor is no longer legally obligated to repay it.

However, some debt is supposed to ineligible for discharge. This includes certain secured debt, federal student loan debt, and debts related to a court-ordered spouse or child support.

Non-dischargeable debt also includes debts incurred through fraud or willful and malicious acts. For instance, if the debtor incurred a sizeable debt in the months preceding filing for bankruptcy with the intention to have the debt discharged, this activity is referred to as defalcation, and it makes those debts ineligible for discharge.

Dismissal of Bankruptcy

In cases where the filer utterly fails to meet their obligations, commits fraud, or engages in misconduct in relation to their filing for bankruptcy, then it’s possible for the courts to dismiss the bankruptcy agreement. Dismissal eliminates the automatic stay, allowing creditors to resume contact and collection actions. The dismissal also prevents debts from being discharged, and it nullifies any agreements made in reference to Chapter 11 or Chapter 13 filings.

Creditors’ Committees in Chapter 11

Chapter 11 proceedings concern businesses, corporations, and other enterprises with certain exceptions.

When a Chapter 11 filing is made, a creditors’ committee is often formed. Usually, this committee will consist of the seven largest holders of unsecured debt. The committee is then supposed to have a voice in the administration of the case, the power to investigate the conduct of the debtor during proceedings, and the ability to assist in formulating a plan for restructuring the business and resolving debts to the extent possible.

Once the order for relief has been granted by the bankruptcy court, the debtor has 120 days to formulate and file a Plan of Reorganization. This plan must meet the approval of the creditors’ committee as well as a majority vote in each class of creditor, which can apply to employees and secured creditors as well as typical unsecured creditors. 

Approval must be made by a simple majority within each class, such that holders of at least 2/3 of the dollar value owed to the class assent to the agreement.

If the debtor fails to file a plan within their 120-day window or creditors’ are unsatisfied with the plan within a 180-day window (which includes the initial 120 days allowed to file), then the creditors are allowed to submit a plan of their own.

Note that in some instances, a bankruptcy court can approve a plan over objections from one or more classes of creditors, which is referred to as “cram down” power wielded by the court.

Reporting a Debtor’s Failures to Abide by Bankruptcy Plans and Agreements to a U.S. Trustee

One or more trustees may be assigned to Chapter 7, Chapter 11, and Chapter 13 proceedings. 

In Chapter 11, a U.S. trustee may be appointed to determine that the debtor organization is operating in the best interests of repaying debt. The business affected by the filing is a fiduciary of the debtors, meaning that the sole purpose of the business during this time is to take actions that can result in satisfactory debt repayment.

Similarly, in Chapter 13, a trustee may be assigned to oversee repayment and to hold the debtor to the terms of their repayment plan.

If a creditor has any reason to believe that the debtor has violated the agreement, committed fraud, or acted contrary to the interests of repaying debt, then a creditor can report their concerns to a trustee. This trustee can raise the acts to the court, and the debtor may face additional court orders — or have their bankruptcy case dismissed outright.

Attorneys Who Represent the Interests of Either Creditors or Debtors During Bankruptcy

New Mexico Financial & Family Law has extensive experience assisting individuals and businesses with filing for bankruptcy. We have also assisted creditors with interests in a bankruptcy proceeding.

Bankruptcy law is complicated, and the courts can sometimes move fast. Without someone familiar with the law to assist you, you may miss a critical window for action.

If you need assistance asserting your rights and staying informed of the rights granted to you during bankruptcy, do not hesitate to reach out to us for a case review and for guidance on the best way to proceed forward.

Schedule a no-risk consultation when you call (505) 503-1637 or contact us online today.

We are a debt relief agency and have practiced bankruptcy law for a combined 50 years. Our services include helping individuals and couples file for bankruptcy relief under the Bankruptcy Code. 

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