Creditors’ Rights Against a Bankrupt Debtor

Businesses lend money all the time, whether it’s in the form of a straightforward loan, or by selling products or services on credit.  But unfortunately, consumers and business debtors don’t always pay their debts, and many debtors file for bankruptcy.  Once bankruptcy is filed, the Bankruptcy Code imposes an automatic stay, temporarily barring any further collection efforts.  The automatic stay is designed to give the debtor some breathing room before proceeding with a Chapter 7 liquidation, Chapter 13 repayment plan, or Chapter 11 reorganization.  This can create a sticky situation for creditors, who would certainly prefer to collect the full amount owed rather than collect pennies on the dollar, as is often the case for unsecured creditors in bankruptcy.  However, a creditor who knowingly violates the automatic stay may be liable for actual and punitive damages, attorneys’ fees, and possibly even sanctions for contempt.  Accordingly, creditors and debt collectors need to implement policies to avoid any negligent or willful violations of the automatic stay, since violations can be extremely costly.

Creditors also need to be mindful of whether they have a claim for secured or unsecured debt.  When a debtor goes bankrupt, secured creditors are generally in a much better position than unsecured creditors. This is because their claims are protected up to the value of the designated collateral, and the creditor may be able to demand that the debtor adequately protect the value of the collateral.  While unsecured creditors often benefit from higher interest rates before bankruptcy, only secured creditors are entitled to accrue interest during bankruptcy.  Thus, unsecured creditors should be wary of the risk that their debtors may file for bankruptcy, which could wipe out much of the value they were originally entitled to.  On the other hand, a creditor should be careful about seeking security interests in anything and everything a consumer owns — under the FTC Act, a creditor is engaging in an unfair business practice if it takes a nonpossessory security interest in household goods.

A knowledgeable bankruptcy attorney will be able to counsel you or your business on what your rights are once a debtor has filed for bankruptcy, and how to maintain good practices to avoid losing the right to collect what’s due.  If you have questions about your collection rights, or the policies your business has implemented, then don’t hesitate to call DK Law Group, LLP at (805) 498-1212, or email our office at info@dk4law.com.