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Bankruptcy - What Are Your Rights When Someone Who Owes You Money Files for Bankruptcy

09/09/2010 | Fall 2010 Newsletter
The filing of a bankruptcy case automatically stays (stops) most creditor lawsuits and other collection efforts against the debtor until the creditor obtains permission of the bankruptcy court to proceed.

Notable examples of actions unaffected by the stay include the enforcement of criminal fines and penalties and the collection of child support and spousal maintenance.

Ignoring this automatic “stay” of collection efforts may result in an order of contempt and monetary damages against the party who violates the stay.

However, the automatic stay is not limitless and it does not grant the debtor the right to abuse the bankruptcy code or ignore creditors’ rights. By disregarding the limits of the automatic stay and taking no action following the debtor’s bankruptcy filing, a creditor often risks multiplying its losses.

The debtor has a continuing obligation to make full disclosure of his or her assets and liabilities during the bankruptcy proceeding. All the debtor’s disclosures must be made “in good faith.” The debtor starts with a clean slate on the date of filing for bankruptcy. However, the debtor must pay rent for periods after the filing and must pay for goods and services “post-petition,” meaning after the bankruptcy filing.

A debtor’s obligation to pay pre-petition rent arrears after bankruptcy filing largely depends on two factors. The first is whether the debtor continues to occupy the leased premises. The second is whether the debtor will assume or reject its lease and its corresponding obligations. Assuming the debtor seeks to keep its lease, the debtor must pay arrears arising pre-petition and pay his post-petition rent and additional rent when it comes due. If the debtor rejects its lease and vacates the leased premises, the debtor’s obligations to pay rent under the lease will end and rent arrears will likely be subject to discharge upon completion of the bankruptcy case.

Bankruptcy strategies for both debtors and creditors often depend upon the type of bankruptcy the debtor chooses when filing his case. The following is a summary of the different types of bankruptcy proceedings.

A Chapter 7 bankruptcy is a liquidation proceeding. Typically, though not always, the debtor is an individual who seeks to discharge his pre-petition “general unsecured obligations,” such as credit card debt, and retain all of his post-petition income. If the debtor is an individual with primarily consumer obligations, meaning obligations incurred for a personal, family or household purpose, and the debtor’s income exceeds the median income for his family unit’s size in the state of his residence, the debtor must pass a “means test” established by Congress before he can file a Chapter 7 case “in good faith.” If the debtor fails the means test, his Chapter 7 case can be dismissed (unless a bankruptcy court finds that there are special circumstances to allow the filing to continue) or converted to a Chapter 13 case, sometimes referred to as a wage earner’s or a debt adjustment proceeding.

Because a debtor cannot assume a lease or continue to occupy the leased premises unless he cures his pre-petition lease defaults, most individual Chapter 7 debtors try to stay current with their landlord. Since a debtor cannot keep his lease and not pay arrears, the debtor’s incentive to pay the landlord is comparatively high. If the debtor owes rent on the date of filing, the landlord is a secured creditor to the extent it holds a security deposit. Essentially, a debtor who wishes to continue in residence and retain the benefits of his lease must pay pre-petition rent arrears and post-petition rent as it comes due.

A Chapter 13 bankruptcy is a debt adjustment plan for individuals with regular income who owe not more than $1,081,400 in secured debt and not more than $360,475.00 in general unsecured debt. In Chapter 13, a debtor adopts a plan to pay off past debts gradually from future income and may take up to 5 years to pay arrears owed to a landlord, so long as the debtor pays future rent when due.

A Chapter 11 bankruptcy, typically filed by businesses, provides for the adoption of a reorganization plan to allow the debtor to reorganize its affairs and pay off some, but usually not all, of its creditors. Occasionally, individuals file a Chapter 11 bankruptcy if they exceed the debt limitations applicable to Chapter 13.

Because a bankruptcy case must conform to the provisions of the bankruptcy code and extensive case law that interprets it, a bankruptcy filing does not conclude the debtor’s responsibility to his creditors. Interested parties should make the effort to compile complete and accurate records of the debtor’s obligations and seek the assistance of experienced counsel to protect their rights.