What Creditors Should Do If a Debtor Declares Bankruptcy During the Pendency of a Lawsuit Against the Debtor

Kegler Brown Litigation Newsletter

In today's tough economic climate, the number of individuals and businesses filing for bankruptcy are on the rise. Bankruptcy brings its own unique set of rules that impact those who do business with the "debtor," or party filing for bankruptcy. This is an overview to show creditors how to avoid missteps in the bankruptcy process.

The Automatic Stay
The automatic stay created by 11 U.S.C. § 362 is arguably the most relevant bankruptcy provision for parties who are not in bankruptcy. The stay is immediately effective upon the filing of the debtor's bankruptcy petition and prohibits:

  • the commencement or continuation of a proceeding against a debtor based on claims that arose before the debtor filed for bankruptcy;
  • the enforcement of a judgment obtained before the bankruptcy was filed;
  • non-litigation conduct such as sending demand letters, garnishing wages, or repossessing the debtor's property; and
  • creating, perfecting, or enforcing a lien on the debtor's property.

§ 362 provides serious penalties for willful violation of the automatic stay. If a creditor willfully violates the stay, the debtor can recover actual damages, punitive damages, and attorneys fees. In some situations, however, a party can move for relief from stay in the bankruptcy court in order to proceed with a non-bankruptcy case.

Assert Your Claim in the Bankruptcy
As a creditor, you have the ability to assert certain claims within the bankruptcy. As mentioned above, you can file a proof of claim to assert your interest. A proof of claim is the easiest way to obtain some payment from a debtor if there are assets in the case. You can also object to a proposed plan and/or treatment of your claim.

Creditors also have the ability to object to the discharge of their debt where the debtor obtained the property or services fraudulently or by misrepresenting its solvency. If the claim is declared non-dischargeable, then creditors could collect the debt from the debtor after the bankruptcy. The time period to object to the discharge of a debt is very short, and contacting your attorney immediately is critical.

Creditors have many rights to exercise within the bankruptcy case. Although there are a lot of nuances within each chapter, filing a proof of claim and asserting any other claims you have within the bankruptcy are important steps for creditors. Because we anticipate rises in both individual and business bankruptcy filings in the coming years, creditors should take the actions necessary to protect their interests, while avoiding bankruptcy's pitfalls, when their business partners take the plunge into bankruptcy.