Bankruptcy Litigation

Within the context of a bankruptcy case, disputes may arise over the dischargeability of certain debts, the debtors overall right to a discharge, creditors’ claims against the bankruptcy estate, and potential preferential or fraudulent transfers made by a debtor. A seasoned bankruptcy litigator is necessary to navigate these issues.

I have represented both creditors and debtors in bankruptcy litigation, and can tell you that the process is significantly more onerous than simply filing a bankruptcy case. As discussed above, there are several common types of disputes that arise when certain facts exist in a bankruptcy case. These include the dischargeability of certain debts, the debtors overall right to a discharge, creditors’ claims against the bankruptcy estate, and potential preferential or fraudulent transfers made by a debtor. Let’s go over these one by one.

Dischargeability of Debts

There a certain situations in which one of your creditors can claim that because of the nature of the debt you owe them, such debt should not be dischargeable. Some examples of these scenarios are fairly simple and do not usually require litigation, such as tax debts or student loan debts. These debts, by statute, are nondischargeable. This means that even if you do successfully obtain a discharge in your bankruptcy case, these debts will not be included in that discharge and you will still be responsible for them.

There are other times when the dischargeability of a debt is not as clear. For example, debts which have been procured by fraud, debts that are considered “in the nature of support”, and debts resulting from willful and malicious injury caused by the debtor will not be considered dischargeable. Unlike the student loan and tax situations, however, it is often hotly disputed whether facts exist to prove fraud, or that a debt is a “support” debt, or that a debtor committed willful injury. This is because the bankruptcy code is not entirely clear on what these terms mean or where the line should be drawn between, say, willful injury and an accident. In these cases, the specific facts surrounding a debt are far more important. Differing outcomes could be reached in these cases depending on what type of evidence is presented to support the parties’ claims, the Court’s interpretation of the bankruptcy code and case law, and in-court testimony. This is without mentioning the need to navigate bankruptcy procedure and understand leverage within the context of a bankruptcy case.

If you have a creditor who you believe could take a position that their debt is nondischargeable, it is important to discuss this with your attorney early on so they can prepare for the possibility of litigation and prepare your case properly from its inception. In practically all cases, litigation of these disputes in bankruptcy is not included in your initial retainer fee, and in many cases your bankruptcy attorney does not even handle litigation at all.

Similarly, if you are a creditor who is owed money by a debtor in bankruptcy, you will want to seek an opinion on whether your debt is entitled to preferential treatment or is nondischargeable. You also will likely need to take steps to ensure that you can collect this debt properly without violating the bankruptcy code.

Objections to Discharge

There can be several benefits to filing for bankruptcy, but one of the main purposes is to obtain a discharge of your debts. When done properly, this means that once the bankruptcy has concluded you no longer owe creditors who existed at the time of your bankruptcy filing. There are circumstances, however, in which a creditor or trustee will object to your obtaining a discharge. If the case has been filed in bad faith or for some unethical purpose, a debtor’s discharge can be denied. The most important element in these cases is to ensure that you are honest and upfront with the trustee and the Court about your income, assets (meaning any property you own) and any issues related to a particular debt. When a court deems that your creditors are being treated unfairly and that you are not making reasonable efforts to pay them back, or have undertaken action to diminish or hide assets that would have been available to them, your discharge may be in jeopardy. Remember, the purpose of bankruptcy is to give the “honest but unfortunate debtor” the right to a fresh start. Also remember that there is a fine line between “bankruptcy planning” and defrauding your creditors. An experienced attorney can devise a strategy to protect your assets without running afoul of the bankruptcy code and state laws protecting creditors.

In a large percentage of cases, debtors simply undergo circumstances that make it very impractical for them to continue paying creditors without modifying or eliminating their debts in some way. You will rarely run into objections from the trustee or a creditor to a discharge. However, when income and/or assets have suddenly “disappeared”, or a debtor has engaged in fraud, certainly a trustee will take a hard look at your filing. You may also run into the case of an overzealous creditor who simply finds it unfair that you won’t be paying them and seeks punitive action. If their claims are frivolous, they can be discarded in short order and you may even be entitled to sanctions. Even if they have a legitimate case, a good attorney can help you defend against their claims and utilize the bankruptcy process to stymie their collection efforts. The flip side of this if you are a creditor is that you want to make sure you do not violate a debtor’s rights under the bankruptcy code in your collection attempts, and you want to navigate bankruptcy procedure efficiently so you can obtain a reasonable recovery where possible. As the saying goes, you can’t draw blood from a stone, so it is important for both sides to consider not their legal standing, but the costs and potential payouts associated with litigation.

Creditor Claims against the Bankruptcy Estate

There are two major issues to be determined regarding creditor claims in bankruptcy. The first is whether the claim is valid. The second is how that claim should be classified.
 
In many bankruptcy cases, the validity of the claims of individual creditors against the debtor is not a major issue because, in the end, the debtor obtains a discharge of the debts and will not have to pay them back. However, in cases where there are significant funds available from the income or assets of the debtor to pay creditors, the individual claims are important. The amount, validity and classification of these claims can impact the debtor and other creditors. For example, there may be cases where a debtor is capable of paying back all of his or her creditors, but there is one particular claim that has caused the debtor major problems.

If this claim can be resolved or eliminated, the debtor will be able to retain his or her assets and then deal with the remaining debts. If there is a valid defense to the claim, the debtor, trustee, or even another creditor can contest it by filing an objection to the claim. Just like in a state court, the claim will be resolved by the parties presenting evidence and argument in a trial. The judge then decides if the claim is valid and in what amount.

Claims litigation can also arise in a business context, where co-owners or equity holders of a business assert claims against the business as creditors. These claims could be for salary owed by the business to a corporate officer, loans made to the company, or other investments in the business which have not been recouped. The stakes in these cases may be highest because businesses often have valuable assets which can be sold by the trustee to pay creditor claims. In bankruptcy, creditor claims are paid first before any owners or equity holders. As a result, having a valid claim as a creditor can mean the difference between recovering your investment and losing out entirely, so be sure that you have pursued all avenues of recovery if your company goes bankrupt.