Q: What is the difference between a discharge and a dismissal?

A discharge means the debtor’s liability to pay pre-bankruptcy debt is erased. Certain debts, however, can be reaffirmed and allowed to continue. These include secured debts such as a mortgage and most car loans, so long as the automobile has not been surrendered or repossessed. Any unsecured debt is canceled by the discharge, and any further attempt to subsequently collect on it can result in serious sanctions from the bankruptcy court. A dismissal means the debtor did not complete the bankruptcy process and is not entitled to the court’s protection. After a dismissal, creditors may resume collection efforts. However, as a creditor, be aware that the debtor could refile fairly quickly. It is common for a debtor to refile after the initial filing is dismissed.

Question 1

How can a creditor recover if a debtor files for bankruptcy?

Accepted Answer

Filing for bankruptcy is a legal process. It’s not intended to be a magic wand to thwart creditors from collecting what they are owed. In fact, creditors have certain protections.

While some debts are discharged entirely, the bankruptcy system typically requires a debtor to pay off as much of their debt as possible.

Depending on the type of bankruptcy the debtor files, a creditor could be paid back over time or receive a lump-sum payment. If the latter is the case, the money to pay back creditors comes from selling off the debtor’s assets, with the proceeds distributed to the creditors.

Whether a creditor will recover funds and how much depends on the priority assigned to that creditor’s claim.

Question 2

What determines the priority of a creditor's claim?

Accepted Answer

Bankruptcy law prioritizes claims. Secured debts get the highest priority because they have collateral attached, such as a mortgage against real property or auto loan. This makes sense because collateral can be used to pay off the debt to the extent of the collateral’s remaining value.

If your loan to the debtor is secured by collateral, and the value of the collateral exceeds the amount of the loan, then you might be able to seek repayment according to the terms of the loan contract, via foreclosure of a mortgage, or via the repossession of a vehicle under the auto loan.

A secured creditor is generally more likely to get paid than an unsecured creditor. Often, a bankruptcy discharge does not eliminate a lien or security interest on a debtor’s property. It only cancels the debtor’s personal liability to pay the debt.

This means that if the person filing for bankruptcy wants to keep their house or car, they must continue making their payments to the creditor until the debt is paid off.

How much a creditor recovers also depends on the type of bankruptcy the trustee is overseeing.

In a chapter 7 bankruptcy where a trustee sells the collateral, the money must go toward fully repaying the secured debt before other creditors receive payment.

In a chapter 13 bankruptcy, a debtor who wants to keep secured property – like their home – can make arrangements to repay arrearages through a three- to five-year plan.

Unsecured debts get the lowest priority because they are not secured by collateral. Unsecured debt includes, but is not limited to, utility bills, credit cards, and medical bills. Creditors with unsecured debt may receive little or no payment once the debtor declares bankruptcy.

Child support payments have such a high priority that they can never be discharged with bankruptcy. A debtor must keep paying court-ordered child support even after finalizing a bankruptcy process. Student loan debt on rare occasions can be discharged, but it is very difficult to do.

Question 3

I just received a bankruptcy notice? What should I do as a creditor?

Accepted Answer

The first thing a creditor should do after receiving a bankruptcy notice is to stop all collection efforts on the debtor who filed. No more phone calls, billing actions, or lawsuits.

The next thing a creditor should do is file a claim with the bankruptcy court. Filing deadlines tend to be short and are rigidly enforced, so it’s important to act quickly to preserve your rights in the bankruptcy proceeding.

Once the strict filing deadline has passed, the bankruptcy trustee will review all claims and determine how much each creditor should get paid, if anything.

As a creditor, you can challenge in court a debtor’s right to the discharge of their payments to you. For example, you can allege that the debtor is defrauding the court in some manner – but only with sufficient cause.

Question 4

What is the difference between a discharge and a dismissal?

Accepted Answer

A discharge means the debtor’s liability to pay pre-bankruptcy debt is erased. Certain debts, however, can be reaffirmed and allowed to continue. These include secured debts such as a mortgage and most car loans, so long as the automobile has not been surrendered or repossessed. Any unsecured debt is canceled by the discharge, and any further attempt to subsequently collect on it can result in serious sanctions from the bankruptcy court.

A dismissal means the debtor did not complete the bankruptcy process and is not entitled to the court’s protection. After a dismissal, creditors may resume collection efforts. However, as a creditor, be aware that the debtor could refile fairly quickly. It is common for a debtor to refile after the initial filing is dismissed.

Question 5

What can I do if my tenant has filed bankruptcy?

Accepted Answer

If the tenant/debtor breached their lease or rental agreement before filing for bankruptcy, you can seek relief from the automatic stay (injunction against creditors) to either begin or continue the eviction process.

If the debtor is leasing property, but not living on it, then the trustee or debtor in possession must take over the lease within a short period after the filing. Otherwise, the court will deem it rejected. If that happens, the bankruptcy trustee cannot attempt to assign the lease to a third party.

Even if the lease is rejected, the trustee could have a right to continue occupying the property until the estate’s assets can be sold or moved to a new location.

If you are the landlord of a bankruptcy debtor, you will likely need a lawyer to enforce your rights in a timely manner.

Question 6

I got notice of the debtor’s discharge. Where’s my money?

Accepted Answer

The bankruptcy discharge happens on one timeline. Distributions on claims happen on a separate timeline. However, the fact the debtor got a discharge does not necessarily mean you will receive any payment on your claim.

After the discharge, the bankruptcy trustee continues administering the assets until the job is complete. Assets must be sold. Claims must be reviewed. Fees must be assessed. Creditors will be paid to the extent there are assets and according to the priority of their claim.

Keep in mind: A great majority of individual chapter 7 discharges have no assets from which creditors can be paid.

Question 7

My employer filed bankruptcy owing me money. What should I do?

Accepted Answer

Employee claims for wages earned in the 180 days (roughly six months) prior to the bankruptcy filing, or the debtor’s business failing, are considered a high priority for payment. That’s the good news.

The bad news is, the court won’t get around to distributing payment owed to employees until the bankruptcy case is over.

Here’s what you can do: File your claim with the bankruptcy court. Check the box on the form for “priority claim,” provide your social security number, and wait.

If you are not sure where to get a claim form, it is probably printed on the back of the notice of the first meeting of creditors. As an employee owed money by a debtor employer, you are now a creditor. You can also get forms from the court clerk or online.

Question 8

What rights or recourse do I have, as a creditor, if a debtor commits fraud?

Question 9

I suspect debtor fraud, but how can I get the bankruptcy court to see it?

Accepted Answer

As a creditor, you can have oppornunties to sit in a room with the debtor and bankruptcy trustee and ask questions.

The first opportunity is at the 341 hearing. There, the trustee will ask the debtor various routine questions to verify their identity and initially confirm the accuracy of their bankruptcy petition. The trustee will also ask standard, fraud-related questions, like “Have you listed all your assets?” and “Have you accounted for all of your income (over a specific period)?” and “Do you expect to receive an inheritance or any other form of windfall soon?”

They are standard questions, sure, and it’s likely the debtor will have been prepared for them by their bankruptcy attorney. That’s no problem. If you still suspect fraud, you can file an “adversary proceeding” or bankruptcy lawsuit asking the court to not discharge or erase debt owed to you or your company.

As a lender or creditor, you can make your own inquiries into:

the accuracy of reported income on a loan application
the location of property securing the loan, and
whether the debtor has sold or given away assets.

If the trustee begins to suspect fraud after the 341 hearing, and after hearing from creditors intending to file an “adversary proceeding”, they can move for a Rule 2004 Examination. This is one way to compel broad testimony and document production, under oath, from the debtor and anyone else who might know if the debtor has committed fraud.

For instance, Bankruptcy Rule 2004 authorizes the bankruptcy trustee to examine:

the debtor’s acts, conduct, property, liabilities, or financial condition
any matter which may affect the administration of the bankruptcy estate, or
any issue which may affect the debtor’s right to a discharge.

The debtor must appear at the examination.

What are a Creditor’s Rights When a Debtor Files for Bankruptcy?