Creditors' Rights

Your rights as a creditor to obtain satisfaction from the debtor depend on the type of debt that is owed to you.

There are two major types of debt:

• Secured debt – A debt that is attached to property. For example, if a debtor takes out a loan to buy a house, that loan is secured by the house. If the debtor fails to pay his mortgage, the creditor can take the house to repay the debt.
• Unsecured debt – A debt that has no attached property. For example, credit card debt is not secured by any property such as a house or car.

Unpaid Secured Debt

The creditor with a secured debt is usually able to acquire the property that the debt is secured to, often through either a repossession or foreclosure.

If the attached property is a vehicle, furniture, or large appliance, repossessing the property is a way to recover for an unpaid debt. Repossessions can be done in a number of ways:

• Hire a repossession company – Repossession companies specialize in repossessing property. If you chose to use a repossession company, it is important that you hire a reputable and bonded one. Otherwise, you could find yourself in legal trouble if they break the law.
• Let the sheriff do it – You can file a lawsuit against the debtor and have the sheriff repossess the property. This method is the safest, but it can be quite costly and take time.
• Do it yourself – While unadvisable, you can repossess the property yourself. But you cannot “breach the peace” in doing so, meaning that you must avoid confrontation or breaking the law when repossessing the property. If you do breach the peace, you can be sued by the debtor for violating their rights. This option is very risky if you are not strongly familiar with the laws of repossession in your locality.

If the attached property is a house or another form of real property, then the creditor may begin foreclosure proceedings against the property in order to have the unpaid debt satisfied through the sale of the property.

Unpaid Unsecured Debt

Collecting an unsecured debt is usually more difficult than collecting a secured debt. The first step to the collections process is to try to collect the debt yourself through reminder invoices and demand letters. If the debt remains unpaid, you can then hire a collection agency. If the collection agency fails, your last option is to file a lawsuit against the debtor.

How Can a Creditor Recover If a Debtor Files for Bankruptcy?

Creditors have certain protections when a debtor files for bankruptcy. As a condition to discharging certain debts, the bankruptcy system requires that a debtor pay off as many debts as possible. Thus, creditors have a right to get at least a portion of whatever funds are distributed to creditors from a bankruptcy estate. Whether or not a creditor will recover mainly depends on the priority that the law assigns to a creditor's claim.

The bankruptcy trustee, who is an official of the court responsible for managing a bankruptcy case, has the authority to disburse funds to creditors.

What Determines the Priority of a Claim?

Bankruptcy law determines the priority of a claim. Secured debts have the highest priority in bankruptcy. Secured debts are debts that have collateral attached, such as a mortgage loan or an auto loan. The reasoning is that if a loan is secured by collateral, that collateral can be used to pay off the debt at least to the extent of the value of the collateral.

A creditor whose loan to the debtor is secured by collateral is either paid according to the terms of the loan contract or is allowed to recover the collateral through foreclosure in the case of a mortgage loan or repossession in the case of an auto loan.

Therefore a secured creditor is not as vulnerable to the loss of repayment as are other unsecured creditors. A bankruptcy discharge does not eliminate a lien, or security interest, on a debtor's property. It only eliminates the debtor's liability to pay the debt. The lien remains, and the creditor can still foreclose or repossess the property if the loan is not paid. So if a person files for bankruptcy and wants to keep property securing a loan, they must continue making payments to the lender until the debt is paid off.

In a Chapter 7 bankruptcy, If the bankruptcy trustee sells the collateral, the trustee must fully pay the secured debt before paying any other creditor. In a Chapter 13 bankruptcy, a debtor who wants to keep secured property can achieve that by making the payment owed each month and repaying any arrearages through a three- to five-year repayment plan.

Unsecured debts have the lowest priority. Unsecured debts are debts that are not secured by collateral; examples are credit card debt, utility bills and the like. Creditors with unsecured debts are at risk of receiving little or no payment if the debtor declares bankruptcy.

Some debts, such as student loans and child support payments, have such a high priority that they can never be discharged and even survive bankruptcy. This means that the debtor remains obligated to pay these loans in full even after going through bankruptcy. A bankruptcy lawyer should be able to help a creditor identify what type of debt the creditor has at issue in a bankruptcy and what steps can be taken to collect payment through the bankruptcy process.

Unsecured debt falls into two categories:

• Priority unsecured claims: These debts cannot be discharged in bankruptcy and, if money is available, the claim will get paid before nonpriority unsecured claims are paid; alimony, child support, certain tax obligations, and debts for personal injury claims or death caused by drunk driving are all priority unsecured claims; the debtor must pay these even after a Chapter 7 bankruptcy;
• Nonpriority unsecured claims: Most of these obligations can be discharged in bankruptcy, except student loans. All priority debts must be paid before these nonpriority unsecured debts can be paid with bankruptcy funds; examples of nonpriority unsecured claims are credit card debt, medical bills, and personal loans.

What Should I Do as a Creditor When I Receive a Bankruptcy Notice?

When a creditor receives a bankruptcy notice, they should immediately stop all collection efforts. This includes phone calls, billing actions and lawsuits related to the debt owed to the creditor. The creditor should then file a claim with the bankruptcy court. The deadlines for filing tend to be short and are strictly enforced, so a creditor should act quickly in order to preserve their rights in a bankruptcy proceeding.

The bankruptcy court will start the process by sending out a notice telling creditors to submit claims on an official proof of claim form. After the deadline for submission of claims has passed, the trustee reviews the claims and determines how much each creditor is entitled to get paid, if anything.

Among the rights of creditors in bankruptcy is the right to object to the debtor's plan for repayment of their debts and related matters. A creditor has a right to challenge a debtor's right to a discharge of the creditor's debt. For example, a creditor might have cause to allege that a debtor committed fraud in some manner.

Secured creditors have additional rights, as well. In bankruptcy, a secured creditor is in a much better position than an unsecured creditor. A lien, for example, entitles the secured creditor to the proceeds from the sale of any property serving as collateral for their claim up to the full amount of the claim.

For example, a trustee might sell real property worth $200,000 owned by the debtor. The debtor might owe only $75,000 to the secured creditor, i.e., the mortgage lender. The trustee is legally required to pay off the secured lender in full before distributing the funds that remain to other creditors. After paying off the $75,000 mortgage, the trustee will distribute the remaining $125,000 to the other creditors according to the rules of bankruptcy priority.

Because of the lien rights, if a secured creditor believes that it is losing money as a result of the trustee holding property in bankruptcy, it can file a motion with the court asking for relief. If the judge agrees to provide the relief requested, the trustee (or debtor) will likely be required to either make payments to cover any potential losses or release the property. The secured creditor is also entitled to the interest on the loan as provided in the contract with some limitations.

Why Do Some Creditors Receive Priority Over Others? Which Creditors Generally Have Priority?

The intent behind the priority of distribution is to protect the types of creditors that society collectively believes should be protected. Bankruptcy administrators are always paid out first, due to the fact that the law requires administrators in order for the bankruptcy system as a whole to function. Domestic support is protected as a priority because of the importance of protecting the families dependent on that support.

Keeping this in mind, the priority of distribution is generally as follows:

1. United States Bankruptcy Court: This is the court in which the bankruptcy is filed and the process is initiated. This court will charge filing fees;
2. Secured Creditors: These are creditors who hold a lien on some piece of property possessed by the debtor. An example of this would be mortgages on a home, or  unpaid balances on vehicles. Secured creditors are always paid due to the fact that the collateral property claimed by the creditor legally belongs to the creditor, unless the debtor has paid off the loan;
3. Unsecured Creditors: In this class, no property is involved that the creditors could legally repossess. The first debt included in the class to be paid would be domestic support, such as child support or alimony. Next would be the costs of bankruptcy administration. These costs likely would include witness fees, accountant's fees, etc. Additionally, administration costs include “one reasonable attorney's fee,” so long as the services rendered are specifically for and directly related to the bankruptcy;
4. Employees: This includes employee wages, salaries, commissions, and benefits plans. However, employees have a payment cap, as well as a time cap. What this means is that each employee may only collect up to $11,752. And, they may only collect if the compensation was earned 180 days prior to their employer filing for bankruptcy; and
5. Government Taxes: Here, taxes include income, property, employment, and any tax the debtor is liable for in whatever capacity. However, it is important to note that each individual tax could be subject to differing time caps. An example of this would be how a property tax can only be collected if the tax was incurred one year prior to the initiation of the bankruptcy process.