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Bankruptcy Overview for Creditors

bankruptcy

If your company lends, collects debts, or provides goods or services on credit, there’s a good chance you'll need to understand some portion of the intricate world of bankruptcy. This overview will lead you through the purpose of different types of bankruptcy, when and why a debtor might file for one, and how you, as a creditor, can best navigate these situations.

What is Bankruptcy?

Bankruptcy helps individuals and organizations to get a “fresh start” when they cannot repay their debts. The United States Court aims to provide this relief and discharge debts while preserving the interests of creditors and other stakeholders. They do this through a complex system of statutes, procedural rules, and judicial precedents that weave together to balance the often competing interests.

The Bankruptcy Code is the primary source for bankruptcy law. The Bankruptcy Code contains a variety of “Chapters” that outline each of the diverse types of bankruptcy. The most commonly filed categories include Chapter 7 and Chapter 13 for individuals and Chapter 11 for businesses.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy, often referred to as liquidation, usually runs its course over 3-4 months. This type of bankruptcy allows the debtor to wipe out unsecured debt completely, choosing which assets to keep in the process. The success rate for Chapter 7 filings sits around 90%, marking it as a commonly sought-after option for those facing significant financial hardship.

One of the top reasons people file a Chapter 7 bankruptcy is medical debt. In 2019, researchers at Harvard Medical School found that 66.5 percent of all personal bankruptcies were tied to medical bills. Medical issues often combine expensive health bills with the inability to work to substantially affect a debtor's situation. Other common reasons people file for Chapter 7 bankruptcy include divorce, business failure, and imminent repo/foreclosure.

The workflows a creditor must complete for a Chapter 7 bankruptcy vary depending on a number of factors, but here are some of the most common workflows we see:

  • Bankruptcy Monitoring: It is always important to monitor consumers for Chapter 7 filing notifications. Actively collecting from consumers with an open bankruptcy case is extremely risky and likely illegal.
  • Filing Confirmation: Sometimes, consumers report filing bankruptcy before filing or with no intention of filing bankruptcy. Best practices are to verify bankruptcy if notified outside of a reliable monitoring service.
  • Objection to Discharge: In some cases, a creditor suspects that the debtor committed fraud or other malicious acts that should prevent the discharge of the debt they owe you. They may review the statements and schedules for inaccuracies and file an objection to discharge the debt.
  • Proof of Claim: A Proof of Claim is a court document indicating the amount of debt that the debtor owes to the creditor. Generally, unsecured creditors don’t file Proof of Claims to reconcile debt in Chapter 7 cases because there is no money to disburse. Notable exceptions include when the Chapter 7 case includes assets or when the debt is a priority debt like a student loan or domestic support.
  • Reaffirmation: This process involves the debtor agreeing to continue paying a debt that could otherwise be discharged in their bankruptcy case. In a Chapter 7 bankruptcy, debtors might reaffirm debts related to secured assets they wish to keep, such as a car or house. As a creditor, you might negotiate with the debtor to reach a reaffirmation agreement, which then must be approved by the bankruptcy court.
  • Dismissal Monitoring: Around 5% of Chapter 7 cases are dismissed. Creditors can resume regular collections when the dismissal happens. Bankruptcy monitoring services provide notifications for when events like dismissal happen.
  • Post-Discharge Update: Most unsecured debt is discharged when the Chapter 7 case is discharged. Creditors should update the consumer status to a bankruptcy discharged status and write off the debt as necessary.

    • Chapter 13 Bankruptcy

    Chapter 13 bankruptcy, also known as personal restructuring, typically spans 3-5 years. This form of bankruptcy consolidates all debts into a single payment, allowing individuals with a regular income to retain valuable assets and maintain a high income during their debt resolution process. Unsecured debt payments under this plan can vary widely.

    Similar to Chapter 7 cases, medical debt frequently is a significant motivator in people's decision to file for Chapter 13 bankruptcy. However, unlike Chapter 7, Chapter 13 allows the debtor to halt foreclosure proceedings and make up delinquent mortgage payments over time. This ability to protect their assets from imminent repo/foreclosure is often a driving force for people with a steady income and/or assets they wish to keep. Many choose to file a Chapter 13 bankruptcy to manage their payments while retaining their property. Other reasons individuals file for Chapter 13 bankruptcy include dealing with the financial aftermath of a divorce and handling debts resulting from business failure.

    The workflows a creditor must navigate during a Chapter 13 bankruptcy also depend on a number of factors, but here are some of the most common we encounter:

  • Bankruptcy Monitoring: As with Chapter 7, it's crucial to monitor consumers for Chapter 13 filing notifications. Attempting to collect from consumers during an open bankruptcy case is not only risky but could also violate the law.
  • Filing Confirmation: Similar to Chapter 7, you may receive reports of consumers filing bankruptcy before they actually file or without any true intention of doing so. If a bankruptcy notification comes from a source outside of a reliable monitoring service, verification is always the best course of action.
  • Proof of Claim: Unlike Chapter 7, unsecured creditors often need to file a Proof of Claim in Chapter 13 cases. This document, indicating the amount of debt the debtor owes, is essential to ensure the debt's inclusion in the repayment plan. This action must be completed within a strict deadline, or the creditor may lose their claim.
  • Sell Bankruptcy Debt: In an effort to increase liquidity and sidestep the complexities of the Proof of Claim process, some creditors choose to sell their bankruptcy claims. This decision allows for immediate cash flow and reduced administrative burden, despite typically accepting a discounted payment. The sale transfers all associated rights and obligations to a third-party buyer, streamlining the creditor's involvement in ongoing bankruptcy proceedings.
  • Plan Review and Objections: Upon filing Chapter 13, the debtor submits a proposed repayment plan. Creditors have the right to review this plan and file objections if they find discrepancies or believe their interests are not adequately addressed.
  • Plan Confirmation Monitoring: After the plan is confirmed, it's essential to monitor the debtor's payments. If they miss payments or default on the plan, you, as a creditor, may have the right to request a case conversion or dismissal.
  • Chapter 13 Plan Payment Processing: After the court approves a Chapter 13 repayment plan, creditors should establish a system for receiving and applying payments according to the plan's terms. The system should accurately track each payment's application to the outstanding balance and interest, where applicable.
  • Plan Modification Monitoring: Chapter 13 plans can be modified post-confirmation if circumstances change. Creditors must stay alert to any notifications or motions for plan modifications to understand how these changes might affect their payment terms or amounts. If a plan modification is proposed, the creditor has the right to object if the change adversely impacts them.
  • Post-Discharge Update: When the debtor successfully completes their payment plan, most, if not all, remaining debts will be discharged. Creditors should update the consumer's status to a bankruptcy discharged status and write off the debt, if necessary. It's also vital to ensure that no further collection attempts are made on discharged debts.

    • Chapter 11 Bankruptcy

    In the business world, Chapter 11 bankruptcy is a pivotal tool for financial restructuring. The timeline for Chapter 11 is not rigid, often spanning several years depending on the business's debt complexity and asset size. Its primary aim is not outright debt elimination but rather allowing businesses to continue operations while reorganizing their financial obligations. This process includes renegotiating contracts, reducing costs, and potentially closing underperforming divisions.

    Several workflows associated with Chapter 11 bankruptcy closely mirror those found in Chapter 7 and Chapter 13 procedures. However, the complexity and scale of Chapter 11 cases can be significantly greater, often involving vast and intricate financial landscapes. We’ll reserve our exploration of Chapter 11 workflows for a separate article or book.

    Other Chapters

    Beyond Chapters 7, 13, and 11, there are additional bankruptcy chapters less frequently utilized. Chapter 12, for example, is specifically designed for family farmers and fishers, providing relief to those struggling in these unique industries. Chapter 9 is reserved for municipalities, including cities and towns, that are unable to meet their financial obligations, and Chapter 15 deals with international bankruptcy situations, providing assistance for cases involving parties in more than one country.

    This bankruptcy overview was written in partnership with BankruptcyWatch. If you would like to learn more about how BankruptcyWatch and Shaw Systems have teamed up to provide bankruptcy data for lease servicing, collections, and recovery management users, sign up now for more info.



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