What to do when you receive a Notice of Bankruptcy? Step 4: What is your liability?

In our previous posts in this series you should have already identified why you received the Bankruptcy Notice and what the deadlines are that might apply to you.  In order to determine whether you should take any action related to this Notice, you now need to determine what you may have to lose.

If you are a creditor and you take no action, the debt owed to you may be discharged.  In most cases, there is nothing a creditor can do to prevent the discharge, especially in a no-asset case.  The right of the debtor to file for bankruptcy trumps your right to be paid by the debtor.  However, there are some examples where taking action can result in payment (or at least non-discharge of your debt).  Some examples where you may be able to prevent discharge of your debt, or all debts, is when the debtor committed fraud, when the debtor is trying to exempt property that should not be exempted, or when the debt is secured or otherwise protected from discharge (these are just some examples and is not intended to be an exhaustive list).

In any case where a creditor can prevent discharge, they are usually required to take some action to notify the court of their dispute and enforce their rights.  For example, in the case of fraud, the creditor must file an adversary proceeding challenging the discharge of that debt based on fraud.  In each individual case, you will have to determine if the value of preventing discharge of the debt is greater than the cost of enforcing that right.  In many such cases the creditor may reach settlement with the trustee regarding payment.

There are also situations where a bankruptcy may affect your liability, but there is nothing you can do about it.  For example, many codebtors will be affected by the bankruptcy of the debtor but have little rights to challenge the bankruptcy, because their liability is due to their own agreement with the creditor and they have no separately existing rights against the debtor.  This is often the case when one spouse, or ex-spouse files for bankruptcy.  Bankruptcy can have a major affect on debts owed by both spouses, and therefore property division, but if the divorce agreement doesn't appropriately address this possibility, the non-debtor spouse may have few or no options.  For more information about cosignors or the interplay of divorce and bankruptcy you may want to review these other posts:

I am the primary borrower on a loan and my cosigner has filed for bankruptcy. What should I do to protect myself?

I co-signed a loan and the primary borrower has filed for bankruptcy. What should I do to protect myself?

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #4: Jurisdiction over Your Assets

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #3: Jurisdiction over Your Debts

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #2: Domestic Support Obligations

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #1: The Automatic Stay

Once you've identified your exposure in a bankruptcy, the last step is to determine if you need help in limiting that exposure.  Should you hire a bankruptcy attorney to help you evaluate your claims? 

What to do when you receive a Notice of Bankruptcy? Step 3: Identify Deadlines.

If you receive a Notice of Bankruptcy, it will contain certain deadlines and meeting dates.  The sample below shows where some of those deadlines will appear:

These dates are important because they limit what you can and cannot do in a case, and if you miss any of these deadlines you may have given up your rights to make certain objections or claims.  You should read the Notice carefully to make sure you understand all of the information contained therein.  To highlight some of these limits we have indicated them with red arrows in the sample Notice above.

Some of the important dates and limitations that appear on the Notice are as follows, in descending order as they appear on the Notice:

The date of filing:  This is the date that the debtors case was filed with the court and some of the other dates will depend on this date.

The meeting of creditors:  This is the date that the Section 341 Meeting of Creditors is first scheduled to take place.  The Creditor's Meeting is scheduled about 30 to 45 days after the bankruptcy petition is filed. At least seven days before this meeting, the debtor is required to provide to the trustee and any creditor requesting it a copy of their most recently filed tax returns and proof of income for the most recent 90-day period. The court-appointed Chapter 7 trustee will preside over this meeting. At the meeting, which the debtor is required to attend, the debtor will be asked to testify under oath as to the accuracy of the statements in the petition. Creditors have a right to attend this meeting and ask questions, though they are not required to.

Deadline to object to discharge or to challenge the dischargeability of certain debts:  
A creditor may object to the discharge of amounts owed to them by the debtor under certain circumstances. If a creditor objects to the discharge of any of the debts listed in the petition or schedules, such objection must be raised within 60 days after the first scheduled §341(a) Meeting of Creditors.  If you do not raise such an objection in a timely manner you risk waiving that right and having any such debt discharged.

Deadline to object to exemptions:  Certain property claimed by the debtor to be exempt (not reachable by creditors), may be claimed as exempt in error.  If that is the case, then that property might be used to pay creditors.  Once the §341(a) Meeting is concluded, creditors only have 30 days to object to these exemptions after which the trustee may (and likely will) release all of this exempted property back to the debtor.

Deadline for financial management course:  The debtor must take a financial management course within 60 days after the first scheduled §341(a) Meeting of Creditors, and if they don't they might not receive their discharge.

Automatic Stay: Immediately upon the filing date, an automatic stay prevents creditors from taking certain actions against the debtor.  If you violate the automatic stay you may be subject to sanctions and fines by the bankruptcy court.  You should ensure that you do not take any action against the debtor after the filing date without consulting with a bankruptcy attorney to ensure that you are not violating the automatic stay.

There may be other deadlines in cases that are different from the Chapter 7 no asset case in our example.  For example, in a case with assets there will also be a deadline for filing a Proof of Claim.    To ensure that you know all of the deadlines and meeting dates read your Notice carefully.

Once you understand what your deadlines are, the next step is to identify: What is your exposure to liability if the debtor receives their discharge?

What to do when you receive a Notice of Bankruptcy? Step 2: Are you a creditor?

If you receive a Notice of Bankruptcy you need to determine why you received the Notice. You might be a creditor, an interested party, or a codebtor.  Creditors are not the only ones who receive a bankruptcy notice, and even if you're not a creditor you may have an interest in what happens in this bankruptcy case.

The Notice will not tell you why you received it.  A sample notice, shown below, doesn't have your name anywhere on it.  It does, however, have the name of the debtor and the case number.  These two pieces of information should help you determine whether you are a creditor or some other interested party.

The Debtor, whose name is listed on our sample notice above as Sample Debtor, is the person who has asked the bankruptcy court for relief with their debts.  If you are aware of a debt that the debtor owes you then you are a creditor and you should review the other information within that Notice.  As a creditor you have certain rights that may include filing a Proof of Claim and attending the Meeting of Creditors.

If you're not sure if the debtor owes you money, then you might be a creditor or you might be something else, such as a contingent creditor, a co-debtor, or simply an interested party.  To determine why you received this Notice, you must look at the schedules.  The Bankruptcy court documents are public record and may be reviewed at the court or online if you have a Pacer access account.  If you need help accessing these files any bankruptcy attorney will have an online account access and be able to look up the case file online.

Once you have access to the file, you will want to review the Bankruptcy Petition and Schedules to figure out where your name appears.  If you are a creditor then your debt should be listed in one of the Schedules of Creditors.

If you are not a creditor you may still have an interest in the bankruptcy proceedings for some other reason.  For example a codebtor (someone who is also responsible for a debt that the debtor owes) could be left being wholly responsible for a debt if the debtor is discharged of that debt.  You might be a codebtor if you cosigned for a loan for the debtor, or if they cosigned for a loan that you took out, or if you borrowed money together for any reason (such as co-owners of a house with a mortgage).  Codebtors are listed on the Schedule of Codebtors.

If you are not a codebtor or a creditor then your name may still appear somewhere else in the schedules, identifying why you received the Notice.  For example, you may receive a Notice of Bankruptcy if you have a lease or other contract with the debtor, even if they are not behind on their payments.  Reading all of the schedules carefully should help you discover why you received the notice, whether you are a creditor, codebtor or some other interested party.

Once you identify why you received the Notice, you can begin to evaluate what type of action you should take.  For example the Notice tells creditors what many of their rights and obligations may be.  The next step, therefore, is to identify: What are the important dates and deadlines I should keep in mind?

My creditor has placed a lien on my house. Will the lien be discharged in bankruptcy?

When a debtor files for bankruptcy and receives a discharge, the Order Discharging Debtor will absolve the debtor of all dischargeable debts, and bar creditors from collecting those debts from the debtor in the future.

However, certain creditors can file a lien against property (usually real property) to ensure that their loan is paid. If your creditors have recorded liens against your property, the discharge order will not automatically discharge those liens. In certain cases, it is possible to avoid the lien (i.e., strip off the lien), but your bankruptcy attorney must file a motion to do so. Certain liens are not avoidable, such as liens given with your consent and tax liens) and will remain on the property. The most common example of an unavoidable lien is your typical mortgage.

Most people are familiar with the legal relationship between a borrower and a lender in the context of a mortgage – a bank lends money to someone wishing to purchase a home, and in exchange for the loan and the borrower’s promise to repay the debt, the lender places a lien against the property granting them certain rights, including the right to foreclose if the debtor does not honor the terms of the borrower’s obligation to repay. This arrangement protects the lender by giving them legal recourse against the collateral, so that they can recoup all or a portion of their loan if the borrower fails to pay.

A lien arising out of a mortgage is not avoidable because it is “voluntary”. Here, the borrower allowed the lender to place a lien on his or her property (or pledged some other collateral) in exchange for something of value, such as a loan. Voluntary liens are not avoidable in bankruptcy pursuant to the U.S. Bankruptcy Code. Although the borrower can never pursue the discharged debtor for any deficiency, in order to pass clear title to the property upon sale, the lien must either be paid by the new buyer or discharged (i.e., forgiven) by the lender.

In addition, liens placed against property by government institutions for taxes are not avoidable in bankruptcy.

In certain cases, however, a creditor may have obtained a lien against your property against your will. The most common is a judicial lien, in which a creditor has taken you to Court for an unpaid debt, obtained a judgment in their favor, and requested a sheriff to “execute” that judgment against your property. A copy of the judgment would be recorded in the registry of deeds in your county against your property. As before, even if the underlying debt is discharged in bankruptcy, the lien obtained by the creditor remains in place. The debt does not have to be repaid by virtue of the discharge, but the lien will continue to cloud the title to the property, making a future sale difficult or impossible if the lien is not paid at closing.

11 U.S.C. § 522(f) permits a debtor to remove liens based on a legal judgment of a nonpriority creditor – to the extent the lien encumbers the value of the debtor’s exemption(s) in the property. Put another way, if the value of the debtor’s equity in the property would be exempt even without the encumbering lien, a court, on motion of the debtor, may avoid the lien, effectively stripping it from the title history of the property.

The procedure for avoiding a judicial lien varies from state to state, and must be made by motion to the court. If any of your creditors have obtained a legal judgment against you, and recorded that judgment as a lien against your property, simply filing for bankruptcy isn’t enough. Ensure that your bankruptcy attorney is aware of the existence of the lien, and they will be able to advise you as to whether it can be avoided, and if so, file the appropriate motion with the Court.