In the last two weeks I’ve written about how bankruptcy "works" - the nuts and bolts of bankruptcy law so that the policy goals of bankruptcy law can be met. The two main underpinnings of bankruptcy are to treat creditors fairly and to allow debtors to live with dignity. My first blog dealt with the contents of the bankruptcy petition, schedules and statements - documents that must be filed in every bankruptcy case - and how the information contained in these documents further the policy goals of bankruptcy.
Last week I took a detailed look as to how the unique features of chapter 13 promote fair treatment of creditors and allowing debtors to live with dignity. This week I’ll write about how bankruptcy law and procedure furthers these policy goals.
The Automatic Stay is a Good Friend of the Debtor, and isn’t Bad for Most Creditors
One of the most unique features of bankruptcy law, when compared to other legal procedures is the automatic stay. The automatic stay, encoded in section 362 of the Bankruptcy Code, refers to the injunction issued by the Bankruptcy Court upon the filing of a bankruptcy case. The automatic stay is very broad, and it requires almost every creditor (the notable exception is a child support or alimony creditor) to stop taking any action against a bankruptcy debtor to collect a debt. As the name implies, the stay goes into effect “automatically” - the bankruptcy debtor need do nothing more than simply file a bankruptcy case.
In other legal processes - whether it involves civil litigation, criminal prosecution, personal injury litigation or family law cases - the filing of papers with the court does nothing more than initiate the proceedings. Without more, all that happens is that the court in these cases starts the process to its conclusion - sometimes months or even years later.
Bankruptcy is different. Upon the filing of a bankruptcy case, all creditors of a debtor have to stand down and discontinue whatever action the creditor has been taking to collect on any debt. The automatic stay applies to all creditors - whether the creditor has a secured, priority or unsecured claim against the debtor. The automatic stay applies to debt that the debtor may fully intend to continue paying - such as a car loan or a home mortgage. The automatic stay applies to debts that are not subject to discharge, such as some taxes and student loans.
It’s a powerful tool, and for the debtor who has been subject to the type of intense contacts that are too-typical for some collectors, or for debtors that are having wages garnished or bank accounts levied, the bankruptcy filing allows them to relax, take a deep breath, and get on with concentrating on providing for themselves and their families without the stress of collection.
When collection activities are terminated by the bankruptcy automatic stay, a bankruptcy debtor’s life improves. The automatic stay is one of the most powerful tools to further the legislative goal of allowing debtors to live with dignity.
The automatic stay also works to further the policy goal of treating creditors fairly. The requirement that all collection activities stop upon the filing of the bankruptcy case allows all creditors to start in the same position when the debtor’s bankruptcy estate is administered. It is not uncommon that a bankruptcy debtor has made agreements with some, but not all of his creditors during the months leading up to a case being filed. These agreements can be a product of the most aggressive creditor receiving the most money and creditors that are less inclined to be aggressive in collection, or creditors that have created a credit account for a debtor later, rather than sooner in the months leading up to the bankruptcy case are not receiving a proportional payment from the debtor. And some creditors, such as home mortgage lenders, have to follow strict and time-sensitive procedures before that creditor can collect on a debt, compared with the relatively quick ways an unsecured creditor can act to collect on a debt.
So the automatic stay calls a time-out for both debtors and creditors, allowing both sides of the debt equation to regroup and deal with the debt in a way contemplated by bankruptcy law. The automatic stay is good for both debtors and creditors.
The Notice Requirement
The Bankruptcy Code is clear: all of a bankruptcy debtor’s creditors have to be notified of the debtor’s bankruptcy case. This seems obvious to people who are not dealing with overwhelming debt, but there’s some concern that almost every person considering filing bankruptcy has about his debt. Almost every debtor has some debts that they are enthusiastic about discharging - the unsecured credit card or online line of credit - that anonymous high-interest creditor that is now aggressively pursuing collection. And there are some debts that debtors are hesitant to “include” in a bankruptcy. These types of debts are often secured debts where the collateral is property that the debtor wants to retain - whether that be the home the debtor lives in or the car the debtor drives. But it can also include the boat, or the fish house, or the four-wheeler that the debtor worked hard to try to afford and now is reluctant to part with. The debtor might also be distressed at the prospect of having a loan with a creditor the debtor knows - like the loan officer at the local bank - included in a bankruptcy case.
But the fact of the matter is that debtors have to include every one of their creditors - including the creditors the debtors would prefer not be included. Notifying all creditors is absolutely essential to furthering the policy of treating creditors fairly. Congress makes the decision as to the treatment of certain classes of creditors - whether they be secured, unsecured or priority. Congress has made it clear that debtors don’t have the discretion to pick and choose what creditors are “affected” by bankruptcy.
The notice requirement helps debtors, too. Some debtors are confident that they can afford to pay some creditors, and they might be. But the truth is that none of us know what our financial future is. The Bankruptcy Code provides the creditors that are not notified of a bankruptcy case in a timely manner can have their debts determined to be non-dischargeable if there are assets to liquidate and creditors’ claims to pay. The bankruptcy debtor who fails to disclose all of his debts so to allow notice to all of the debtor’s creditors is gambling with potentially very high stakes.
But what about a creditor that a debtor simply forgets? In most bankruptcy cases, it’s not a big thing - the creditor can be added at any time and the protection given to the debtor in the bankruptcy will cover the late-added account. But late notice doesn’t do much good in chapter 7 cases in which creditors are going to receive a payment or chapter 13 cases - in those cases the “forgotten creditor” does not have its debt discharged.
That’s enough for this week. Next week I’ll continue writing about bankruptcy nuts and bolts - how bankruptcy “works.”
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