What Happens If A Debtor Files Bankruptcy? Where Does That Put My Debt In The Line Of Creditors? What If There’s Nothing To Collect? What Do You Do If It’s A Chapter 7?
An old saying I am sure that most everyone has heard is that “you can’t squeeze blood out of a turnip.” So hopefully we have learned about the potential of a bankruptcy before we’ve spent too much time, effort and money. In some situations, the debtor might have been very solvent when we first started the collections process, but as time went on, their financial situation changed for the worse and they gave up and filed bankruptcy. The discussion below focuses on Chapter 7 or liquidation bankruptcies.
If our client is an unsecured creditor, they will be last in line when it comes time to liquidate the debtor’s assets, assuming there are any. . If, however, we are a secured creditor — e.g., if our client had a prior security interest or we were able to file/record a judgment lien — that status elevates us above unsecured creditors and gives us a much better chance of receiving at least a percentage of our claim through the bankruptcy liquidation process.
However, the vast majority of Chapter 7 bankruptcies are termed “no-asset” bankruptcies because there are simply no non-exempt assets for the bankruptcy trustee to liquidate. In this case, it does not matter if you are considered a secured or unsecured creditor; you are generally not going to receive anything.
If the debtor is a business that needs time to reorganize, they might file a Chapter 11 bankruptcy. If you are a secured creditor in that type of case, you are definitely in a more favorable position to receive a distribution especially then if you are only an unsecured creditor.
If You Are Able To Collect A Debt On Behalf Of Your Client, But The Debtor Then Files Bankruptcy, Could They Try To Claw Back On That Payment?
This could happen if the debtor files bankruptcy within 90 days of our client’s receipt of a payment from the debtor. Let’s say we conduct a bank levy and collect a significant sum. If the debtor files bankruptcy 80 days later, the bankruptcy trustee could attempt to claw back that payment since it was received within 90 days of the bankruptcy filing. Payments received during this 90-day window are considered “preference” payments under bankruptcy law. Of course, creditors have certain defenses to these claims and, as a practical matter, they are usually settled at a significant discount.
The more common situation is when a client has received preference payments without our involvement and the debtor then files for bankruptcy. In this case, our client generally receives a letter from the assigned bankruptcy trustee demanding a return of all preference payments. We handle those types of cases as well on behalf of our clients, and generally, they are settled for much less than what the trustee was originally demanding.
Is There Anything You Can Do if I Know Or Suspect The Debtor Is Disposing Of Assets While We Are Trying To Collect On What They Owe?
In California, there exists a voidable transfer law that allows the court to set aside transfers of money or property if we can show these transfers fall within certain criteria and were used primarily to frustrate our efforts to collect.
For example, if a debtor owns a piece of real property and deeds it to their uncle for no consideration, that is pretty clearly a voidable transfer if the purpose of the transfer was to make it more difficult for us to collect. Fortunately, there is almost always a paper trail in these situations.
However, the time and effort required to prevail on a voidable transfer claim can be significant, and therefore, I would not recommend pursuit of this type of claim unless the amount due is at least $100,000. If that is the case, then it might make sense to dig in and find out how someone who had assets is now insolvent.
Have You Ever Seen A Debtor Close Up Shop And Disappear? What Can Be Done In That Situation?
If we do not have a personal guaranty or evidence of alter ego liability and are dealing with a business that simply closed with no remaining assets, there is frankly not a lot we can do. We saw an increase in these situations during the COVID pandemic as small companies, especially those in the hospitality or restaurant industry, could not sustain the lengthy closures forced upon them and had to close their doors. . Unfortunately, business closures are a reality of the collections process but hopefully our client pursued its claims in a timely manner and collected what is owed before the business closed.