Bankruptcy Litigation

Bankruptcy provides a means for individuals and businesses to regain their financial footing by discharging their debts. Bankruptcy cases are handled by the federal courts; each federal district contains a bankruptcy unit that hears only these cases. Bankruptcy litigation involves the hearing of the bankruptcy petition as well as actions by creditors who are contesting bankruptcy petitions or attempting to reach debtor funds.

Parties contesting bankruptcy may raise their arguments through adversary proceedings. Most actions to recover money or property, to determine the validity or priority of a property interest, to object to the discharge of a debt in bankruptcy or to address other fundamental debt issues fall into this category. Adversary proceedings follow most of the same rules of procedure applicable in federal trial courts, but some rules are modified to fit the bankruptcy model.

Creditors can bring preference actions to establish their rights to the bankruptcy debtor's assets. Although generally creditor rights are fixed at the time of the bankruptcy petition, the fair distribution principle allows creditors to remedy situations that disadvantage their interests in the bankruptcy proceeding.

Example: If Greg files for bankruptcy immediately after paying off a large unsecured loan to his best friend, other creditors holding older debts may object to this transaction because it decreases the amount available to satisfy their interests. The bankruptcy court may allow the bankruptcy trustee to avoid (undo) Greg's transaction to preserve the other creditors' rights.

Either a bankruptcy trustee or a creditor can object to the discharge of debts in bankruptcy. A discharge releases the debtor from all qualifying debts that he or she incurred prior to filing for bankruptcy. The objecting party has the burden of proof to show that the debtor should not receive a discharge. The debtor may not discharge debts if he or she intentionally transferred, removed, destroyed, mutilated or concealed property in order to delay, obstruct or defraud creditors or the bankruptcy trustee.

Example: If Stacey gives her brother her new Ferrari for "safekeeping," knowing that she will declare bankruptcy later that year, her creditors may object to the discharge of their debts that would be satisfied by the sale of the car.

Creditors may also object to dischargeability. Some debts, such as alimony obligations and student loans, cannot be discharged in bankruptcy proceedings. A successful objection will prevent the discharge of the debt and enable the creditor to press for payment.

A bankruptcy proceeding imposes an automatic stay on judicial or administrative proceedings, collections and property actions against the debtor. A creditor or other party must receive relief from the automatic stay in order to continue with these procedures. If the creditor does not seek relief from the stay by filing a motion with the bankruptcy court, it may be found guilty of contempt. Therefore, it is important to commence proceedings for relief quickly in order to maintain other actions.

The bankrupt debtor, creditors and trustees all play a role in these procedures. If not executed properly, these actions can form the basis for further litigation and liabilities. This type of litigation has become more common as bankruptcy becomes a more acceptable financial decision for individuals and businesses. Bankruptcy's rules are extremely complex and require legal expertise. Whether a party is a debtor or creditor, an attorney versed in bankruptcy law is a must for these actions.

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