Bankruptcy Law and Creditors

Over a million people file for bankruptcy each year. Bankruptcy law helps them liquidate assets to pay creditors and work out arrangements to repay debts.


Chapter 7 allows a trustee to take control of debtor assets and sell them. The law allows some debtor assets to be protected, such as Social Security payments, unemployment compensation, household furniture and appliances and tools of the trade.


The bankruptcy process offers indebted individuals and businesses a fresh start. Bankruptcy law protects the rights of debtors while also ensuring that creditors receive their claims in full.

Generally, the court will only allow a debtor to keep certain assets if they are essential for his survival. These include household furniture and appliances, tools of the trade and vehicles up to a set value. Anything above this limit can be sold to pay the debtor’s creditors.

A debtor may choose to “reaffirm” a debt, which means that they promise to repay a portion or all of the debt that would otherwise be discharged in their bankruptcy case. Creditors may object to a debtor’s reaffirmation of a debt if they think it is not in their best interests.

In most chapter 7 cases, individual debtors will receive a discharge of all dischargeable debt within a few months after filing their petition. However, a few types of debt are not eligible for discharge under this chapter, including student loan and alimony debts. In addition, some debtors may not qualify for a chapter 7 discharge because of the income test enacted in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.


Creditors have certain rights when a debtor files for bankruptcy. For example, they are entitled to a share in the distribution of assets that is part of the debtor’s estate. They are also allowed to challenge a debtor’s right to discharge a particular debt. However, it is critical for a creditor to work with an experienced attorney to ensure their rights are protected in a bankruptcy proceeding.

Creditors must file an official Proof of Claim to prove their validity as a claimant. They must also provide supportive documentation for their claims. Failure to do so could result in the court not awarding them any distribution.

The Proof of Claim must be submitted by the “Bar Date,” which is a court-set deadline for the submission of claims. Proofs of Claim that are submitted after this date will not be taken into consideration.

A Creditor can question the debtor under oath about his assets, liabilities and financial history at a creditor meeting or separately scheduled examinations under Rule 2004 of the Bankruptcy Rules. However, a creditor must be mindful that the automatic stay (injunction against collection) is in effect until the bankruptcy case is over.


The bankruptcy code requires full disclosure of all assets. This includes a section asking whether any payments have been made to insiders. If the answer is yes, the trustee will want to find out who they are and why the payment was made.

Generally speaking, a creditor who receives a preferential payment from an insider can expect to lose some or all of the payment in bankruptcy. That’s because the law states that all creditors are supposed to be treated equally. Depending on the circumstances, this could mean that the insider must return the preference payment to the bankruptcy trustee so it can be distributed to all creditors.

However, there are many situations where it is difficult to determine if a person or entity is an insider. For example, a debtor may own a business that leases equipment or property from another company. The bankruptcy court must decide whether that relationship constitutes a “close association” or a transaction that is not conducted at arm’s length. The Supreme Court has yet to provide a clear guideline for how these relationships should be analyzed.


A company in financial trouble but not bankrupt can attempt to revive its business through a court-supervised reorganization. If the reorganization fails, it will be forced into liquidation. A successful reorganization typically involves drastic steps to reduce costs and increase revenue, as well as a plan for paying off debts.

The order confirming the plan discharges a corporation, partnership, or individual debtor from all of its prepetition obligations except for those secured by a lien on assets and certain obligations that are made nondischargeable by law – such as wages and employee benefits; consumer deposits; taxes; and some employee benefit plans. The plan must also be confirmed by the court as being “feasible.”

A company reorganization may be voluntary or mandatory, depending on the circumstances. In the case of a voluntary reorganization, it often includes staff and management changes to boost profits. It can also change the company’s business tax structure or update its marketing strategies and offerings. Reorganization can also include a company name change, letting go of obsolete products or services and reducing its number of locations.


Among the principal benefits of bankruptcy for debtors is the discharge of certain types of debt. The discharge prohibits creditors from seeking legal action or collecting any amount of the unsecured debt that was adjudicated in the bankruptcy case.

A Chapter 7 discharge eliminates most or all debts for an individual consumer debtor in a short time. The bankruptcy trustee liquidates the debtor’s nonexempt property, distributing proceeds to unsecured creditors. Debtors may retain exempt assets such as household furnishings and appliances, tools of the trade and vehicles up to a value established by law.

Creditors who wish to collect a debt after a bankruptcy discharge must obtain a court order to do so. Generally, the creditor must prove that the debt was not discharged by showing one of the reasons listed in section 727(a) of the Bankruptcy Code: failure to file required tax returns; concealment or destruction of records relating to financial condition; fraud or intentional misrepresentation; and other misconduct.

Some debts survive a bankruptcy discharge, including most student loans, child support obligations and some taxes. The bankruptcy discharge also does not eliminate the liability of co-signers on a debt.