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Bankruptcy Filing by a Creditor

Worried that you are missing several payment deadlines, and your creditor might be closing on your assets? Learn from our basic guide what will likely happen in the situation you are in.

Also learn what you and your creditors can do to avert a bankruptcy and make the most of the situation.

Creditors may file a petition to declare a debtor bankrupt so that they could collect on debts owed to them. This may be the best option for a creditor to recoup payment if he is owed a substantial amount and the debt is secured. But for creditors, in general, this is not the ultimate solution.

Payment Distribution to Creditors

All creditors are not the same; some have acquired higher priority over others by securing collateral for the debts or getting lien on some properties through court judgments. When assets of the debtor are sold during a bankruptcy, the proceeds are distributed in a way that the higher priority creditors – the secured ones -- get paid first. Unsecured creditors are paid next, with the unsecured priority ones first then the general unsecured.

During bankruptcy, unexempt assets of the debtor will be sold and the proceeds distributed to creditors. Unexempt properties under Chapter 7 include a second vehicle or a second home. Well and good if the debtor has substantial assets because everyone gets paid. But if there is not enough, those further down the list of creditors risk not getting anything. And so, while creditors could actually drive a debtor into bankruptcy, they are not so much enthusiastic about it either.

Creditors’ Role in Averting Bankruptcy

For a heavily-indebted company that shows sign it might yet be rehabilitated, creditors could be better off helping the business get back to its feet. For example, unpaid suppliers (that become creditors because of their collectibles) will benefit more from continued business with the debtor than from just having to recoup payment for several unpaid deliveries. Creditors could help a lot in making sure the business does not close or file for bankruptcy. They could agree to waive some late charges for overdue loans, agree to defer interest or principal payment due dates, or make debt payment easier for the debtor by lowering the minimum amount a debtor would have to pay to service a debt.

Of course, the law also protects businesses from malicious actions of creditors, particularly those who are seeking better treatment over other creditors. Creditors attempting to put a debtor under bankruptcy must prove to the court that the circumstances surrounding the debtor justify the filing and that the filing was not made in bad faith. If it is proven that a creditor was acting maliciously he could face financial penalties, and possibly, punitive damages.

How to Counter a Bankruptcy Filing by Creditors

If you are faced with an involuntary bankruptcy filing, immediately contact a bankruptcy lawyer. To defend the soundness of your finances, gather supporting documents that will show this. Come up with verifiable record stating your debt, your income, expenses, and past debt payments. You must show that you are able to keep up with payment dues, and that you have enough assets that you can access to meet with payment obligations as they come due. Or, if you are indeed having difficulty, you can show that your finances are getting better or that your debt is in such amount that a bankruptcy is not really needed. You can also try to invalidate the bankruptcy filing by showing it was not made in good faith. If you fail to do all these, consult with a lawyer what you can do so that the court will allow, at least, just the refinancing of the debt, and not foreclosure on assets.

For bankruptcy-related information, including a link to a lawyer directory, visit www.nolo.com.

<< Creditors’ and Debtors’ Guide to Avoiding Bankruptcy
What Types of Bankruptcies are There >>

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