Bankruptcy Basics
By Colin T. Darke and Latanishia D. Watters
Colin T. Darke is an assistant editor of The Young Lawyer and an associate with Mirick O’Connell in Worcester, Massachusetts. He can be reached at Latanishia Watters is an assistant editor of The Young Lawyer and an attorney with Haskell Slaughter Young & Rediker, LLC,in Birmingham, Alabama. She can be reached at
For many attorneys, bankruptcy law is unfamiliar and difficult to understand. For example, Charlie Creditor and Danny Debtor negotiate a resolution regarding a debt Danny owes Charlie. Danny pays down the entire outstanding account in one lump-sum payment but still has trouble paying his other creditors and is forced to file for bankruptcy protection under Chapter 7 of the Bankruptcy Code. The Chapter 7 trustee (who administers Danny’s new bankruptcy estate) sues Charlie Creditor to recover the lump-sum payment for the bankruptcy estate, claiming it was a preferential transfer—and the trustee is probably right.
Policy issues aside, bankruptcy concerns run throughout many areas of law and may be at play without your even realizing it. This article is a brief overview of some common bankruptcy concepts.
Preference Actions: “Fair” share. The example above illustrates a preference action that is part of a Chapter 7 trustee’s arsenal in bringing money back into a debtor’s bankruptcy estate. The trustee has a duty and obligation to bring certain pre-petition transfers (or the value thereof) back into the bankruptcy estate so that the money may be redistributed among the debtor’s creditors on a pro rata basis.
Specifically, the trustee may sue a creditor who received payment of an antecedent debt within 90 days prior to the debtor’s filing for bankruptcy protection (or within one year if the payment was to an insider). Creditors, however, have certain defenses to a preference avoidance action: The Bankruptcy Code protects transfers made in the ordinary course of business. For example, when two parties have a long-standing business relationship whereby the debtor pays the creditor $50 on the 15th of every month, those payments may not be avoidable. The Bankruptcy Code also protects transfers to the degree that the creditor provided the debtor with new value (i.e., goods or services) after the transfer.
Automatic Stay: Stop everything. The Bankruptcy Code imposes, with few exceptions, an immediate stay against all entities from any actions against the debtor or the debtor’s property (there are no notice requirements for the stay to be effective). A creditor who fails to stop certain collection efforts would violate federal law. For example, a creditor would violate the automatic stay if she sought to enforce a judgment or perfect a security interest (with some exceptions) against the debtor. Certain exceptions to the automatic stay, such as the continuation of certain criminal proceedings or the collection of alimony, do exist. When in doubt, however, the party is better off asking for permission to continue collection efforts because a violation of the automatic stay may result in stiff penalties such as punitive damages—along with the action’s being voided from inception.
Prebankruptcy Planning: All is not lost. Prebankruptcy planning is done prior to filing bankruptcy to protect assets. It allows a debtor to take maximum advantage of exemptions by converting nonexempt assets into exempt assets. Exempt assets are those a debtor can keep out of the hands of a creditor. Typical examples include a homestead exemption for the debtor’s principal residence, retirement plans, annuities, and insurance policies. There are both federal and state exemptions. One possible pitfall to consider is the debtor’s conversion of nonexempt property within one year of filing bankruptcy with the intent to “hinder, delay or defraud” a creditor. The risk is that the conversion may result in a denial of the claim of exemption or (more extreme) a denial of discharge.
Proof of Claim: Know your rights. Charlie can file a proof of claim listing all debts owed to him by Danny, including any amounts the trustee may have recovered from Charlie in the preference avoidance action. A proof of claim is a written statement setting forth a creditor’s claim—it is what the trustee uses to distribute any monies he has recovered for the benefit of the estate. If the claim is based on a writing, the writing must be filed with the proof of claim. If the claim is secured, it must be accompanied by evidence that the security interest has been perfected. Creditors have a certain amount of time—typically set by the court soon after the date of the creditors’ first meeting—within which to file claims, so awareness of this deadline is crucial.
• Attorney Liability in Bankruptcy. 2006. PC # 5150415. ABA General Practice, Solo and Small Firm Division.
• Portable Bankruptcy Code and Rules, 2007 ed. PC # 5070549. ABA Section of Business Law.