When a business or individual debtor files for bankruptcy, typically they will stop making payments on most outstanding debts and will discharge whatever balances they can. Their unsecured creditors have minimal influence over bankruptcy proceedings, although they do have some protections under the law.
Creditors do have a right to repayment during bankruptcy whenever possible, and they can challenge questionable moves by the filing party. One of the ways for creditors to protect themselves from abuses of the bankruptcy process is through adversary proceedings.
Creditors can file a hearing request with the courts. Doing so is much like litigating in civil court. The courts will interpret the claims made by the creditor and potentially enter rulings that could affect the bankruptcy proceedings. These are the primary scenarios wherein creditors might choose to initiate adversary proceedings related to a bankruptcy filing.
1. When they want to lift the automatic stay
If a creditor has the right to repossess certain property repossess or foreclose on certain property, bankruptcy might prevent them from doing so. In certain scenarios, the courts might agree to lift the automatic stay so that creditors can recover certain property or even move forward with a lawsuit.
When the creditor does not wish to wait for the courts to resolve the bankruptcy proceedings before resuming collection activity or other legal actions against the person filing the filing party, an adversary proceeding could grant them the right to continue debt collection efforts or repossession.
2. When they want to exclude a debt from being discharged
Many unsecured debts are eligible for discharge in bankruptcy proceedings, but there are cases in which creditors can exclude certain accounts or a portion of a debt from the discharge order. Such efforts may allow creditors to at least partially recoup what they would otherwise have had to write off as a total loss following the bankruptcy.
Especially in cases wherein fraudulent behavior, such as taking out additional debt shortly before filing for bankruptcy, the courts may agree that the inclusion of certain debts in the discharge order would be unfair.
Although bankruptcy largely benefits the filing party, there are still ways for affected creditors to protect themselves and possibly secure partial repayment. Learning more about creditors’ rights and adversary proceedings can help those impacted by a recent bankruptcy filing.