Bankers confront the bankruptcy world regularly. It can be a world of somewhat unfamiliar, if not confusing, concepts and terms. Unfortunately, it can also be a world fraught with risk associated with taking actions (or not taking actions) that run afoul of the rules or jeopardize the bank’s rights against the borrower. Here are a few of the “truths” that bankers need to keep in mind in the bankruptcy world.
1. The automatic stay is, well, automatic.
The automatic stay goes into effect automatically (no order is issued!) from the moment that the petition is filed, even at 3:07 a.m. on a Sunday morning. Any collection action that is taken after the filing of the case is technically a violation of the automatic stay, even though the bank is without actual notice of the filing of the case.
2. The automatic stay is broad and probably covers whatever the bank has already done or wants to do soon.
The automatic stay is the great equalizer: it gives the debtor relief and breathing room (at least temporarily), and it levels the playing field among the creditors by stopping the first-come-first-served, “winner takes all” collection scheme of state law. Therefore, the automatic stay is intentionally broad and applies to all actions to collect debts, perfect liens, attach property, repossess property, setoff accounts, etc.
3. Know whether, when and where a proof of claim has to be filed, and file it on time and in the right place.
Read the initial bankruptcy notice that comes a few days after the case is filed. It contains important information about the filing and the deadlines for taking certain actions or filing proofs of claim in the case, including whether the case is a “no asset” case that does not require the filing of a proof of claim.
4. Receiving a preference payment from a future bankruptcy debtor is not illegal (or immoral). Always take the money; worry about the preference claim later.
Even if you know that the debtor intends to file a bankruptcy case soon, you should take a payment that the borrower wants to make. In addition to there being some exceptions and defenses to a claim by a trustee to recover a preference, even slam dunk preference claims are seldom settled for full value.
5. Bankruptcy cases are all about compromise and very seldom about litigation.
Because most bankruptcy issues have predictable results, matters can often be settled, saving money for the bank on attorneys’ fees and taking uncertainty as to the results out of the picture. Of course, sometimes there is too much money involved or a precedent to avoid or establish and litigation of the case will be necessary.
6. A discharge ends the debtor’s personal liability, but the bank’s lien is forever (except when it’s not).
Even though the bank cannot take any action against the debtor to collect the discharged debt as the personal liability of the debtor, secured creditors holding collateral retain their liens. The debtor who wants to keep the collateral must keep paying for it, either through a reaffirmation of a car loan or continued payments on the home mortgage.
7. If you think that your loan to the debtor was induced through the debtor’s fraud or false financial statement, there is a limited amount of time to object to the dischargeability of the debt.
Section 523 of the Bankruptcy Code provides a long list of debts that are not dischargeable, but the dischargeability of certain debts in several important categories is not self-effecting. For these debts (including debts based on fraud or false financial statements), the creditor must file an adversary proceeding (litigation within the bankruptcy case) and ask the court to find that the debt is nondischargeable. The deadline for doing so is listed in the initial notice of the case.
8. The bank’s contract terms can usually be modified in a chapter 11 or 13 case, unless the only lien is on the debtor’s house.
In cases under chapters 11 and 13, the debtor can often modify the terms of the loan with the bank: to adjust the interest rate, the term, the payment amount and/or the principal amount. However, in chapter 13 cases and individual chapter 11 cases, the terms of a home mortgage loan cannot be modified without the consent of the bank.
9. Focus quickly on the issues of the reaffirmation of secured debt.
A reaffirmation agreement must be signed by the debtor and the bank and filed with the court within 60 days after the first date set for the creditors’ meeting. A reaffirmation agreement signed or filed with the court after the debtor receives her discharge is unenforceable. The agreement must be on the approved form and must include copies of the note and security documents showing the lien on the collateral.
10. Think twice before participating in an involuntary bankruptcy case.
A petitioning creditor that is on a vendetta against the debtor can drag other petitioning creditors down with it, if the motive for the filing is not related to a legitimate bankruptcy purpose. While there are appropriate times to force a debtor into bankruptcy, there are sanctions and possible damages for participating in an involuntary bankruptcy in which the debtor successfully has the petition dismissed.
11. (BONUS) Legal fees spent early are more productive than legal fees spent late.