What are Creditor’s Rights?

Collections are an important part of business. When bills are not paid, creditors have a variety of rights available to them to help ensure that they are able to recover the amounts owed to them. The attorneys at Marshack Hays are experienced in helping their clients maximize their recovery.

What rights do creditors have?

Often a creditor’s collection efforts lead to litigation, and lawsuits are rarely resolved quickly. During the pendency of litigation, a debtor’s ability to pay an obligation can change dramatically. Creditors have provisional remedies available to them during the pendency of litigation to help ensure that they will be able to collect the amounts owed once litigation is concluded. The provisional remedies available depend on the nature of the underlying obligation.

Secured Creditors

Generally, secured creditors have an advantage over unsecured creditors; they have collateral that can be used to satisfy their obligation. Before a secured creditor can recover its collateral, it must file a lawsuit and obtain a judgment. Therefore, a secured creditor’s provisional remedies focus on ensuring that the value of the collateral is protected during the pendency of litigation.

The most common provisional remedies available to secured creditors include the appointment of a receiver and a preliminary injunction.

  • Receiver. Secured lenders can seek the appointment of a receiver, which is a court-appointed professional that takes control of the secured creditor’s collateral and protects it. Commonly, this provisional remedy is employed when the lender’s collateral is a parcel of income-generating property and the borrower is engaged in mismanagement. Once appointed, the receiver reports to the court, not the secured creditor
  • Injunction. A secured creditor can obtain an injunction prohibiting the dissipation or destruction of its collateral pending turnover. Although injunction are difficult to obtain, they are often sought in connection with the appointment of a receiver.

Unsecured Creditors

In litigation, an unsecured creditor’s recovery is more speculative. Unsecured creditors often use a writ of attachment to obtain a lien against certain of the debtor’s assets, which improves the creditor’s ability to recover when litigation concludes.

  • Writ of Attachment. When a debt is contractually based, the creditor can obtain a court order imposing a lien on certain assets of the debtor. Once the lawsuit concludes and a judgment is obtained, the lien provides collateral that can utilized to satisfy the obligation.
  • Injunction. In certain situations, a creditor can obtain an injunction prohibiting a debtor from dissipating assets while the creditor takes the necessary steps to obtain a lien against certain assets (writ of attachment).

A creditor’s rights in bankruptcy

When creditors seek provisional remedies (such as a writ of attachment), debtors occasionally respond by filing a bankruptcy petition. Typically, these petitions result in the debtor receiving a discharge (meaning, in general terms, that debts that arose before the bankruptcy was filed cannot be pursued by creditors), and creditors receiving a de minimis amount in satisfaction of the obligations owed.

Although the Bankruptcy Code gives the debtor certain advantages, it also provides creditors with potent protections to balance the scales. These protections include the following:

  • Motion to Dismiss. Creditors can seek to have a bankruptcy case dismissed. The legal framework governing such a request depends on the chapter under which the bankruptcy petition was filed, but can take into account the bad faith of the debtor.
  • Discharge litigation (§523). Typically, a debtor is able to discharge debts through the bankruptcy process. There are, however, circumstances under which a debt cannot be discharged. For example, a debt resulting from fraud cannot be discharged as long as the creditor takes steps to have the bankruptcy court declare the debt to be non-dischargeable.
  • Discharge prevention/revocation (§727). Under certain circumstances, a creditor can either prevent the debtor from obtaining a discharge of debt or have the discharge revoked. Some of the most common actions that result in a debtor’s loss of discharge involve failing to disclose (or hiding) assets and failing to keep (or destroying) records that adequately explain the debtor’s financial condition.
  • Rule 2004 Exam. When a bankruptcy is filed, the debtor is required to provide the trustee and creditors with a complete picture of the debtor’s financial condition. Some information is provided in the debtor’s schedules of assets and liabilities. A creditor can obtain additional information or probe the validity of the information provided by utilizing the discovery tools provided in Rule 2004 of Federal Rule of Bankruptcy Procedure. Although there are some limits to Rule 2004 exams, courts generally consider such exams to be sanctioned “fishing expeditions.”
  • Proof of Claim/Objection to Claim. Creditors are entitled to file a proof of claim against the debtor, explaining the amount and basis for the debt owed. When a proof of claim is properly filed, the underlying debt is presumed to be valid. A proof of claim can be disputed if the challenger presents evidence regarding the validity of the debt. When a proof of claim is challenged, the ultimate burden of persuading the court that a debt is valid is on the claimant.
  • Objections to plan. When a debtor is using a plan to reorganize, creditors can object to plan and argue that certain aspects should be changed. Some of the most common objections relate to the plan’s feasibility (the debtor’s ability to make the proposed payments), the amount offered to creditors (whether the debtor is using its “best efforts”), and whether the debtor is unfairly attempting to retain valuable assets without paying creditors in full (the absolute priority rule).
  • Cash collateral disputes. After a bankruptcy case is filed, a debtor cannot use cash or cash equivalents that are subject to a lien without a court order authorizing the use. To obtain such an order, the debtor must “adequately protect” the creditor against the risk that the value of the collateral will be diminished by the use.
  • Lien-priority disputes. When a debtor offers the same property to multiple creditors as collateral, disputes can arise with respect to the priority of the creditor’s liens. The senior position is the most valuable.
  • Lien-stripping disputes. Under certain circumstances, a debtor can force a creditor to remove a lien from the debtor’s property if the property is over-encumbered (the value of the property is less than the value of the creditor’s lien plus senior liens). If a creditor can show that the property is not “under water,” then the lien cannot be stripped away.

The attorneys at Marshack Hays are well-versed in protecting creditors and their rights both before and after a bankruptcy case is filed.