Judgement Enforcement in Bankruptcy

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October 02, 2018
Author: Brett Kepley
Organization: Rawles, O’Byrne, Stanko, Kepley & Jefferson, P.C.

A. Types of Bankruptcies and Automatic Stay Effect
Bankruptcy is a species of federal law dealing with debt arising from either state, federal, or foreign law which allows debtors (the parties who owe a debt to creditors) to either discharge their debt (permanently wipe out pre-bankruptcy obligations) or to restructure those debts, typically with a payment plan.1

There are four principle types of bankruptcies to be used by non-governmental debtors, Chapter 7, Chapter 11, Chapter 12, and Chapter 13. Individuals and most corporations can file for bankruptcy relief under Chapters 7, 11, and 12. Only individuals with income may file a Chapter 13. By whatever chapter a debtor initiates, the bankruptcy code imposes what is called an “automatic stay” upon collection activities by creditors.2 The filing of the bankruptcy, from the moment it is filed, operates to put a halt to any creditor activity until the stay is removed, either by statute, or by order of a bankruptcy court overseeing the case. Those activities which are stayed include the commencement or continuation of any judicial, administrative, or other action or proceeding against the debtor, which was or could have been commenced before the bankruptcy case to recover a claim against the debtor that arose before the commencement of the case; or enforcement against property in which the debtor has an interest, including any act to exercise control over property of the debtors; an act to create, perfect, or enforce any lien against property of the debtors; and any act to collect or recover a claim against the debtors that arose prior to the filing of the bankruptcy.3

There are exceptions to the application of the stay listed under the bankruptcy code and the most prominent among those is lawsuits involving domestic support obligations, establishing or modifying domestic support obligations, orders concerning child custody, the establishment of paternity, dissolution of marriage, and orders regarding domestic violence. Another notable exception where the stay is not in effect is where a landlord of non-residential real estate is seeking to evict a person whose tenancy was terminated under the lease terms, or in which an order of eviction was granted in a case prior to the filing of the bankruptcy.4 So, if a landlord obtained a judgment to evict, the stay does not apply and the landlord can evict.

As a practical matter, what all of the above gibberish is saying is that under the automatic stay of the code no creditor can take any action to collect. This includes writing letters or contacting the debtor by telephone, e-mail, or otherwise, to demand payment. It bars the filing of a lawsuit or any action in furtherance of a lawsuit. Generally, any legal or administrative action undertaken after the filing of the bankruptcy without permission of the bankruptcy court is null and void (which is to say it has no effect under the law).

If the debt in question is or may likely be covered by the automatic stay, the creditor cannot take any action to collect the debt until, or unless, the stay is ended by terms of the bankruptcy code, or a bankruptcy court issues an order to a creditor modifying the stay so that the creditor can take the particular action asked for by the creditor.

A lack of adequate protection for the creditor is a common basis for a creditor to seek modification to the automatic stay where a creditor has a lien or other interest in the property owned by the debtor. The creditor feels that the property is in jeopardy, such as not having insurance which covers the property, or the property is declining in value, or the equity cushion of the property is declining because of the interest rate accruing on a debt, which may cause the property to lose its equity. In such scenarios the creditor can also assert it/he/she is not adequately protected in those lien rights if no payments are being received from the debtor during the pendency of the bankruptcy. The creditor thus demands that the stay be lifted in order for the creditor to proceed with foreclosure or other seizure of the liened property.

In chapter 11s and 12s the creditor may negotiate an interim payment agreement with the debtor in exchange for the creditor withdrawing its request seeking modification of the stay so as to foreclose on the property. Such interim payment agreement, called “adequate protection payments”, would then need to be approved by the bankruptcy court. Once it is approved, the debtor is obligated to make those payments during the life of the adequate protection agreement, failure of which could result in the creditor going back to the court asking for modification of the stay so as to foreclose on the liened property.

Another situation for asking for relief of stay is where the debtor may not have any equity in the property at the time the relief of stay is asked of the court, and the property is not necessary to an effective reorganization of the debtor. This often occurs in Chapter 7’s where residential mortgagees seek a relief of stay if the debtors are in default under the mortgage and if the debtors have no equity in the property and the property is not useful for any reorganization.5 In these instances the creditor must make the effort to file a request with the bankruptcy court seeking a relief of stay asserting there is no equity in the property, which then shifts the burden onto the debtor to show that the property is needed for an effective reorganization (i.e. in Chapter 11, 12, or 13 cases). In cases of homestead residential properties, the equity is considered the value of the debtor’s property minus the homestead exemption of the debtor and the mortgage.

If there is equity in the property, the case trustee (the person in charge of overseeing the bankruptcy) may object to allowing the property to be foreclosed upon by the lien holder because the property has worth to the unsecured creditors were it to be liquidated by the trustee and the lien holder is paid in full together with any exemptions the debtor is entitled to With respect to personal property owned by the debtor which has a lien on it, or the debtor is leasing at the time of filing the case, the automatic stay will automatically terminate where the debtor is an individual and fails to timely file a statement of intention in his bankruptcy petition.

A statement of intention is where the debtor must state that the debtor intends to either i) surrender such personal property or retain it, and ii) if retaining it, whether debtor intends to redeem such property or iii) intends to enter into a reaffirmation agreement which allows the debt to survive a discharge in bankruptcy (or assume such unexpired lease). This means that if the debtor does not so timely file his statement of intentions the stay will be automatically terminated.6 The deadline to file a statement of intentions is within 30 days after filing the initial bankruptcy petition under a Chapter 7, or on or before the date of the meeting of creditors, whichever is earlier, or within such additional time as may be fixed by the court, or in any other bankruptcy chapter, within 30 days after the first date set for the meeting of creditors.7 Such law is really designed for automobile lenders whose debtors might be in default, and the debtor does not state their intention on whether they want to reaffirm or redeem the debt. Then, the creditor waits until the time frame for the filing of statement of intentions passes. There are exceptions to this rule in the event that there is equity in the property, which a Chapter 7 Trustee, for example, may seize upon. As a general practice, creditors should file motions seeking a relief of stay if the issue is ever in the slightest doubt as to whether the automatic stay is in effect on a particular property.

The automatic stay also ends in Chapter 7 cases when a discharge has been granted to the debtor. A chapter 7 creditor must remember that if their debt has been entirely discharged, then it doesn’t matter whether the temporary automatic stay is in effect or not, the debt is vanquished and the creditor can take no further action to enforce it as they are permanently prohibited from seeking enforcement (except where the creditor has a lien on debtor’s property). However, there may be situations where a particular debt is not discharged in a Chapter 7 (for example, a student loan) whereupon the granting of the order of discharge by the bankruptcy court, which officially extinguishes the automatic stay, can allow the creditor to thereafter proceed to take collection action.

Likewise, in Chapter 11 cases the stay will terminate upon the confirmation of a plan, except where the plan itself vests ownership of the property, not in the debtor, but in the bankruptcy case itself. This typically occurs where a mortgagee has a lien on real estate and the plan specifically says such property is vested in the ‘bankruptcy estate’ rather than the debtor. As long as the case remains open, the stay remains in effect and, accordingly, the mortgagee would need to seek a specific order of relief from the bankruptcy court before action could be taken to foreclose on the property.

So too, in Chapter 13 cases, the stay would remain in effect during the course of a plan repayment. Chapter 13 provides for an individual to have a plan of repayment of unsecured debts which lasts not longer than 60 months. When the discharge is granted at the conclusion of the plan, then the stay is lifted. Otherwise, the creditor should seek relief of stay any time prior thereto.

The bottom line of all of this is that if the issue is in doubt about whether a stay is applicable or not, a creditor should file a motion with the bankruptcy court to have the issue specifically ruled upon by the court. Violations of automatic stay through the activities or actions of a creditor could result in the creditor being punished by virtue of money awards granted in favor of the debtor. On those debts where a discharge has been granted, in effect there is an automatic and permanent stay on any further collection activity against a debtor per that debtor’s personal obligation on the debt (which is not otherwise dealt with in a reorganization plan, such as the case is under Chapters 11, 12, and 13).

The automatic stay does not apply to the personal debt obligation of a co-debtor to a bankruptcy debtor. So the filing of a bankruptcy by a debtor does nothing to halt the activities of a creditor in trying to enforce the debt as to the non-bankruptcy cp-debtor(s). However, where the co-debtor might own property jointly with the bankruptcy debtor, that property would have the automatic stay apply to it to the extent of the bankruptcy debtor’s interest in that property.

B. Filing of Claims and Collection Actions Available for Each Type of Bankruptcy
Bankruptcy Claims are administrative actions filed by a creditor on the debt obligation which the creditor claims is owed by the debtor so as to be treated in the particular bankruptcy case. This involves filing a ‘Proof of Claim’ with the bankruptcy clerk’s office within the deadline set by law and notices that are sent by the bankruptcy clerk to the creditors. Proofs of Claim are prepared and filed on forms utilized by the bankruptcy courts. While not absolutely required, supporting instruments (notes, mortgages) should be attached to support the claim, particularly if the claim is one that is secured by property of the debtor. Proofs of Claim must be filed by the deadline noted on a notice that is sent out by the bankruptcy clerk to all creditors listed in the debtor’s bankruptcy petition. In chapter 7 cases, there may be no assets which are subject to distribution to the debtor’s creditors. In those instances no claims are filed with the clerk.

In cases where assets are subject to distribution or where the bankruptcy is one where a plan of reorganization is to be made, if a creditor does not timely file a Proof of Claim, the claim may be reduced in priority behind all other claimants, which could mean the claimant gets absolutely nothing if there are not enough funds being paid out of the bankruptcy case to pay all other claims in full.

Creditors who were not listed on the bankruptcy petition by debtor and thus did not receive notice from the bankruptcy clerk of the deadline to file claims, and did not otherwise have or receive actual notice or knowledge of the bankruptcy filing by the debtor so as to file a timely Proof of Claim, may be able to have their debt prevented from being discharged.

However, in Chapter 7 cases, if a creditor did not receive notice of the bankruptcy, but there were no assets that were distributable in the Chapter 7 case, then the creditor cannot reap the benefit of a non-dischargeability (i.e., the creditor’s debt is also discharged in spite of the fact that he did not receive notice). The exception is where the creditor believes the claim would have been non-dischargable for one or more basis and was denied the opportunity to object to such discharge (see section D below)

Claims that are filed in bankruptcy cases may be challenged by the case trustee in Chapter 7 and 13 cases, and by the debtors in possession in Chapter 11, 12, and 13 cases. The challenge might be in the adequacy of establishing what the claim is. Perhaps the creditor has a pending lawsuit in which liability has not been established at the time of the bankruptcy case filing, and accordingly the debtor or the trustee can contest that any money is actually owed.

The dispute would thus have to be either resolved in the bankruptcy court or the bankruptcy court may allow the litigation that was pending in some other court prior to the bankruptcy to proceed, with the results there to then be finally ruled upon by the bankruptcy court as to whether a viable claim has been established or not. However, where a money judgment has been competently rendered in some court prior to the filing of the bankruptcy, and that judgment is final and non-appealable, then that judgment shall be binding in the bankruptcy as to the issue of whether a debt is owed, and if so, as to its amount.

In Chapter 7 cases, a creditor will only receive payment on their claim if: i) there are assets available for collection by the case trustee who is in charge of overseeing and making the determination of whether assets are collectable, and ii) if the creditor has filed a Proof of Claim which the bankruptcy court allows. If there are no assets to be collected, or if there are only enough assets collected which are only payable to priority unsecured creditors (i.e., governments to whom taxes are owed) then the unsecured creditor may not receive anything and its debt will be subject to a general discharge--meaning the creditor is out of luck and will not be able to collect anything.

Debtors are allowed to exempt a certain value of the debtor’s assets in bankruptcy and so the trustee cannot seize for distribution in chapter 7 cases, for example. The amount and type of assets is determined by each state. Among those exemptions in Illinois for individuals are up to $4,000 in personal property of any type chosen by the debtor; $2,400 in any one vehicle; all necessary wearing apparel; all pension or retirement funds; and any life insurance proceeds in which a spouse or dependant is the beneficiary. Corporation debtors have no exemptions for corporate owned property. The calculation and exemption for assets is only for those assets the debtor has an interest in prior to filing the bankruptcy. In chapter 7 cases, any property or wealth acquired after the filing is generally exempt from seizure by the chapter 7 trustee, except for anything inherited within 6 months of the case filing.

In Chapter 11, 12, and 13 cases, the creditor will only be able to enforce its claim to the extent that payment is provided for under a plan of reorganization which has been approved by the bankruptcy court. In Chapter 13 cases, once the plan has been approved, the debtor is to make monthly payments, but those payments are tendered to the case trustee who will hold the funds until the debtor has completed all payments under the plan (plans cannot exceed 60 months, but can be a fewer number of months). Once all of the payments have been tendered per the terms of the plan, then the trustee will issue a single payment to each creditor who has a filed, approved claim. If the unsecured creditors were not paid in full under the confirmed plan, then they will only receive their pro rata share of the collected funds for the amount of their claim as a ratio to all other creditor claims. The balance of their claims would then be discharged by the bankruptcy court.

In Chapter 11 and 12 cases, typically the bankruptcy case will be terminated once the plan is confirmed and has been substantially consummated by the debtor (which means, the debtor is starting to do what the debtor is supposed to do under the plan). Thereafter, the plan acts as a new contract between the debtor and the creditor, and any breach by the debtor thereafter can only be enforced as a breach of a new contract, which may require the creditor to file a suit to seek a new judgment under the terms of the confirmed plan. This is true even if the original claim had been taken to a judgment in some court prior to the debtor filing a bankruptcy. This is because the original judgment is, in effect, restructured under the rights afforded the debtor under federal bankruptcy law protection.

Bankruptcy claims are either secured or unsecured. A single debt may be both a secured claim and an unsecured claim for bankruptcy purposes. This occurs where there is a claim that is collateralized, but the amount of the claim is in excess of the value of the collateral at the time the bankruptcy is filed. Typical of this might be where a creditor has obtained a judgment prior to the bankruptcy filing, and then obtains a judgment lien on debtor’s real estate. At the time of getting the judgment lien, however, the debtor may have prior lien holders such a mortgage, or even perhaps other judgment creditors who have obtained liens prior in time on the real estate.  In this example, say the value of debtor’s land is $10,000.00, and a prior mortgage has $8,000 debt remaining on it. A judgment creditor then obtains a judgment lien in the amount of $4,000. The debtor then files bankruptcy. The mortgage holder has a fully secured lien in the amount of $8,000 since the land is worth more than that and the mortgage is prior in time to judgment creditor. The judgment creditor, being junior in time, is junior in priority and so at the time the debtor files, there is only $2,000 of value left in the property not consumed by the mortgage. So the excess value above the mortgage debt gives the judgment creditor a secured claim to the extent of $2,000. However, the balance of the judgment creditor’s original debt of $4,000 (in this example, $2,000) will be treated as unsecured.

C. Enforceability of Liens in Bankruptcy
In all chapters of bankruptcy, liens are not automatically dismissed or eliminated, nor can they be discharged, unless that occasion is specifically provided for in approved plans that are in reorganization-type bankruptcy cases (chapters 11, 12, and 13). However, creditors are entitled to receive payment in Chapter 11, 12, and 13 cases equivalent to the value of the property which collateralizes their debt (the collateral’s value being calculated at the moment that the bankruptcy was filed). If there is a depreciation that occurs to the property following the bankruptcy, that does not allow the debtor to come up with a plan which pays only for the depreciated value—the debtor must either pay the value of the property as it was at the time of the filing of the bankruptcy or provide a turnover of the property in satisfaction of the claim. But remember as discussed above on undervalued collateral, the secured creditor only has a secured claim to the extent the claim is covered by the value of the property. If, say there are 2 mechanics lien judgment creditors each having a $4,000 claim on a parcel of debtor’s land, and their liens were established at the same time in the same judgment, and the land is only worth $2,000 when the debtor/defendant filed a bankruptcy, each claimant will have their claim reduced pro rata and thus each has a secured claim of $2,000 and an unsecured claim of $2000. In Chapter 7 cases where there may be property which has equity for the creditors—and even the debtor--the trustee would be permitted to seize and liquidate the property. However, the secured creditor would be entitled to payment of its entire secured claim before the trustee can pay funds to other unsecured creditors or return any equity left thereafter to the debtor. Certainly, in reorganization bankruptcies, plans can be proposed which modify the terms of repayment under the pre-bankruptcy loan terms, even if those loans were awarded a money judgment. Many courts require the proposed repayment plan to have an interest rate which is reasonable under market conditions, and perhaps even above current market rates, depending upon the amount of risk associated with the collateral (e.g., loans for vehicles may require a higher interest rate than loans collateralized by real estate, since vehicles are prone to immediate and massive depreciation or subject to severe damage or destruction).

As mentioned in section A above regarding automatic stays, the creation of a lien on debtor’s property occurring after debtor has filed bankruptcy may be null and void. For example, the filing of a judgment lien on debtor’s real estate post bankruptcy filing is barred even where the creditor may have a pre-bankruptcy judgment. However, some actions to perfect liens as to third party creditors are not barred by the stay (e.g. filing a mechanic’s lien claim in the county recorder’s office to perfect a mechanics lien which itself is created when the money becomes owing to the lien claimant).

Furthermore, pre-bankruptcy Liens can be avoided under bankruptcy if they are a “preference”. ‘Preferences’ are where there is: i) a transfer of property of the debtor; ii) that was done within 90 days prior to the filing of a bankruptcy; iii) the transfer was pursuant to a preexisting debt: and iv) the transfer caused the creditor to get more value from the debtor than the creditor would get from the bankruptcy.8 Most typically, this occurs when a creditor has a judgment lien which was itself created within the 90 day period prior to the debtor filing bankruptcy. Such action taken by a trustee or a debtor in any of the bankruptcy chapters can result in converting a pre-bankruptcy secured creditor into an unsecured creditor to the extent that the judgment lien is removed.

But (and a big ‘but’ this is), if a debt is created simultaneously to the giving of a lien (a new mortgage, or a new loan for the purchase of personal property) then such transaction would not fall as a preference since the preference must be the giving of a lien on a pre-existing debt. Also exempt as a preference would be if new value is given on a pre-existing debt in exchange for the giving of the lien.9 This is typically where an operating loan may be giving new funds out which then attaches to property already collateralized under the original loan agreement. In Chapter 7 cases (as well as Chapter 13), often liens will remain after the case is over and the discharge granted. The discharge removes the personal obligation of the debtor behind the lien, but the lien itself is still enforceable on the collateralized property. This will occur typically in Chapter 7 cases where a debtor remains current on their mortgage or car loan, for example, but they never execute a reaffirmation agreement (an agreement necessary to keep the pre bankruptcy personal obligation in force and effect following the discharge in the case). Nevertheless, the mortgage remains untouched and as a practical matter, the debtor then has to continue to tender payment in order to prevent the foreclosure of the lien by the lien holding creditor. The same principle applies to judgment liens. While the underlying personal obligation of the judgment defendant is gone, the lien collateralizing the judgment, if properly perfected and not a preference, remains for the life of the lien under the law.

On a final note for lien enforcement of mortgage foreclosures, where a foreclosure judgment has been entered but a sale has not yet happened, the real state foreclosed upon remains property of the debtor who, if a bankruptcy filing is done prior to the sale, remains subject to the bankruptcy (and any automatic stay). If a sale has occurred, and such sale is not invalidated as having been improperly conducted, then the property belongs to the sale purchaser and would not be subject to a debtor subsequent bankruptcy filing.

D. Dischargeability in Bankruptcy
All bankruptcies will grant a debtor a discharge of the debtor’s debt obligations, except where certain debts are specified by bankruptcy statute as not subject to discharge at any time, or where a creditor seeks to object to the discharge based on certain exceptions under the bankruptcy code, but which the creditor must prove through an objection brought before the bankruptcy court. It should also be noted that corporations do not obtain a discharge under any circumstance by the corporation’s filing of a Chapter 7. Nor do corporations obtain a discharge under a Chapter 11 where substantially all of the property of the corporation is being liquidated under its Chapter 11 plan.

Debt which is not discharged by force of statute without any action taken by the creditor include student loans, or payroll taxes of an employer owing to the government, or income taxes of a debtor that are within three years of the year of the filing of the bankruptcy. There are debts which can be prevented from being discharged in bankruptcy, but those require an objection being raised before the bankruptcy court. Among such debts are those that were created by an act of fraud in the inducement of getting the loan10, a debt arising out of embezzlement or breach of a fiduciary capacity11; or a debt arising out of a willful or malicious injury to property or person by the debtor12.

The creditor is generally obligated to file the objection of discharge within 60 days of the first meeting of creditors.13 In Chapter 13 cases, deadlines for filing objections based on malicious injury of property may be further set by the court.14 If no objection is filed within time, the creditor is thereafter barred from ever raising an objection to discharge (unless the creditor had no reasonable basis to know it had been defrauded until after the deadline for objecting passed—which would be incredibly rare). Any objection raised will then need to be ruled upon by the bankruptcy court in an evidentiary hearing before the court. The burden will be on the creditor to prove the basis for the objection. If the court finds that the claim for the objection is not proven, then the debt will be subject discharge. If the court finds that the creditor has proven the objection, then that debt will not be discharged (even if all other creditors have their debts discharged—which, for the objecting creditor, is the best of all worlds since that eliminates competition to collect from the debtor!)

There are also circumstances where an objection to any discharge may be raised by a party or the case trustee on the basis that the debtor has intentionally inaccurately listed the debtor’s assets in the bankruptcy petition. If the bankruptcy court were to so find, that could result in the bankruptcy case being dismissed without any discharge being granted. A creditor must remember, however, that even where a creditor’s debt has been found to be nondischargeable, the creditor must still be wary of whether an automatic stay remains in effect in a pending case before that creditor takes action to enforce the debt.

In situations where the debt is dischargeable and an order of discharge has been granted, this places a permanent prohibition on creditors to not take any further action forever and ever to collect on the debt, except to the extent where there may be an obligation under a reorganization plan which has been confirmed in Chapter 11 and Chapter 12 cases.

Generally speaking, only debts created pre-bankruptcy are subject to discharge. Any debts created thereafter are not subject to discharge, except for certain situations that might be provided for in chapter 11 or 12 plans. Thus if a debt is made by the debtor after debtor has filed his bankruptcy, that debt is not subject to that bankruptcy case filing. And, whether a claim has been reduced to a judgment or not is immaterial as to whether the claim is considered a pre or post bankruptcy claim. The issue is whether the claim arose prior to the bankruptcy filing, not whether a judgment was entered. If a money lawsuit is pending at the time the debtor/defendant files a bankruptcy, and that claim--even if not brought to hearing for a final judgment—gets discharged, then the claim becomes forever unenforceable as a personal obligation of the debtor, which means that the lawsuit gets dismissed without a trial!

And remember, co-debtors are unaffected by a debtor’s discharge. So if a debtor obtains a discharge, that discharge has no bearing on any co-debtor who themselves have not filed a bankruptcy. The obligation by that co-debtor remains in place.

Judgment enforcement in bankruptcy is complicated and fraught with peril. If you have a debtor filing one, pick up the phone and call your lawyer.

1 11 U.S.C. §101 et seq.
2 11 U.S.C. §362
3 11 U.S.C. §362a
4 11 U.S.C. §362b(10)
5 11 U.S.C. §362d(1) and (2)
6 11 U.S.C. §362h(1)
7 11 U.S.C. §521(a)(2)
8 11 U.S.C. §547(b)
9 11 U.S.C. §547(c)
10 11 U.S.C. §523(a)(2)
11 11 U.S.C. §523(a)(4)
12 11 U.S.C. §523(a)(6)
13 Bankruptcy Rule 4007(c)(d)
14 Bankruptcy Rule 4007(d)

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