Yes, creditors can still pursue legal action against a business even if it is in bankruptcy proceedings. Bankruptcy is a legal process that helps individuals or businesses who cannot pay their debts to seek relief from some or all of their debts and to repay creditors through a court-approved repayment plan or have their debts discharged. However, bankruptcy does not automatically stop all legal actions by creditors.
Types of Bankruptcy
There are different types of bankruptcy, including Chapter 7, Chapter 11, and Chapter 13. Each type has different rules and procedures, but all bankruptcy proceedings involve a court process that allows a debtor to either restructure their debts or liquidate assets to repay creditors.
- Chapter 7: Also known as “liquidation bankruptcy,” Chapter 7 involves the sale of a debtor’s non-exempt assets to repay creditors. Once the assets are liquidated, the remaining debt is typically discharged, and the debtor is no longer obligated to repay it.
- Chapter 11: This type of bankruptcy is most commonly used by businesses to reorganize their debts and continue operating. It allows the debtor to propose a plan to repay creditors over time while continuing business operations.
- Chapter 13: Chapter 13 bankruptcy is typically used by individuals with a regular income. It allows debtors to create a repayment plan to repay all or part of their debts over three to five years.
Automatic Stay
When a business files for bankruptcy, an automatic stay goes into effect, which halts most collection actions by creditors. The automatic stay is a court order that prohibits creditors from taking any action to collect debts from the debtor or the debtor’s property. This includes lawsuits, wage garnishments, foreclosure proceedings, and harassing phone calls from creditors.
However, the automatic stay is not absolute, and there are exceptions where creditors can still pursue legal action against a business in bankruptcy proceedings.
Exceptions to the Automatic Stay
There are certain situations where creditors can seek permission from the bankruptcy court to continue or initiate legal actions against a debtor despite the automatic stay. Some common exceptions include:
- Secured creditors: Creditors who hold a security interest in the debtor’s property can ask the court for relief from the automatic stay to repossess or foreclose on the collateral securing the debt.
- Domestic support obligations: Creditors seeking to collect alimony, child support, or other domestic support obligations are not subject to the automatic stay.
- Criminal proceedings: Legal actions related to criminal matters, such as lawsuits for fines or penalties, are not stayed by the bankruptcy process.
- Certain tax actions: The IRS and other taxing authorities can continue to pursue tax audits, assessments, and collection actions against a debtor in bankruptcy.
- Eviction proceedings: Landlords can seek relief from the automatic stay to evict a debtor if they can demonstrate cause.
Post-petition Debt
Even if a business successfully discharges its pre-bankruptcy debts through the court process, it can still incur post-petition debt during the bankruptcy proceedings. Post-petition debt is any debt that arises after the filing of the bankruptcy petition but before the case is closed or dismissed.
While post-petition debt is not subject to the automatic stay, the bankruptcy court may still have jurisdiction over these debts. Creditors with post-petition claims must file a proof of claim with the court to seek repayment from the debtor’s estate.
Reaffirmation Agreements
In some cases, a debtor may choose to reaffirm a specific debt during the bankruptcy process. A reaffirmation agreement is a voluntary agreement between the debtor and a creditor where the debtor agrees to remain liable for a particular debt even after the bankruptcy discharge.
Reaffirmation agreements are common in Chapter 7 bankruptcies, where the debtor wants to keep certain secured assets, such as a car or home. By reaffirming the debt, the debtor can retain ownership of the asset as long as they continue to make payments on the debt.
Chapter 11 Bankruptcy and Creditors’ Rights
In Chapter 11 bankruptcy, creditors play a significant role in the reorganization process. The debtor must propose a plan of reorganization that outlines how the business will repay its debts over time while continuing operations. Creditors have the opportunity to vote on the plan and can object to it if they believe it is unfair or not feasible.
If the court approves the reorganization plan, creditors must abide by its terms, including accepting reduced payments, extended repayment periods, or a partial debt discharge. However, if the debtor fails to comply with the plan, creditors may have the right to pursue legal action to enforce their rights under the bankruptcy code.
Impact on Creditors
Bankruptcy proceedings can have a significant impact on creditors, especially if the debtor’s assets are insufficient to repay all debts in full. Creditors may receive only a portion of what they are owed, or in some cases, nothing at all. However, creditors do have certain rights and protections under the bankruptcy code, including the right to:
- Receive notice of the bankruptcy filing and important court dates
- File a proof of claim to assert their right to repayment
- Participate in the bankruptcy process, including attending hearings and voting on reorganization plans
- Challenge the discharge of specific debts if they believe the debtor engaged in fraudulent behavior
- Seek relief from the automatic stay if necessary to protect their interests