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Holding The Bag And Other Worthwhile Endeavors: The Standing Of Judgment Creditors In Bankruptcy

September 03, 2009 BY Def Admin

            After a lengthy and costly legal brawl, you've obtained a monetary judgment against a back-sliding individual defendant.  Let's call him Marley Bankrupt.  During litigation, you learned that Marley works as the manager of a small company, enjoys a nice salary, and owns a pair of vehicles.  With excitement, you instruct your attorney (Ms. S.K. Rouge) to begin preparing post-judgment collection documents, including bank garnishments and wage garnishments.  Ms. Rouge calls the local sheriff to schedule a levy of Marley's personal and real property, and the moving vans are warming up.  You and Ms. Rouge decide to serve the garnishments on the day Marley receives his paycheck.  Just as you are mentally tallying the proceeds from the collection of your judgment, Ms. Rouge calls with grave news.  "Plutarch, old friend," said she, "Marley is bankrupt."  What now?

            Unfortunately, the foregoing scenario is not an uncommon occurrence.  Many judgment creditors are uncertain of the status of their judgment in the event the debtor files for bankruptcy protection.  The result is that judgment creditors simply give up when they learn the debtor has filed bankruptcy.  Indeed, because the United States Bankruptcy Code (11 U.S.C. § 101 et seq.) is largely written for the protection of debtors, many judgment creditors are left "holding the bag" once the debtor declares bankruptcy.  This article will help you understand the bankruptcy minefield creditors face by identifying the bankruptcy remedies available to debtors, the actions creditors may (and may not) take once a debtor has filed a bankruptcy petition, and the treatment of judgments by the Bankruptcy Code.

            As a threshold matter, Marley can generally file a bankruptcy petition under two separate provisions of the Bankruptcy Code – “Chapter 7” (11 U.S.C. § 701 et seq.) or “Chapter 13” (11 U.S.C. § 1301 et seq.). Chapter 7 is often referred to as a “clean slate” bankruptcy, in that the debtor’s assets are liquidated, creditors are paid with the proceeds, and the debtor is discharged from her debts by the bankruptcy court.  Under Chapter 13, the debtor enters a plan, approved by the bankruptcy court, to repay a portion of her debts to a bankruptcy trustee.  The trustee then divides and disburses that portion amongst the creditors based upon the creditors' relative priority, which is discussed below, so that each creditor receives at least some payment.  Once the debtor has fulfilled the terms of the plan, judgment debts, in particular, are discharged.  Chapter 11 (business and personal reorganization bankruptcy) and Chapter 12 (agricultural or farming bankruptcy) petitions are beyond the scope of this article.

            Initially, the most important factor to bear in mind is that the Bankruptcy Code imposes an automatic stay in favor of the debtor once the debtor files bankruptcy.  11 U.S.C. § 362(a).  The automatic stay is, of course, automatic and immediately prevents any further efforts to collect your judgment after a debtor declares bankruptcy.  The goal of the automatic stay is to preserve the status quo by protecting the debtor’s remaining assets; the more assets remaining with the debtor, the larger the bankruptcy estate to be distributed to creditors. To achieve this goal, the automatic stay stops foreclosures, garnishment actions, levies, and any other attempt to file a suit, enforce a judgment, or obtain property from a debtor.  In addition, if your judgment is the result of a motor vehicle accident in which the debtor was uninsured, you may not suspend the debtor's driver's license once the debtor files bankruptcy.  In short, any efforts to collect the judgment must cease.  The Bankruptcy Code enforces the automatic stay by imposing stiff penalties, including attorneys' fees and treble damages, if the stay is violated.

            Sometimes, you will have obtained a judgment against both an individual and a corporate entity in which the individual is an officer.  Thereafter, the individual debtor files a bankruptcy petition.  It may become unclear whether you would be able to proceed against the debtor who is not a party to the bankruptcy proceeding.  For example, can you continue your collection efforts against the corporate entity if the individual has filed bankruptcy?  While the answer is usually “yes,” the safest procedure is to file a “motion for relief from stay” with the bankruptcy court.  The court will then issue an order indicating that there is no stay against the corporate entity, and you are free to try and collect your judgment against the entity.  Most importantly, this procedure insulates you from any suggestion that you violated the automatic stay provision.

            At this point, it is important to note that a bankruptcy court may dismiss a bankruptcy petition for a variety of reasons.  If a petition is dismissed, the automatic stay is no longer effective and you may continue your regular post-judgment collection procedures.  Accordingly, it is suggested that, even if a bankruptcy petition is filed, you continue your preparations to pounce on the debtor in the event the petition is dismissed. For example, if you have a judgment, but it has not been recorded in the land records of the county where the debtor lives, keep the judgment on hand and record it as soon as the bankruptcy petition is dismissed.  Likewise, continue any unofficial, “behind-the-scenes” investigation to try and locate the debtor’s assets (i.e., reviewing records, drafting post-judgment discovery pleadings, etc.).

            Typically, the bankruptcy court or the debtor will notify you or your attorney in the event the debtor files bankruptcy; in order to have the judgment debt discharged, the debtor must list your judgment in her bankruptcy petition.  Based upon the information contained therein, the bankruptcy court will send you a notice of bankruptcy confirming that the bankruptcy petition has been filed, advising you of certain important rights, and setting forth a schedule for the resolution of the bankruptcy case.

            Next, the Bankruptcy Code establishes a priority for creditors.  First, Georgia law provides several exemptions to which debtors are entitled and are not included in the bankruptcy estate.  See O.C.G.A. § 44-13-100(a).  These exemptions may include cash on hand, household good and furnishings, apparel, vehicles, and pets.  At the top of the priority chain are secured purchase money creditors.  For example, a company that lent money to the debtor for the purchase of a home or a vehicle, in exchange for a collateral interest in that property, will generally be paid first as a secured creditor.  Next in line are creditors who have unsecured priority claims.  These creditors may include government entities, domestic obligations (including child support), and claims for death or personal injury while the debtor was intoxicated.  For example, the Internal Revenue Service and the state Department of Revenue enjoy priority over many other creditors in a bankruptcy petition.  Likewise, the payment of domestic support obligations is favored above most other creditors. Finally, there is a rabble comprised of unsecured, non-priority creditors.  In this group are found credit card companies and, unfortunately, judgment creditors.  In practice, recoveries by judgment creditors in Chapter 7 bankruptcies are rare, while collections in Chapter 13 bankruptcies may only result in pennies on the dollar.  Unfortunately, the Bankruptcy Code even includes a provision to allow debtors to escape most judicial liens.  See 11 U.S.C. § 522(f).

            While the landscape may appear bleak, all is not lost.  Once the debtor has declared bankruptcy, judgment creditors may file a “proof of claim” with the bankruptcy court.  The proof of claim identifies your judgment, provides notice of your judgment to the bankruptcy court, and establishes your right to collect from the proceeds of the bankruptcy estate (if any ultimately exist).  The proof of claim does not cost anything to file and is usually a one-page form.  Filing a proof of claim is encouraged for Chapter 13 cases and is solicited by the bankruptcy court, since there will often be a bankruptcy estate from which you may receive some payment. Bankruptcy courts actively discourage proofs of claim in Chapter 7 cases since it has already been determined that there are no assets to be distributed.  However, there is no penalty for filing an unsolicited proof of claim in a Chapter 7 case, and there is the potential that assets could be discovered at a later date.  Accordingly, filing a proof of claim form in Chapter 7 cases is also recommended.  In no event is a recovery guaranteed, under either Chapter 7 or 13, simply by filing a proof of claim.  A proof of claim does, however, represent your best opportunity to collect from the bankruptcy estate.

              In sum, once a judgment debtor files a bankruptcy petition, any effort to collect your judgment must cease pursuant to the automatic stay.  However, you should continue to prepare to collect your judgment in the event the bankruptcy petition is dismissed.  You should also file a proof of claim with the bankruptcy court to make certain that you receive a portion of the bankruptcy estate.  If there is any doubt whether an associated party is subject to the automatic stay, you should file a motion for relief from the automatic stay, obtain clarification from the bankruptcy court, and proceed against any judgment debtor not a part of the bankruptcy proceeding.  By employing these simple tactics, you may be able to make progress toward the satisfaction of your judgment and, in turn, avoid “holding the bag.”

The Journal is a publication for the clients of Drew Eckl & Farnham, LLP. It is written in a general format and is not intended to be legal advice to any specific circumstance. Legal Opinions may vary when based upon subtle factual differences. All rights reserved. 

Editorial Board:

H. Michael Bagley