How Does Bankruptcy Work with Debtors and Creditors?

How Does Bankruptcy Work with Debtors and Creditors?
Information in this article does not constitute legal advice, it is for informational purposes only, and may not constitute the most up-to-date information. Readers should contact their attorney for advice on any particular legal matter.

When someone borrows money, they enter into a debtor-creditor relationship with the lender. This relationship is governed by debtor-creditor law, which outlines the rules and regulations for borrowing and lending. However, if the borrower files for bankruptcy, the Bankruptcy Code takes over, and the relationship between the borrower and lender is now governed by this code. It's important to note that creditors cannot choose to opt-out of a bankruptcy case, meaning they must comply with the rules set forth by the code.

During a bankruptcy case, the roles of the debtor and creditor are quite different. The debtor is the person who owes money and has filed for bankruptcy, while the creditor is the person or entity that is owed money. The bankruptcy process is designed to help debtors get back on their feet by restructuring or eliminating their debts. Creditors, on the other hand, may have to accept less than the full amount owed to them. While this can be challenging for creditors, bankruptcy is an important tool for helping individuals and businesses get a fresh start financially.

Learn More About Debtors and Creditors in Bankruptcy

Have you ever wondered what the terms "debtors" and "creditors" mean? Well, let's break it down.

A debtor is a person or entity that owes money to someone else. This could be an individual who has taken out a loan from a bank or a company that has purchased goods or services on credit from a supplier. In short, a debtor is someone who is in debt and has an obligation to pay back what they owe.

On the other hand, a creditor is a person or entity that is owed money by someone else. This could be a bank that has lent money to an individual, or a supplier that has provided goods or services to a company on credit. Essentially, a creditor is someone who is owed money and has the right to collect it back from the debtor.

Understanding the difference between debtors and creditors is crucial in the world of finance and accounting. It helps individuals and businesses keep track of their finances and manage their debts effectively.

What Is a Debtor?

When you borrow money from someone, you become a debtor. But in the case of bankruptcy, the debtor is the one who files for bankruptcy relief. The goal of the debtor is to obtain a bankruptcy discharge, which means they are no longer legally responsible for their debts.

Bankruptcy can be a helpful tool for those struggling with overwhelming debt. It allows individuals to start fresh and rebuild their financial lives. However, the process can be complex and challenging. It's important to understand the implications of filing for bankruptcy and to seek guidance from a qualified professional.

What Is a Creditor?

When someone borrows money or gets credit, the party that provides the money or credit is called a creditor. However, in a bankruptcy case, there are three different types of creditors:

Secured Creditors

When a borrower takes out a secured loan, the lender has a legal right to take possession of the collateral if the borrower fails to make payments as agreed. The collateral is the asset that secures the loan, and it can be real estate, a vehicle, or personal property. If the borrower defaults, the lender can repossess the collateral to satisfy the debt.

If the collateral is real estate, the lender can foreclose the mortgage and sell the property at a foreclosure sale to pay off the debt. If the collateral is a vehicle or personal property, the lender can repossess and sell it to recover the amount owed.

If the sale of the collateral does not cover the full amount of the debt, the lender can seek a deficiency judgment. This is the amount of money the borrower still owes after the sale proceeds have been applied to the account. The lender can take legal action to collect the deficiency judgment, such as wage garnishment or seizing personal property and financial accounts.

Priority Creditor

When a bankruptcy case is filed, priority creditors are the first to receive payment before unsecured creditors. These creditors do not have any collateral, but their debts are given priority by a statute. In Chapter 13 cases, priority creditors must be paid in full through the plan.

Priority creditors include, but are not limited to, most income tax debts, debts owed to the government, Chapter 13 trustee administrative fees, wages, salaries, and commissions owed to an employee, alimony, child support, spousal support, personal injury claims related to DUI accidents, and court fines. These debts are considered more important than general unsecured debts, giving them higher standing in a bankruptcy case.

For creditors, having priority debts means their debts are paid first in a bankruptcy case. For debtors, ensuring some creditors receive payment could be important. For example, if back child support and alimony are paid in full through a Chapter 13 plan, the debtor can avoid family court sanctions.

Unsecured Creditors

Unsecured debt refers to debts that are not backed by collateral. This means that creditors cannot take legal action to collect their debt after a bankruptcy filing. Instead, they have to wait and see if they might receive any money from the bankruptcy. Examples of unsecured debts include credit cards, personal loans, medical debts, some old income tax debts, most judgments, and old rent/lease payments.

In a no-asset Chapter 7 case, unsecured creditors do not receive any money. The debts are discharged, and the debtor is not required to repay those debts. However, if the Chapter 7 trustee liquidates an asset, unsecured creditors may receive some money if any funds are available after paying priority debts in full. To file under Chapter 7, you must qualify. You can use our free Chapter 7 calculator to estimate whether you meet the income qualifications for a Chapter 7 bankruptcy.

In Chapter 13 cases, unsecured creditors receive a percentage of their debts based on the debtor’s disposable income and other factors. Generally, the payment equals pennies on the dollar. You can use our free Chapter 13 calculator to estimate how much your Chapter 13 plan payments may be based on your current financial situation.

What Can Creditors Do If I Do Not File Bankruptcy?

If you're in a situation where you can't pay off your debts, you might be worried about what your creditors could do. There are several legal remedies they may take, including seizing and selling the collateral for the loan if it was secured. They may also turn your account over to debt collectors, which could negatively impact your credit score. In some cases, creditors may even file a debt collection lawsuit and garnish your wages if they obtain a judgment.

But before your creditors take legal action, there are options available to you. We'll work with you to explore debt relief options that fit your needs and budget.

While bankruptcy may be a viable option for some, there are other alternatives to consider as well. Debt settlement, debt payoff planning, and debt management are just a few of the options that may be available to you.

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