So I loaned my friend $25,000 and just found out he is going to file bankruptcy. Now what???

by Jaburg Wilk

1.         Because he is my friend, he offered to settle and pay me outside of the bankruptcy and he agreed to not include my debt in the bankruptcy case.  Can I do this?

 No.  Once a bankruptcy case is filed an automatic stay goes into effect, whether or not you have actual notice of the bankruptcy filing, which prevents you from taking any action to collect your debt, including negotiating a settlement.  If you engage in negotiations to get paid outside of the bankruptcy case, you will not only violate the automatic stay, but you could subject yourself to an avoidance claim by the bankruptcy trustee if you get paid, which could result in your having to later turn over any payment(s) you received to the bankruptcy trustee.

2.         My friend filed a Chapter 13 bankruptcy case.  Do I need to file anything with the Bankruptcy Court regarding the debt he owes me?

Yes. You should at least file a Proof of Claim with the Court.  Depending upon the case and the debtor's income and assets, a portion of your claim may be paid the through the Chapter 13 Plan. You should file the Proof of Claim, just in case.  Forms for such claims are available on the Arizona Bankruptcy Court’s website, or you can have an attorney assist you with the filing of the Claim.

3.         What if his bankruptcy case converts to a Chapter 7 bankruptcy case?

If a Chapter 7 bankruptcy case is filed, or if a case originally filed as a Chapter 13 case is converted to a Chapter 7 case, you should receive a notice from the bankruptcy court.  The notice will either contain a deadline for filing claims, in which case you should file a timely claim, or it will state not to file a claim unless the Court issues a subsequent notice setting a deadline for claims to be filed.  This will typically only occur if the bankruptcy trustee assigned to the case has acquired assets to liquidate and distribute to creditors.  If a deadline for claims has been set you should definitely file a claim.  If you fail to file a timely claim, you will likely not be able to participate in the distributions made to creditors.

4.         When I made the loan to my friend he gave me a lien on his house to secure the loan. What does this mean in the bankruptcy case?

First, if a bankruptcy case was filed and you did not record a deed of trust / mortgage to perfect the lien on the real property before the bankruptcy case was filed, your claim will not be treated as a secured claim.  Further, it would be a violation of the automatic stay if you recorded the deed of trust / mortgage after the bankruptcy case is filed.

Second, if a Chapter 7 bankruptcy  case is filed, you will need to obtain relief from the automatic stay in order to exercise your remedies against the real property, such as foreclosure. An analysis should be performed to determine the value of the property and amount of liens with priority over your lien to determine if foreclosure on the property makes sense.  While the underlying obligation / debt will likely be discharged in the bankruptcy case, the lien on the property will survive the bankruptcy, unless someone (i.e the debtor or bankruptcy trustee) takes some action to avoid the lien.  If there was a lien recorded against the property ahead of your lien which was foreclosed before or during the bankruptcy, then your lien against the property was extinguished and your claim can and should be treated as an unsecured claim, in which case you should file an unsecured proof of claim.

If a chapter 13 bankruptcy case is filed, you should file a secured Proof of Claim in the case.  You will need to review the Chapter 13 Plan proposed by the debtor to see how your claim is proposed to be treated.  For example, the debtor could propose to pay the regular monthly payments owed to you directly, outside of the Plan, commencing with the first payment you are owed after the date the bankruptcy was filed, and then pay the past due payments / arrearages owed (payments not made prior to the bankruptcy filing) through the Chapter 13 Plan.  If the loan is secured by real property which is not the debtor's principal residence, then the debtor can propose to "cram down" your claim and pay you only the current fair market value of the property, and not the full amount of your loan balance.  If your loan was secured by a junior position lien against the debtor's principal residence, and the amount owed to the senior / first position lien holder is greater than the value of the real property, your loan may be considered to be wholly unsecured and treated as an unsecured claim, and the debtor will likely seek to avoid / release your lien, typically upon entry of the discharge order.  Note you should never agree to the avoidance / release of your lien prior to either (a) the debtor's completion / full performance of the Chapter 13 Plan, or (b) the entry of the discharge order.  That way, if the bankruptcy case is dismissed or converted to another Chapter your lien and status as a secured creditor will remain intact.  Should you disagree with the proposed treatment of your claim in the debtor's Chapter 13 Plan, be sure to file a timely objection to the Chapter 13 Plan, to protect your rights.  An attorney can assist you with this process.

5.         I received notice that a bankruptcy case was filed, but never heard anything further.

You should monitor the bankruptcy case after it is filed.  Many bankruptcy cases get dismissed, either voluntarily by the debtor or by a trustee or the court if the debtor fails to do certain things required for the type of case filed.  If the case is dismissed and terminated / closed, your debt will not be discharged and you will be free to resume your remedies to collect your debt.   However, as many dismissed cases are quickly reinstated by the debtor by taking certain action required by the court, i.e. paying a filing fee, I recommend waiting 30 days after a bankruptcy case is dismissed before resuming collection remedies, to make sure the bankruptcy case is not reinstated and the bankruptcy stay is not re-imposed.

6.         I received notice that a discharge was entered. What does this mean?

In a Chapter 7 case, this means that the debts included and covered by the bankruptcy case are discharged and can no longer be collected.  As set forth above, if your debt was secured by a lien on real or personal property, the lien may survive the bankruptcy allowing you to exercise remedies against such property / collateral only, but the underlying debt / obligation will be discharged.

In a chapter 13 case, the discharge is typically entered after the debtor has fully performed under and completed all required payments to creditors under the confirmed Chapter 13 Plan, which is typically a 5 year Plan in Arizona.  Most debts covered by and paid through the Chapter 13 Plan will be discharged at this point, and no collection may be had on any balances which may remain unpaid on such debts.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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