Most people think of bankruptcy as a straightforward process that, unlike many court cases, doesn't involve a dispute with someone else. You file paperwork and receive a discharge (the order that wipes out qualifying debt) without worrying that someone will object to your case.
For the vast majority of matters, that's how it works. Although every creditor involved in bankruptcy could dispute the discharge, few do—primarily because they don't often have grounds to make a challenge. But there are still opportunities for those involved (known as "interested parties," such as the debtor, the creditors, and the trustee) to engage in full-blown litigation. In this article, you'll learn how typical bankruptcy litigation occurs.
How the Bankruptcy Court Distinguishes Litigation Types
The bankruptcy rules distinguish between litigation matters based on their relationship to the bankruptcy itself. The distinction is important because it affects the jurisdiction and decision-making authority of the bankruptcy judge.
- Core matters. These are uniquely derived from the bankruptcy case, like litigation over a debtor's right to keep property covered by a bankruptcy exemption. For these issues, the bankruptcy judge has the final say (subject to appeals).
- Non-core matters. These affect a bankruptcy case but are matters that could have been brought between the parties even if a bankruptcy case had not been filed. Examples include contract disputes and tax litigation. A bankruptcy judge's authority or jurisdiction in a non-core matter is limited to making a recommendation to the federal district court (of which the bankruptcy court is a component) unless all parties agree to allow the bankruptcy judge to have the final say.
Although all controversies in bankruptcy cases are matters of serious concern, some are more complex than others and require the application of special litigation rules.
- Adversaries. Some litigation in a bankruptcy case must be brought as a separate case called an adversary proceeding. These cases are connected with the main case but are assigned their own case number and are conducted according to a special set of litigation rules. They generally take the familiar form of plaintiff versus defendant and proceed forward much like other trials.
- Contested matters. These are matters that usually do not rise to the level of full-blown litigation (although they can develop into it) and often address a discrete issue in the bankruptcy case. Examples include objections to proof of claims (more below), objections to Chapter 11 or Chapter 13 plans, and motions to lift the automatic stay.
Not all litigation in a bankruptcy case derives directly from the bankruptcy itself. Almost any litigation that a debtor can be a part of can potentially be brought in the bankruptcy court, especially if it concerns the debtor's money or property. Even a case pending in another court can be moved to the bankruptcy court depending on the nature of the suit and its status in the nonbankruptcy court. And if not removed to the bankruptcy court, the bankruptcy judge can retain jurisdiction to have the final (or close to the final say) over a decision made by a state court.
Although there is very little litigation a bankruptcy judge won't touch, the following matters usually aren't decided in a bankruptcy court:
- Divorce or child custody cases. Property divisions and ownership disputes might be brought into the bankruptcy, or responsibility for a secured debt (a debt guaranteed by collateral, such as a house or car), but bankruptcy judges will not dissolve a marriage or determine custody rights.
- Probate matters. Although the death of a debtor will not automatically terminate a bankruptcy case, the bankruptcy court tends to deal only with issues of liquidation of assets and payment of debts. It would be unusual for the court to take on an issue concerning the transfer of ownership, or other matters usually handled by the probate court.
- Personal injury matters. Bankruptcy courts will usually let state courts grapple with a liability determination (the job of deciding who is at fault in an accident). Bankruptcy courts will hear insurance coverage cases and are often called upon to decide whether a state court judgment occurred due to fraud, willful injury, or intoxication, all of which can prevent the debt from being discharged.
Types of Bankruptcy Litigation
Here are some common types of disputes that occur in a bankruptcy case.
Between Debtor and Creditors
- Dischargeability of debts. Some debts are nondischargeable (they don't go away in bankruptcy). But in some situations, the debtor or creditor must file a lawsuit within the bankruptcy case asking the court to decide whether the debt will remain.
- General discharge. A creditor can challenge the debtor's right to the entire discharge if the debtor has defrauded the creditor or the court.
- Claims. Debtors can challenge a creditor's right to payment on a proof of claim (the form a creditor must submit before receiving payment).
- Automatic stay or discharge injunction violations. A debtor can sue a creditor for attempting to collect a debt in violation of the automatic stay or the discharge injunction. (The automatic stay is a court order that prohibits a creditor from collecting after a bankruptcy filing.)
Between Debtor and Trustee
- General discharge. Like a creditor, the trustee can challenge a debtor's right to a discharge. It usually occurs due to an allegation of bankruptcy fraud.
- Exemptions and other property issues: The trustee can litigate the debtor's right to claim an exemption (a debtor can protect property that is exempt under the law). By contrast, the debtor can object to the trustee's right to seize the debtor's exempt property.
Between Trustee and Creditors or Other Interested Parties
- Trustee's strong-arm powers. The trustee has broad powers to take back some assets. For instance, the trustee can reclaim preferential payments (money paid to a particular creditor shortly before the bankruptcy filing) or property that was fraudulently transferred to someone else to avoid its sale by the trustee.
- Claims. The trustee can challenge a creditor's right to payment on a proof of claim.