What Exactly Is Bankruptcy Litigation?

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When describing bankruptcy litigation, it is helpful to define litigation more generally.

Litigation involves legal disputes in a court of law.  Litigation frequently takes the form of lawsuits, but the term may also refer to something that is disputed without the complete formality of a lawsuit.  In bankruptcy, lawsuits are referred to as adversary proceedings, while other disputes are referred to as contested matters.

Another important term in bankruptcy is the “trier of fact.”  This usually refers to a judge because bankruptcy trials are before a judge rather than a jury.  However, in the rare case where there is a jury trial in a bankruptcy case, the term “trier of fact” refers to the jury.

Bankruptcy litigation is litigation that takes place in the bankruptcy court.  Some bankruptcy litigation deals explicitly with bankruptcy matters, or issues that arise from the Bankruptcy Code.  Other bankruptcy litigation has connections to nonbankruptcy law.  This is because when some bankruptcies are filed, there are nonbankruptcy matters that are closely related to the bankruptcy case.  Therefore, in these cases, the bankruptcy judge has to consider these nonbankruptcy matters as well.

It should be kept in mind that bankruptcy courts are courts of limited jurisdiction.  That is, they are federal courts that have jurisdiction over bankruptcy matters and matters that are related to bankruptcy.

In sum, bankruptcy litigation is about any dispute that is heard in a bankruptcy court.

What are the Common Types Of Disputes That Occur in a Bankruptcy Case?

1. Dischargeability Challenges

   One of the most common type of dispute is whether or not a certain debt can be discharged.

   In bankruptcy, some kinds of debts are dischargeable, meaning you are no longer responsible for them once the Court grants you a discharge.  Medical debts, for example, are viewed very sympathetically by bankruptcy courts, in part because of the unequal bargaining power associated with them.  Most credit card debt — unless there is something fraudulent going on — will also usually be discharged.

   Other kinds of debts will be much harder, if not impossible, to discharge.  Common examples include most tax debts, obligations to pay child support or alimony, and student loans.

   There are three kinds of debts that will be discharged unless a creditor successfully challenges their discharge:

   1. Debts incurred through fraud,
   2. Debts that are the result of a breach of fiduciary duty (including larceny and embezzlement), and
   3. Debts that are the result of doing willful and malicious harm to a person or property.

   If a creditor wants to challenge the discharge of a debt under one or some combination of these three theories, it must initiate an adversary proceeding.  The debt will still be discharged if the creditor loses the adversary proceeding.  However, if the creditor wins the adversary proceeding, the debt will not be discharged.

   One wrinkle in this rule has to do with different types of bankruptcy.  The same type of debt may be dischargeable in one type of bankruptcy, but not dischargeable in another.  For instance, there are some sorts of debt that are dischargeable in Chapter 13 bankruptcy, but not in Chapter 11 or Chapter 7 bankruptcy.  One of these types of debt is debt incurred through willful and malicious harm to property.  This sort of debt can be discharged in Chapter 13, but not in Chapter 11 or Chapter 7.

   Actions to determine whether or not a debt can be discharged are fairly common.

2. Claims Objections

   Another common type of dispute is a claim objection.  Let’s say a debtor is in a plan of reorganization, either in a Chapter 11 or a Chapter 13.  For a limited time after the debtor filed the bankruptcy petition, creditors can file proofs of claim.  When a creditor files a proof of claim, it asserts that the debtor owes it a certain amount of money, to be repaid through the reorganization plan.

   Creditors sometimes file grossly inflated proofs of claim, or claims that are barred by the statute of limitations.  If a claim is exaggerated, invalid, or otherwise objectionable, the debtor can challenge its legitimacy.  These challenges are not done via adversary proceeding.  Instead, they are done as a contested matter.  A contested matter is not a full-blown lawsuit, so it’s less complicated.

3. Property Valuation And Lien Stripping

   Under the right circumstances, a debtor can remove a judgment lien against an asset — most typically a residence.  And under the right circumstances, a debtor can remove a wholly unsecured junior mortgage.  In the current Southern California housing market, lien stripping is less common.  However, when the real estate market was depressed, it was done with some regularity

   One of the key factors in lien stripping — whether to remove a judgment lien, or to strip off a junior mortgage lien — is the value of the property.  If the property value is too high, the lien cannot be stripped.

   For example, if the goal is to strip off a junior mortgage from the debtor’s principal residence, then the mortgage lien must be wholly unsecured.  The debtor can’t bifurcate the lien into secured and unsecured portions.  Thus, if there is a dispute over the stripping of the lien, it is typically over the value of the property.

   These are the most common types of disputes that give rise to legal action in a bankruptcy court.  There are other types of disputes that arise from time to time — such as fraudulent transfer and preference avoidance actions, which I discuss in the next few segments — but these are the ones I see most frequently.

For more information on Litigation Over Bankruptcy Disputes, an initial consultation is your best next step.  Get the information and legal answers you are seeking by calling (562) 777-9159 today.