Getting sued by a creditor starts a very fast-ticking time bomb. You should and you CAN prevent this bomb from going off.

 

A Lawsuit Should Catch Your Attention AND Spur You to Action

For certain economic reasons, most conventional creditors don’t sue you as quickly as they legally could. That means that if you are getting sued you are very likely in some significant financial trouble. Even if you feel like there is nothing you can do, there almost always is, and you owe it to yourself to treat it as a wake-up call. You will feel better if you are proactive and at the very least understand your options, instead of just avoid the situation out of understandable fear or embarrassment.

Most debts that people get behind on are at some point—often quite quickly—assigned by the original creditors to collection agencies. This can happen two ways. Either the creditor still owns the rights to the debt and the collection agency simply gets a percentage of what it collects, or the creditor sells all of its rights to the debt to a collection agency and then is legally no longer in the picture.

Either way, the collection agency then tries to get you to pay the debt. In most situations it is reluctant to sue you—at least at first—because a lawsuit costs it money that it doesn’t know if it will ever recoup from you. Instead—again at least at first—it will tend to aggressively contact you and try to make you pay whatever it can. Depending on the facts of the situation—including whether you have a job or real estate or other assets—the collection agency will then decide whether it’s worth suing you. If you ARE sued, there’s a good chance that the collection agency believes it can force payment from you by garnishing your paycheck or bank account, or by putting a lien on your home or by attaching other assets. Once you are sued, the collector has upped the ante and is signaling that it believes investing in a lawsuit is worthwhile to it.

This is a signal you need to pay attention to right away.

The Game Collectors Play

Collection agencies act out of their own self-interest. They don’t generally sue you without doing a cost-benefit analysis: they don’t invest the cost of a lawsuit without thinking that the odds are good that they’ll get a decent return on that investment—getting those costs repaid and the debt as well. After all, a collection agency that wastes too much of its money on lawsuits that don’t pay off won’t be in business long.

So if you’re sued, most likely the collector has its eyes on one or more potential ways it expects to force you to pay—such as a paycheck to garnish, or some real estate to put a lien on (to foreclose on or get paid when you sell or refinance). Even if you are not working now, your prior work history may make you a decent target. The collector has decided it would benefit from forcing you to pay the debt by court order and enforcement—through garnishment, forcing you to appear for a judgment debtor examination, placing a judgment lien on your real estate, and such.

In fact the collection agency is banking on you not taking the lawsuit seriously enough. The sad truth is that a large majority of the time people don’t respond to lawsuits so that judgments are entered against them by default. The collector is hoping to get a judgment against you, and then to use the force of law to start grabbing your income and your assets.

How to Beat Collectors at This Game

Don’t assume that there is nothing you can do. Don’t take the seemingly common sense but wrong approach that you owe them the money and so you have to take whatever they dish out. Find out what they can and can’t do to you, and how you can protect yourself. And do that before the time expires and the creditor or collection agency gets its judgment against you.

Don’t let your creditors take advantage of you and your lack of knowledge.  Most consumer or bankruptcy attorneys will give you a free consultation with honest advice about your options. Learn what’s best for you in light of your own personal goals and hopes. You can and ought to have a proactive game plan.

Timing is Absolutely Crucial

When you find out you’ve been sued, there is very little time to respond. If you don’t in time, you lose the lawsuit “by default.”

The judgment that results is much more than simply an admission that you owe the debt. The formal complaint in most creditor lawsuits consist of a statement that you owe a debt, and now owe the full balance, plus the interest accrued so far and into the future, plus whatever attorney fees and other costs paid by the creditor/collector to sue you.

Letting a default judgment be entered against you makes you forever legally liable based on whatever allegations the creditor put into its complaint, even if inaccurate or not supported by your contract or by the law.

The complaint may include admissions that can be even more dangerous, for example, that you incurred the debt through fraud, potentially making the debt not dischargeable even in bankruptcy.

Reasons to Not Allow a Default Judgment

Quickly see an attorney as soon as you are sued because:

a) You should understand the consequences of the lawsuit, and your options for dealing with it. Know what your options are instead of assuming you have none.

b) You may have defenses so that you don’t legally owe the debt after all. Collection agencies routinely try to collect debts on which the statute of limitations has expired. They can sue the wrong person. They may include allegations which are not accurate or supported by law.

c) You may have a counterclaim—an argument that the creditor acted illegally in some way and actually owes you money for damages. At the least this could give you leverage to settle the debt under much better terms.

d) Once the time to respond expires and a judgment is entered, it is too late to deny the allegations in the complaint.   

e) By having an attorney review the lawsuit and your overall debt picture, and discuss your options, you may end up solving deeper problems. Most consumers do not have an attorney who they talk with regularly. So problems accumulate. You don’t have a chance to ask questions when they arise. This often leads to lots of confusion and anxiety. Seeing an attorney about a pending lawsuit could lead to addressing how to improve your entire financial life.  

 

Bankruptcy stops a wage garnishment instantly. Except local laws and the exact timing determines what happens to any current paycheck.

 

Federal Bankruptcy Law and State Garnishment Law

Bankruptcy is in the U.S. Constitution, which was ratified 226 years ago this month. The Constitution gives Congress the power to make laws about bankruptcy. So it’s a federal proceeding governed by federal law. But we live in a federalist form of government, meaning that governmental power is shared between the national government and that of the various states. The impact of state law on wage garnishments with the filing of a bankruptcy is a good example of the mix of federal and state law.

The Necessity of a Judgment

Except in rare circumstances (involving income taxes and student loans, mostly), your wages cannot be garnished to take money from you in payment of a consumer debt until after the creditor sues you in court and gets a judgment. That would almost happen in state court. A large percentage of the time when debtors are sued in this way, they do not respond by the legal deadlines, so creditors win their judgments by default. Once your creditor has such a state court judgment in hand, it must then follow state law in collecting on it.

Diverse State Laws

States’ garnishment laws vary widely. Most states permit wage garnishment in some form, but some restrict it to only special kinds of debts (like child support, taxes, and/or student loans). Other states which permit wage garnishment for most debts nevertheless may favor some of those same special debts. State laws also protect paychecks for debtors to a different degree through “exemptions.” And finally state laws differ on their timing details and other quirks of garnishment procedure, which are often critical for the question being faced here: how fast a bankruptcy filing stops a garnishment.

The “Automatic Stay”

Simultaneous with the filing of your bankruptcy case, the “automatic stay” goes into effect. The filing itself operates to stop virtually all collection activity against you. It operates as an immediate and one-sided court order against creditors, stopping the enforcement of a wage garnishment.

Complications of Timing

What if a bankruptcy case is filed at court within just a day or two after the money has been taken out of your wages under a court garnishment order but not yet turned over by your payroll office to the creditor? What does the automatic stay require when it says that the bankruptcy filing stops “the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the [bankruptcy] case”? (Section 362 (a)(2) of the Bankruptcy Code.)

Money that was taken out of your paycheck before your bankruptcy case was filed is not “property of the estate”—which is essentially all your assets at the moment your case is filed. But arguably it’s not your money to keep either because it was already legitimately taken from you by the garnishment order at the time your bankruptcy case was filed.

So can the creditor get that money that your employer is holding, or would that be a violation of the automatic stay? The answer likely turns on a careful reading of your state garnishment law—the statute itself plus possibly how the state’s courts have interpreted that statutory language.

Practically Speaking

Many creditors tend to be cautious about violating the automatic stay, and may back off when there is some legal ambiguity about whether it is entitled to funds from a garnished paycheck. Other creditors are more willing to be aggressive, especially if the state’s statutes and/or courts have given them some cover to do so.

To state the obvious, do what you can to avoid this whole situation by seeing an attorney in time so that your bankruptcy case can be filed before your payday, so that the wage garnishment can definitely be stopped in time.

 

Chapter 13 “adjustment of debts” goes a big step further than a Chapter 7 case by protecting your co-signers and their assets.

 

The Regular “Automatic Stay”

The automatic stay—your protection against just about all collection efforts by your creditors—kicks in just as soon as your bankruptcy case is filed. It applies to all bankruptcy cases, including those filed under Chapter 7 and Chapter 13. It is one of the most powerful and important benefits of filing a bankruptcy case.

But it protects only you—the person or persons filing bankruptcy—and your assets. It does not protect anybody else who may also be legally liable on one of your debts.

The Very Special “Co-Debtor Stay”

The very first section of Chapter 13—Section 1301—also deals with the automatic stay, but adds another layer of protection—applicable to your “co-debtors, or co-signers—that only applies to cases filed under Chapter 13.

Section 1301 states that once a Chapter 13 case is filed, “a creditor may not act, or commence or continue any civil action, to collect all or any part of a consumer debt of the debtor from any other individual that is liable on such debt with the debtor.” (Emphasis added.)

A creditor on a consumer debt is already prevented by the regular automatic stay from doing anything to collect a debt directly from the debtor. Now, under Chapter 13 only, and only on consumer debts, that creditor is also prevented from collecting on the same debt from anybody else who has co-signed or is otherwise also obligated to pay that debt.

A Very Special Protection

If you think about it, that’s rather powerful, and quite unusual. The person being protected—your co-signer—has nothing to do with your bankruptcy case filing. The co-debtor stay gives you the power to protect that person—likely somebody you really care about—who is not filing bankruptcy and so is not under the direct jurisdiction of the court. The person may not even know that you are protecting them from the creditor.

Conditions and Limits of the Co-Debtor Stay

Besides being limited to consumer (not business) debts, the “co-debtor” protection:

1. Does not protect spouses from joint liability on income taxes. That’s because income tax debts are not considered “consumer debts” for this purpose.

2. This protection does not extend to those who “became liable on… such debt in the ordinary course of such individual’s business.”

3. Creditors can ask for and get permission to pursue your co-debtor to the extent that:

(a)  the co-debtor had received the benefit of the loan or whatever “consideration” was provided by the creditor (instead of the person filing the bankruptcy)—in effect that you were co-signing for him or her; or  

(b)  the Chapter 13 plan “proposes not to pay such claim.”

4. Even if a creditor does not seek or get the above permission, this co-debtor stay expires as soon as the Chapter 13 case is completed, or if it’s dismissed (for failure to make the plan payments, for example), or converted into a Chapter 7 case.

Conclusion

Choosing between Chapter 7 and 13 often involves weighing a series of considerations. If you want to protect a co-signer or someone liable on a debt with you from being pursued for that debt, seriously consider Chapter 13 because of the co-debtor stay. 

 

Eligibility depends on 1) the kind of debtor, 2) the kinds and amounts of debts, 3) the amount of income and 4) of expenses.

 

1) The Kind of Debtor

If you are a human person, you may be eligible for either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts” case. You and your spouse may also be eligible to file one or the other of these together in a joint case.

However, if you are the owner or part-owner of a business partnership, corporation, limited liability company or other similar business entity, that business entity could not file its own Chapter 13 case. But it could file a Chapter 7 one. Regardless what your business entity itself could file, you could individually file either a Chapter 7 or 13 case, to address your own personal liabilities (beyond whatever liability for which the business itself would be responsible).

2) The Kinds and Amounts of Debts

If your debts are “primarily consumer debts” (more than 50% by dollar amount), then to be able to file a successful Chapter 7 case you have to pass the “means test.” That’s a test related to your income and expenses (discussed more below.)  If 50% or more of your debts are not consumer debts, than you can skip the “means test.”

Chapter 7 does not limit the amount of debt you can have to be eligible to file a case. However, you cannot file a Chapter 13 case if your debts exceed the maximums of $383,175 in unsecured debts and $1,149,525 in secured debts (or if you do file a case it will very likely be “dismissed” (thrown  out)).

3) Amount of Income

You can quickly and easily satisfy the “means test” and be eligible for a Chapter 7 case if your income is no more than the regularly adjusted and published “median income” for your family size and state.

To be eligible for Chapter 13 you must have “regular income.” That is defined not very helpfully as income “sufficiently stable and regular” to enable you to “make payments under a [Chapter 13] plan.”

Also for Chapter 13, if your income is less than the “median income” for your family size and state of residence, then the plan generally must last a minimum of three years (but in many situations it can last longer, especially if you need it to, but for no longer than five years). If your income is at or above the applicable “median income” amount, the plan must almost always last five years.

4) The Amount of Expenses

In Chapter 7, if your income is NOT less than “median income” for your family size and state of residence, then you may still pass the “means test” and be eligible for filing a Chapter 7 case IF, after accounting for all your allowed expenses, you don’t have enough money left over to pay a meaningful amount to your creditors.

In Chapter 13, a similar accounting of your allowed expenses determines the amount of your “disposable income,” the amount you must pay into your plan each month.

Summary

Once you recognize that you need relief from your creditors, choosing between Chapter 7 and 13 is often not difficult. But because there are many, many differences between them, the choice can sometimes turn into a delicate balancing act between the advantages and disadvantages of those two options. That’s why when you have your initial meeting with your bankruptcy attorney, it’s smart to be aware of and communicate your goals, but also be open-minded about how best to accomplish them.

 

A creditor can challenge the discharge of its debt in bankruptcy. This is not common, but is more so after a debtor closes a business.

 

Why Creditor Challenges Are More Common in Closed-Business Bankruptcies

For the following reasons, creditors tend to object more to the discharge of their debts in bankruptcy cases that are filed after the debtor has operated and closed a business:

  • The amount of debt owed, and thus the amount at stake, tends to be larger than in a conventional consumer case, making objection more tempting to the creditor.
  • In the business context some debtor-creditor relationships can be very personal, so when the business fails, these creditors take it personally. Consider debts between former business-partners who are blaming each other for the failure of the business, or between a business owner and the business’ primary investor who believes the owner drove the business into the ground, or between the contract buyer of a business and its seller in which the buyer feels that the seller misrepresented the profitability of the business. In these situations the aggrieved creditor is more personally motivated to fight the discharge of its debt.
  • The owners of businesses in trouble find themselves desperate to keep their businesses afloat. So they make questionable decisions which then expose them to objections about fraud and such once they file bankruptcy.
  • In the kinds of close creditor-debtor relationships mentioned above, the creditor often has hints about the business owner’s questionable behavior, and so is more likely to believe it has the legally necessary grounds to object.

But Objections to Discharge Are Still Not Very Common

When former business owners hear that any creditor can raise objections to the discharge of its debt, they figure an objection would very likely be raised in their case. But in reality these objections occur much less frequently than might be expected, for the following reasons:

  • The legal grounds under which challenges to discharge must be raised are quite narrow. To be successful a creditor has to prove that the debtor engaged in rather egregious behavior, such as fraud in incurring the debt, embezzlement, larceny, fraud as a fiduciary, or intentional and malicious injury to property. These are not easy to prove, so creditors do not tend to try unless they have a strong case.
  • In his or her bankruptcy case the debtor publically files a set of papers containing quite extensive information about his or her finances, and does so under oath. The debtor is also subject to questioning by the creditors about that information and about anything else relevant to the discharge of his or her debts. If the information on the sworn documents or gleaned from any questioning reveals that the debtor truly has no assets worth pursuing, a rational creditor will often decide not to throw “good money after bad” by raising an objection.

Conclusion

In a closed-business bankruptcy case there are these two opposing tendencies. Challenges to discharge are more likely, especially by certain kinds of closely related creditors. But these challenges are still relatively rare because of the narrow legal grounds for them and the financial practicalities involved. A good bankruptcy attorney will advise you about this, will prepare your bankruptcy paperwork to discourage such challenges, and will help derail any such challenges if any are raised.