Bankruptcy – what it is and how it works

When people are being sued for debts, they often panic and look for the quickest, easiest, or least scary way out. Bankruptcy sometimes seems to be that way. What is bankruptcy? and how does it work? How does it affect some of your other rights?

What Bankruptcy is

Most people have an intuitive idea of what bankruptcy is – legal protection for people who are broke, right?

Sort of.

Bankruptcy is at least equally a protection for creditors. You see, when people are financially troubled, this doesn’t mean that they literally have NOTHING. Rather, they will spend or distribute an inadequate number of resourses in a way to relieve them of the most pressure, or to favor people they want to favor. Bankruptcy exists to help prioritize and organize the ways debtors distribute their money so as to protect the creditors from favoritism or sneaky behavior. It does protect the debtor (person declaring bankruptcy) from all lawsuits or judgments, and this in turn spares the creditors from having to “race to the courthouse” to file suits against the financially weakened.

That makes good sense, right? So shouldn’t anybody with debt troubles dive into bankruptcy?

Price of Bankruptcy

Bankruptcy is not a “free lunch” to debtors. It can be expensive to do, and over the past decade or two has been made much trickier to get in and finish. It is also extremely intrusive and occasionally time-consuming. It also does not protect you from all claims, notably those associated with “secured” debts – debts like home and auto loans.

In my opinion, bankruptcy is RARELY a good first option for people being sued for debts, especially if they’re being sued by debt collectors. On the other hand, if you expect to negotiate with a debt collector or creditor in any way, our position is that you should consult a bankruptcy lawyer. You should know what it costs and requires, and letting a debt collector know you’ve actually talked to a bankruptcy lawyer can have a wonderful effect on their willingness to accept lower amounts of money.

Issues in Bankruptcy

Perhaps surprisingly, bankruptcy and debt law are not closely related, and lawyers who practice one kind of law rarely know much about the other. Unless your lawyer (if you have one) actually practices both types of law, he or she is probably not qualified to give you advice about the area in which he does NOT regularly practice.

Bankruptcy and FDCPA

Another issue comes from the interaction of bankruptcy and debt laws. This isn’t uniform, consistent, or particularly fair. In some jurisdictions, for example, if you declare bankruptcy, creditors will come out of the woodwork to file “claims” against the bankruptcy estate. It would be illegal for them to sue you, but in SOME courts it’s fine for them to litigate against you in bankruptcy. This is plan stupid and bad, but some federal appeals courts allow it while others make it a violation of the Fair Debt Collection Practices Act (FDCPA). The Supreme Court has not addressed the issue yet.

Bankruptcy and Student Debt

The courts are even less consistent or fair when it comes to student debt. If most of your debt problem comes from heavy student loans, bankruptcy may not offer you much help. They are treated differently from almost all other debts, and in many courts they are almost impossible to shake off. Strangely, perhaps, this issue has not been organized or even considered very much by bankruptcy or debt lawyers. I have addressed the issue in Getting Out of the Trap of Student Loans. That book discusses the way bankruptcy law and student loans collide and, on a federal circuit by circuit basis, what your chances of escaping the trap might be.

Against Debt Collectors

Our view on suits brought by debt collectors is that bankruptcy is rarely a good first option – and only sometimes a good last option. However, you should know that, if bankruptcy will work for you at all, it will work for you just about as well even if the debt collector has obtained a judgment. That is, bankruptcy protection applies to state court judgments as much as any other kind of debt, alleged or proven. Thus you could defend yourself pro se and, if you lost (as very few of our members do), you would still be able to declare bankruptcy if it would help.

Bankrupts Beware – FDCPA No Longer Applies to Claims

Bankruptcy has been one refuge debtors have from debt collectors, but the Supreme Court has recently made things much worse. In Midland Funding, LLC v. Johnson, No. 16-348 (Slip Op. 5-15-17), the Court held that filing claims in bankruptcy court on debts that are beyond the statute of limitations does not violate the Fair Debt Collection Practices Act (FDCPA). If you are in bankruptcy or considering it, this is huge.

Opening the Floodgates to Bad Claims

What Bankruptcy Does

In general, if your debts get too bad, you can file bankruptcy and force all your creditors to stop contacting you. They have to file claims in your bankruptcy action, and the court will either grant those claims or deny them. The court then determines the amount of payments you must make, over what period of time, and you do your best to do that.

It isn’t an easy path, and in fact most bankruptcies are dissolved without “discharge.” That is, most bankruptcies end without accomplishing their purpose. Obviously, the less money you have to pay, and the shorter the period you have to make payments, the better your chances of getting what you wanted out of bankruptcy in the first place: a “fresh start.”

The dirty little secret of bankruptcy, though, is that if claims are not disputed, they are generally granted. In bankruptcy cases brought by poor people (you can bet Donald Trump never had this problem), the lawyers representing the bankrupts have little (personal) incentive to dispute wrongful claims because they’re being paid out of the scanty resources of their clients. There’s a U.S. trustee who is supposed to oversee the process and protect the bankrupt and legitimate creditors from bad claims, but guess what?

They often don’t. Likewise, the court should attempt to winnow out bad claims, but given the number of bankruptcies and their complexity, this often does not happen.

In most bankruptcies, allowing a bad claim means that it’s going to get paid (eventually) by the person filing for bankruptcy. Under current realities, that means a lot of bad claims get paid by poor people.

Enter the junk debt buyers to make things much worse. They buy vast amounts of LONG overdue debt – debt far beyond the statute of limitations – and file claims in bankruptcy cases. This bogs the bankruptcy courts, the trustees, and bankruptcy lawyers down. The more bad claims they file, the more get through because of carelessness. They should NEVER get through, because an unenforceable claim should ALWAYS be denied under bankruptcy rules.

Bad claims hurt the chances of the bankrupts to get their fresh start, hurt the chances of the legitimate creditors to get paid, and incidentally makes the whole process stink to high heaven of injustice. Concern about this obvious corruption of the entire process, incidentally, is not just liberal “blather.” The courts jealously guard their claims to legitimacy – legitimacy is essential to their ability to work at all. Allowing a bunch of hoodlums in fancy suits to steal wholesale from the poor damages the legal system at its very core.

The FDCPA used to offer some protection against that, but the Supreme Court negated that protection with its holding in Midland Funding, LLC v. Johnson, No. 16-348 (Slip Op. 5-15-17). In that case, the Court ruled that debt collectors could file claims in bankruptcy that would be illegal if filed in other courts.

Midland Funding, LLC v. Johnson

The relevant facts in Midland Funding are very simple. Midland, a junk debt buyer, was buying extremely old debts for very small amounts of money. They were using these debts, which were far beyond the statutes of limitations, as the basis for many claims in bankruptcy. Johnson opposed and had the claim in that case disallowed, and then filed suit in district court under the FDCPA, alleging that the claim had been unfair or unconscionable. The essence of Johnson’s claim was that filing obviously time-barred claims in a bankruptcy proceeding was an unfair debt collection practice.

The Supreme Court ruled that it was not.

There is no need to review (here) the tortured logic that effectively immunizes from consequences the intentional doing of something that never, under any circumstances, should be allowed. The state of the law simply is this: debt collectors can file obviously unenforceable claims in bankruptcy without worrying about the FDCPA.

There is perhaps one glimmer of light in this very bad decision. The Supreme Court was addressing “obviously outdated” claims. What Midland was doing was buying obviously unenforceable claims and hoping they would be overlooked and erroneously allowed. While this obviousness is one main way a debt collector’s intention to file outdated claims would be known, the obviousness was also a reason the Court found that the claims were not “deceptive.” What if the claims were known to be outdated by the debt collector but were not obviously so? Facts like that, or similar facts tending to show some actual intent to deceive would present difficult evidentiary issues, but the case could arise and might tip the balance in the other direction.

Conclusion

What the Midland Funding case means, in practical effect, however, is that even if you’re in bankruptcy you’re going to have to know and protect your own rights. Your lawyer has VERY LITTLE incentive to challenge bad claims, and the U.S. Trustee has VERY LITTLE time (or incentive) to do it. If the claims are allowed, you will be stuck paying them in all likelihood. That means that even if you file for bankruptcy you must be prepared to defend yourself against the debt collectors. You will AT LEAST need to know your rights, and you will very probably have to defend them pro se. You’re probably not going to get much help from your lawyer on this one.

Bankruptcy Might Not be the Best Choice

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