Bankruptcy is a path to a new financial beginning for many. However, when pursuing bankruptcy discharge, disputes can arise, resulting in an adversary proceeding. If you are considering filing for bankruptcy in California, these proceedings can affect everything from what is discharged in your bankruptcy case to what collections the creditor or trustee could pursue.
Creditors, bankruptcy trustees, or debtors can initiate adversary proceedings. Adversary proceedings differ from regular bankruptcy matters, which are resolved by motions and hearings without filing formal lawsuits. This blog explains when and how adversary proceedings occur and what they mean for your case.
Contested Matters Versus Adversary Proceedings
Not all disputes in a California bankruptcy case are considered adversary proceedings. Contested matters are those resolved in simpler processes and are less formal than adversary proceedings.
Contested matters occur when a party to the bankruptcy case, such as a debtor, bankruptcy trustee, or creditor, challenges some aspect(s) of the case. These challenges can include objections to creditors' claims and to those seeking relief of the automatic stay, which prevents creditors from pursuing collections when the bankruptcy case progresses.
In contested matters, disputes are often resolved through motion practice. Both sides file documents supporting their positions, and the judge rules after a hearing. Contested matters are faster and less expensive than adversary proceedings because no separate lawsuit exists.
On the contrary, adversary proceedings are full-blown lawsuits within the bankruptcy case. They are similar to civil litigation because they begin with a complaint, proceeding to discovery, trial, and judgment. You could use it for adversary proceedings if the problem is complex. For example, when your creditor alleges you have defrauded them or asks the court to deny the dischargeability of some debts.
Such proceedings are usually more time-consuming and difficult to get through as the rules of civil procedure apply to them, and they involve more formal legal steps. An adversary proceeding can result in a denial of discharge or ordering you to repay debts that would otherwise have been discharged.
Cases Filed as an Adversary Proceeding
If you file for bankruptcy in California, you may think the process only entails paperwork and hearings. However, some problems are beyond administrative matters and require adversary proceedings. These lawsuits are part of your bankruptcy case that normal motion practice cannot resolve. Creditors, trustees, or even you, the debtor, can file adversary proceedings if a part of your bankruptcy case needs more legal scrutiny.
For example, if a creditor alleges that you committed fraud in acquiring a debt, he may bring an adversary proceeding to prevent that debt from being discharged. Adversary proceedings also arise when there is a question as to whether a particular debt should be discharged. These proceedings also resolve disputes over property, liens, or even claims you made fraudulent transfers before filing for bankruptcy.
A common scenario is that a trustee will challenge some of the transactions you made before you filed for bankruptcy. However, if you transferred property to a family member or another third party to protect property from creditors, the trustee may do an adversary proceeding to bring those assets to creditors. A lawsuit of this type can make it more difficult for you to get any form of debt relief through bankruptcy because it adds extra legal hurdles you must jump through.
Another kind of adversary proceeding challenges the automatic stay that pauses creditors from pursuing collections on debts once you file for bankruptcy. However, creditors may bring an adversary proceeding to remove this stay if they feel their interests are not protected. For example, if you have fallen behind on your mortgage payments and a creditor wants to foreclose on your home even though you filed for bankruptcy, they could ask to have the stay lifted through an adversary proceeding so they can foreclose it.
Common Types of Adversary Proceedings
Bankruptcy adversary proceedings are not one size fits all. They arise in several contexts, and each has its challenges. When pursuing your bankruptcy case in California, you encounter several adversary proceedings that deal with specific legal disputes. These proceedings make your case even more complicated, so you should have a strategic approach to achieve a favorable outcome. Some of the most common adversary proceedings you might encounter are explained below.
Fraudulent Transfers
You commit a fraudulent transfer when you change your asset ownership just before filing for bankruptcy to prevent creditors from pursuing collections. Because these transfers can be viewed as an attempt to avoid your financial obligations, bankruptcy trustees can sue to recover them. If a trustee believes you made such a transfer, they will bring an adversary proceeding to return the asset to the bankruptcy estate.
For example, you may sell a valuable piece of property to a family member for far less than its actual value before you file for bankruptcy. The trustee may contend that the transfer was fraudulent to thwart creditors' access to the property's value. If the court agrees, the transaction will be reversed, and the property will be returned to the estate. This means the assets up for distribution are fairly shared among the creditors.
Fraudulent transfer cases often focus on the timing and intent behind the transaction. State laws may allow trustees to go back beyond two years, but transfers made within two years of filing are scrutinized closely. The question the court will consider is whether or not you got fair market value and whether or not you were insolvent at the time of the transfer. These factors will also point out whether this transaction was done to defraud the creditors.
Preferential Transfers
When you pay one creditor more than your fair share of your debt before filing for bankruptcy, you give them an unfair advantage over others, which is called a preferential transfer. When you make payments to a particular creditor shortly before filing, the trustee may perceive this as an attempt to favor one creditor over others and may refuse to accept your payments.
The trustee will initiate an adversary proceeding to recover those payments and re-allocate them to all creditors.
For example, paying off a large portion of a personal loan to a family member within 90 days before filing could be a preferential transfer. The court would consider this repayment to favor that creditor (your family member) over others (credit card companies or medical debt holders). If the trustee can prove it was a preferential transfer, they can recover the payment and divide it among all creditors according to bankruptcy rules.
Preferential transfers typically fall under two timeframes, including:
- Payments to 'general creditors' within 90 days of filing
- Payments to 'insiders' (such as family members or business partners) within one year of filing
The issue is whether the payment was to one creditor and gave them more than they would have under a normal bankruptcy distribution. The court uses this principle to determine whether the payment should be reversed to maintain fairness in the process.
Lien Stripping
Lien stripping is a powerful tool in bankruptcy, especially in Chapter 13, that allows you to remove, or strip off, certain liens on your property, reducing the secured debt you owe. Most of this process happens with second mortgages or home equity lines of credit where the value of your home is less than the amount owed on the first mortgage. If your home is underwater (your first mortgage is greater than the property's value), the second lien can be removed because there is no equity to secure it.
In practice, lien stripping begins with filing a motion in your bankruptcy case, which often begins an adversary proceeding. You or your attorney must prove that the property's value is less than the balance on the first mortgage. Once the court agrees, a second lienholder's claim becomes unsecured, and they can no longer foreclose on your home if you default. The debt of an unsecured creditor can be discharged or greatly reduced in your bankruptcy plan.
For example, you have a first mortgage of $300,000 and a second mortgage of $50,000, but your home is only worth $280,000. In this case, lien stripping would get rid of the second mortgage. That $50,000 would be treated as unsecured debt, and you would treat it as unsecured debt, which could be reduced or eliminated as part of your bankruptcy discharge. Nevertheless, lien stripping is not automatic, and creditors may contest it through litigation in an adversary proceeding.
Dischargeability of Debt
Bankruptcy is all about the dischargeability of debt or whether or not some debts can be wiped out and you are free of future obligations. Not all debts are dischargeable; in some cases, an adversary proceeding may be necessary to decide what debts are dischargeable. Not all debts are dischargeable; sometimes, an adversary proceeding may be necessary to determine what. Creditors and trustees may initiate this proceeding, or you (the debtor) may challenge or confirm the dischargeability of a specific debt.
Most unsecured debts, including credit card balances and medical bills, are dischargeable. However, if you cannot show the court extraordinary circumstances, loan debts, including student loans, recent tax debts, or child support, are typically only discharged. Dischargeability is often at issue in an adversary proceeding when creditors believe their debt should not be erased.
If a creditor claims the debt involves fraud, it can file a complaint with the bankruptcy court to block the debtor's discharge. Such litigation is usually handled under the rules governing adversary proceedings.
If the court finds it in your favor, the debt will be discharged, and you can exit bankruptcy without paying. In the bankruptcy case, if the court rules in favor of the creditor, the debt continues to exist, and you will be expected to pay it off.
Sale Of Property Jointly Owned By The Debtor
If you file for bankruptcy, the sale of property you own jointly with another party can become contentious. Sometimes, the bankruptcy trustee may try to sell the jointly owned property to pay your debts. Often, this results in an adversary proceeding, especially when the co-owner is not a debtor and objects to the sale. However, in these cases, the court must decide what interests of the non-debtor co-owner should be balanced with your creditors' interests.
Selling the property is in the best interest of the bankruptcy estate, the court will usually assess. The trustee will argue that the sale is justified if the property has significant equity that could be used to pay your debts. However, selling joint property is a process that takes time, and several factors must be considered.
For example, the trustee must show that selling your share of the property would be better for the bankruptcy estate than leaving it alone. The court will also consider the hardship the sale would cause the non-debtor co-owner.
If the sale is approved, the co-owner will receive his share of the proceeds, and you will receive yours to pay creditors.
Objection to Discharge
During the bankruptcy process, you may be subject to objections to your discharge (the court's formal forgiveness of your debts). Under certain circumstances, creditors, or sometimes the bankruptcy trustee, can challenge your discharge. This is not a formality; it could negatively impact your financial future. An objection filed leads to an adversary proceeding where the court considers whether the claim had merit against you.
The objections are usually raised for fear of fraudulent behavior or hiding assets. A creditor may oppose your bankruptcy if they believe you have engaged in dishonest practices such as transferring property to friends or family to avoid including the property in the bankruptcy estate. Also, if you do not comply with the court’s requirements, such as not supplying the documents required, you could be objecting.
The burden of proof resides on the party objecting. They have to prove their claims. If the objecting party wins, you may be denied a discharge of your debts. That means you are still responsible for the debts listed in your bankruptcy petition, and you may end up right back where you started with bankruptcy financially.
Preparation is key to countering an objection. A competent bankruptcy attorney can help you obtain the evidence and have a good defense. They will walk you through the intricacies of the adversary proceeding and will protect your rights.
How an Adversary Proceeding Works
When an adversary proceeding is initiated, several key players are involved, each with a distinct role. You will encounter trustees, creditors, and debtors, each with their own perspectives.
Trustees
Trustees are central to the functioning of adversary proceedings in bankruptcy. You will find that the trustee acts in a neutral as well as position when overseeing the bankruptcy case, and the laws obey the matters. Their main duty is to handle the estate of bankruptcy, which means liquidating nonexempt assets and spreading the proceeds to creditors.
However, the trustee's involvement becomes more pronounced when an adversary proceeding arises. If they suspect fraudulent transfers or want to dispute a claim put against them by a creditor, they may initiate a complaint. This is because by doing so, the trustee ensures the interests of all creditors with care to provide fairness in the distribution of assets in their distribution to creditors. Their knowledge of the debtor’s financial situation helps to give context to the court and helps to clarify the legitimacy of the claims being made.
In addition, the trustee helps the parties communicate with each other. You need to know what the trustee does if you are a debtor. When they bring you into this process, they will ask you for all kinds of documents and information to ascertain whether or not the claims made against you are real. You must cooperate because it can greatly affect how the adversary proceeds. In that sense, the linchpin of this process is the trustee: balancing the interests of all parties toward a just resolution.
Creditors
In adversary proceedings, a creditor is not simply a passive observer but an active participant with interests and rights central to the proceeding. As you walk through the maze of a debtor's bankruptcy case, you might be a creditor, weighed down with financial uncertainty. Knowing your role can greatly impact how you interact with the process.
What that means for you as a creditor is that you can file claims against the debtor's estate. Your goal is straightforward: to recover the amounts you are owed. But the path isn't always clear-cut. You may be called by an adversary proceeding to dispute the validity of some of the debts or the debtor's claims to the financial obligations. Given the importance of your involvement, the court must consider your interests and those of all other parties.
You may also be able to appear at hearings and give testimony about your claims. You have to prepare well because your insights can change the course of the proceedings. Your input is the trustee's guidance in deciding whether claims are valid and whether creditors are treated equally.
In addition, you can object if the debtor tries to discharge a debt you believe should not be discharged. Your persistence in pursuing this matter can challenge safeguarding your financial interests.
Consult a Bankruptcy Attorney Near Me
Adversary proceedings in bankruptcy cases can be complicated. This necessitates working with a knowledgeable bankruptcy attorney to handle possible disputes. These proceedings can have a huge impact on your financial future, whether you are a debtor being challenged by a discharge or a creditor wanting you to pay back the money you owe.
You can try to handle an adversary proceeding alone, but it can be costly and lead to misunderstandings and unfavorable outcomes. At the San Diego Bankruptcy Attorney, we deeply understand the bankruptcy law, including adversary proceedings. Call us today at 619-488-6168, and we will fight for your rights and the best possible result for your situation.
