What is an Adversary Proceeding in Bankruptcy?
Bankruptcy, whether Chapter 7, Chapter 13, or Chapter 11, can be complex, and one facet of this complexity is that a trustee, creditor, or the debtor can file an adversary proceeding under specific provisions of the Bankruptcy Code. An adversary proceeding is a lawsuit that is related to the bankruptcy, but is still separate. Much like any other lawsuit, an adversary proceeding in bankruptcy is initiated by the filing of a Complaint – or a lawsuit, and once filed, the lawsuit proceeds as any other lawsuit, generally requiring a response to the lawsuit, discovery, dispositive motions, and trial.
What are the Bases for an Adversary Proceeding in Bankruptcy?
Pursuant to Bankruptcy Rule 7001, an adversary proceeding can be filed for the following proceedings:
- (1) a proceeding to recover money or property, other than a proceeding to compel the debtor to deliver property to the trustee, or a proceeding under §554(b) or §725 of the Code, Rule 2017, or Rule 6002;
- (2) a proceeding to determine the validity, priority, or extent of a lien or other interest in property, but not a proceeding under Rule 3012 or Rule 4003(d);
- (3) a proceeding to obtain approval under §363(h) for the sale of both the interest of the estate and of a co-owner in property;
- (4) a proceeding to object to or revoke a discharge, other than an objection to discharge under §§727(a)(8), (a)(9), or 1328(f);
- (5) a proceeding to revoke an order of confirmation of a chapter 11, chapter 12, or chapter 13 plan;
- (6) a proceeding to determine the dischargeability of a debt;
- (7) a proceeding to obtain an injunction or other equitable relief, except when a chapter 9, chapter 11, chapter 12, or chapter 13 plan provides for the relief;
- (8) a proceeding to subordinate any allowed claim or interest, except when a chapter 9, chapter 11, chapter 12, or chapter 13 plan provides for subordination;
- (9) a proceeding to obtain a declaratory judgment relating to any of the foregoing; or
- (10) a proceeding to determine a claim or cause of action removed under 28 U.S.C. §1452.
This non-exhaustive list encompasses many different kinds of lawsuits.
Common Examples of Adversary Proceedings in Bankruptcy
- 1. Objection to Dischargeability of a Debt
Under 11 U.S.C. § 523, there are certain kinds of debts that may not be subject to a discharge under bankruptcy. These include for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny and for willful and malicious injury by the debtor to another entity or to the property of another entity. For example, if a debtor misstated their income on a loan application and would not have received the loan without the misstatement, the debt could be the subject of an adversary proceeding under the code section.
- 2. Objections to Discharge
If a debtor hides assets or otherwise does fraudulent activity within the bankruptcy case itself, a trustee or a creditor can object to the entire discharge of the debtor, which is typically the goal of a bankruptcy. The bankruptcy discharge is a Court order that reduces or eliminates certain kinds of debt, and if successful, a trustee or creditor can prevent the debtor from receiving a discharge.
- 3. Violation of the Automatic Stay
If a creditor violates the automatic stay by taking collection action against property of the bankruptcy estate, the Bankruptcy Code allows the debtor to file an adversary proceeding against the creditor for violation of the automatic stay. A party filing an action for violations of the automatic stay can request attorneys’ fees and punitive damages, as the automatic stay is one of the most important facets of bankruptcy.
- 4. Violation of the Discharge Injunction
Similarly, if a creditor collects on a debt that was discharged in bankruptcy, the debtor can file an adversary proceeding against the creditor for violating the discharge injunction. The discharge order is a Court order that reduces or eliminates debt, and also serves as an injunction to prohibit collection of particular debts that arose before the bankruptcy case was filed. Similar to an adversary proceeding for violations of the automatic stay, a debtor can request attorneys’ fees and punitive damages for these violations as well.
- 5. Preferences
A bankruptcy trustee or a debtor-in-possession can file an action against a creditor to recover certain transfers made on account of a debt shortly before a bankruptcy case has been filed. Preferences generally include payments made to creditors within 90 days before the bankruptcy case is filed, and the period is extended to 1 year for payments made to insiders, or those who have a relationship to the debtor, such as a family member, relative or shareholder of the debtor.
- 6. Fraudulent Conveyances
Fraudulent conveyances are broader than preferences, but are another kind of adversary proceeding in bankruptcy that can be filed by a trustee or debtor-in-possession to recover funds for the benefit of the bankruptcy estate. In Maryland, the statute of limitations on a fraudulent conveyance lawsuit is 3 years. In order to provide a fraudulent conveyance, the party seeking to set aside the transfer must prove the following elements: 1) a conveyance; 2) the debtor either already is insolvent, or will be made insolvent by this conveyance; 3) the existence of a debtor-creditor relationship; and 4) lack of fair consideration.
Adversary proceedings in bankruptcy can have significant consequences for debtors and creditors alike. If you have questions about bankruptcy, please call Steiner Law Group at (410) 670-7060.