In addition to the underlying bankruptcy proceeding, a lawsuit might arise during the course of a bankruptcy that relates to the bankruptcy but is handled separately. This is known as an adversary proceeding. A debtor, a creditor, or the trustee can initiate an adversary proceeding when they want to accomplish something that cannot be achieved by filing a motion within the bankruptcy case. For example, they might want to object to a discharge, get an injunction, obtain a ruling on whether a debt can be discharged, or pursue money from a party not in the bankruptcy proceeding.
A party involved in a bankruptcy case can start an adversary proceeding by filing a complaint. This will describe the basis for the lawsuit and ask the court to provide a remedy for this party, known as the plaintiff. Also, the plaintiff will need to serve the complaint and the summons issued by the court on the defendant in the lawsuit.
Stages of an Adversary Proceeding
If the defendant wants to oppose the lawsuit, they will need to file an answer in response to the complaint within the required time period. Otherwise, the court will issue a default judgment in the plaintiff’s favor.
Assuming that the defendant responds to the complaint, each party will go through the discovery process. This may involve depositions, interrogatories, requests for admissions, and other litigation tools designed to gather information from the other party. Once each side has a clearer sense of the strength of their position, they may be able to resolve the dispute outside court. Mediation might be effective, or the parties might be able to reach a mutually acceptable settlement. If they cannot reach an understanding outside court, they will need to go through a trial before a judge or jury. This will follow formal rules of evidence and procedure. The judge or jury then will issue a verdict in favor of one side or the other. The losing party has a right to appeal if they believe that there was an error in the process.
When an Adversary Proceeding Might Happen
Many adversary proceedings arise from alleged fraud by a debtor. If it appears that a debtor has committed fraud or violated a court order, the trustee or creditors might file an objection to the debtor’s discharge. (You can read more here about these situations.) Also, if the debtor transferred money or property to someone else two years or less before they filed for bankruptcy, the trustee might file an adversary proceeding to allege fraud by the debtor. Another situation in which an adversary proceeding based on the debtor’s alleged fraud might arise is when a creditor argues that the debtor incurred a debt fraudulently, which would make it a non-dischargeable debt.
A trustee also might bring an adversary proceeding based on an allegedly preferential transfer. If you repaid more than $600 to any creditor within 90 days before filing for bankruptcy, you might face this type of complaint. The trustee would need to show that you were insolvent when you transferred the property, the creditor did not give you anything in exchange, and the creditor received more than it would have been entitled to obtain under a Chapter 7 bankruptcy. A transfer to a family member can be challenged if it occurred at any time within one year before the debtor filed for bankruptcy.
Sometimes an adversary proceeding will arise when a debtor owns property with someone else. The trustee may need to bring a lawsuit to divide your interest in the property from the interest of the co-owner so that they can force a sale and take the proceeds to pay your creditors. Another situation in which an adversary proceeding may arise related to real estate is when a debtor files a lawsuit to remove junior mortgages from their home under Chapter 13. This would allow them to be treated as unsecured debts. (Read more here about when lien stripping may be appropriate.)
Certain types of disputes can be resolved more efficiently within the bankruptcy proceeding, rather than by filing a separate lawsuit. These usually do not require substantial discovery. A judge can simply make a ruling based on a motion by a party. For example, a contested matter might arise when a debtor seeks to modify a Chapter 13 repayment plan, a creditor seeks to lift the automatic stay, or a party objects to a creditor’s proof of claim.
While adversary proceedings adhere to the Federal Rules of Bankruptcy Procedure, which are similar to the Federal Rules of Civil Procedure, Rule 9014 governs contested matters. This is similar but not identical to the rules governing adversary proceedings. Sometimes a judge will convert a contested matter into an adversary proceeding if they feel that this is appropriate.