The Best Interest of Creditors in Bankruptcy Law

Unless you are in the business of lending money to others, most of you might not think there is such a thing as a best interest of creditors, even when it comes to bankruptcy. The truth is that bankruptcy laws have been passed to make a level playing field for both creditors and debtors. Therefore, there is actually a bankruptcy law that looks after the best interest of creditors in the bankruptcy process.

English: Page 3 of 3, Official Receiver report...

Receiver report to creditors (Photo credit: Wikipedia)

When you are financially bankrupt and wanting to make a fresh financial start, you are allowed by bankruptcy laws to file for bankruptcy protection. Filing for bankruptcy protection allows you under certain circumstances to keep a portion of your assets. Depending on your financial situation, a bankruptcy court may discharge all of your unsecured debts held by creditors, or you may make a financial reorganization plan through the bankruptcy court to pay all or a portion of your creditors who hold your unsecured debts.

Bankruptcy laws simply help both creditors and debtors to fairly deal with a bad financial situation when it evolves. Some creditors might think it is unfair for a client to be protected by bankruptcy laws that allow a debtor to walk away from a lending contract. The truth is most all creditors are aware of the risks involved when extending credit to their clients. Most creditors spend a certain amount of time and money investigating their client’s credit trustworthiness before they ever risk giving them credit; most understand credit and bankruptcy laws; and others build in the cost of bad debts when extending loans, so their new clients in effect pay for the bad debts of others.

Nevertheless,bankruptcy law has been passed with a distinct responsibility of protecting creditors as well as their debtors. Congress must have realized the importance of honoring a contract if at all possible when it passed the best interest of the creditors section of the Bankruptcy Code.

Title 11 of the Bankruptcy Code, section 1325(a)(4) reads: “the value, as of the effective date of the [chapter 13] plan, of property to be distributed under the plan on account of each allowed unsecured claim is not less than the amount that would be paid on such claim if the estate of the debtor were liquidated under chapter 7 of this title on such date.”

This section of the code is often referred in bankruptcy circles as “the liquidation test,” or another way of putting it is “best interest of creditors test.” Basically, this law requires unsecured creditors in a chapter 13 case be paid at least as much through a confirmation of a proposed chapter 13 plan as they would have received had the debtor’s assets been liquidated under a chapter 7 of the Bankruptcy Code.

This particular law helps protect creditors’ interests from a filing debtor who wants to keep as many of his assets as possible through filing a chapter 13 bankruptcy. In a chapter 13 bankruptcy, a qualifying debtor must pay as much of his disposable income allowed by bankruptcy law up to 100% pay back of the unsecured principal of debt owed. This bankruptcy law, to me, seems to have been passed in the best interest of creditors.

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