Sheehan & Associates, P.L.C.

Notice of an adversary bankruptcy proceeding: What's next?

Most bankruptcies go forward fairly smoothly—unless a debtor receives notice that he or she is facing an adversary proceeding, which means a creditor wants the bankruptcy judge to deny the discharge of a debt and force the debtor to pay up.

What should you do if you become the subject of an adversary proceeding?

First, make sure that you have an attorney representing you that is ready to handle the time-consuming process and court appearances that adversary proceedings take. Not all bankruptcy attorneys are prepared for that type of case.

Second, make sure that you don't agree to repay or settle a debt that you aren't even sure that you owe without a fight.

That's advice that as many as 2,000 Michigan residents could have used prior to filing for bankruptcy over false fraud allegations from the state's Unemployment Insurance Agency. The state began using the Michigan Data Automated System in October, 2013, to notify former recipients that they were overpaid. However, MIDAS was so flawed that it had a 93 percent error rating, which the state now concedes.

Compounding the problems with the huge percentage of false overpayment reports, Michigan tacked on a 400 percent penalty, plus interest and court fees. In one case, that turned an alleged $8,700 unemployment overpayment into a $44,000 debt.

Then, lax laws allowed the state to seek wage garnishments and use other collection methods more easily than regular creditors. The state would begin collecting on the false debt—leaving people without enough money to pay their regular bills. Many debtors felt forced into seeking bankruptcy protection just to survive.

Even then, filing bankruptcy couldn't protect them. The state would file an adversary proceeding to collect the overpayment and penalties, although it would usually allow those in bankruptcy to settle for the alleged debt plus a 100 percent fine instead of demanding payment in full. In the case of the debtor mentioned above, that meant settling for a little more than $18,000—all for a debt that wasn't real in the first place.

Bankruptcy petitioners who fought the proceedings were often successful, however. Only 8 percent of the MIDAS alerts were upheld when challenged. The odds of reopening the old bankruptcy cases, however, are slim because they were settled rather than fought.

If you find yourself in the midst of an adversary bankruptcy proceeding, have a frank discussion with your attorney about how to proceed.

Source: Detroit Free Press, "Did claims of fraud make jobless go bankrupt?," Paul Egan, Jan. 28, 2017

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