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1. The Chapter 7 requirements for bankruptcy.
2. The basic steps in the bankruptcy process.
3. Preferential transfers, competing claims, and discharge.
4. The purpose of a Chapter 11 reorganization.
5. Chapter 13 plans.
This chapter covers bankruptcy law. Congressional authority to regulate bankruptcies comes from Article I, Section 8, of the U.S. Constitution. Current law is based on the Bankruptcy Reform Act of 1978 (the Code).
I. BANKRUPTCY RELIEF
Bankruptcy law (1) protects a debtor by giving him or her a fresh
start and (2) ensures equitable treatment to creditors competing
for a debtor’s assets. Bankruptcy proceedings are held in
federal bankruptcy courts. Current law is based on the Bankruptcy
Reform Act of 1978 (the Bankruptcy Code). Relief can be granted
under the Code’s Chapter 7, Chapter 11, Chapter 12, or Chapter
13.
II. LIQUIDATION PROCEEDINGS (CHAPTER 7)
This is the most familiar type of bankruptcy proceeding. A debtor
declares his or her debts and gives all assets to a trustee,
who sells the nonexempt assets and distributes the proceeds to
creditors.
A. WHO CAN FILE FOR A LIQUIDATION
Any “person”—individuals, partnerships, and corporations
(spouses can file jointly)—except railroads, insurance companies,
banks, savings and loan associations, and credit unions.
B. FILING THE PETITION
1. Voluntary Bankruptcy
a. The Debtor Files a Petition with the Court The petition includes schedules (lists) of (1) creditors and the debt to each, (2) the debtor’s financial affairs, (3) the debtor’s property, and (4) current income and expenses.
b. Filing of the Petition Constitutes an Order for Relief
The clerk of the court must give the trustee and creditors notice
of the order within not more than twenty days.
c. Substantial Abuse
A court can dismiss a petition if granting it would constitute
substantial abuse (if the debtor seeks only an advantage over
creditors and his or her financial situation does not warrant
a discharge of debts) [11 U.S.C. Section 707(b)].
2. Involuntary Bankruptcy
A debtor’s creditors can force the debtor into bankruptcy
proceedings.
a. Who Can Be Forced into Involuntary Proceedings
A debtor with twelve or more creditors, three or more of whom
(with unsecured claims of at least $10,000) file a petition.
A debtor with fewer than twelve creditors, one or more of whom
(with a claim of $10,000) files. Not a farmer or a charitable
institution.
b. When an Order for Relief Will Be Entered
If the debtor does not challenge the petition, the debtor is
generally not paying debts as they come due, or a receiver, assignee,
or custodian took possession of the debtor’s property within
120 days before the petition was filed.
C. AUTOMATIC STAY
When a petition is filed, an automatic stay suspends all action
by creditors against the debtor. The adequate protection doctrine
protects secured creditors by requiring payments, or other collateral
or relief, to the extent that the stay may cause the value of
their collateral to decrease.
D. PROPERTY OF THE ESTATE
1. What Property Is Included in the Debtor’s Estate
Interests in property presently held; community property; property
transferred in a transaction voidable by the trustee; proceeds
and profits; after-acquired property; interests in gifts, inheritances,
property settlements, and life insurance death proceeds to which
the debtor becomes entitled within 180 days after filing.
2. What Property Is Not Included
Property acquired after the filing of the petition except as
noted above.
E. CREDITORS’ MEETING AND CLAIMS
Within “not less than ten days or more than thirty days,”
the court calls a meeting of creditors, at which the debtor answers
questions. Within ninety days of the meeting, a creditor must
file a proof of claim. The proof lists the creditor’s name
and address, as well as the amount of the debt.
F. EXEMPTIONS
1. Federal Law
Exempts such property as interests in a residence to $7,500,
a motor vehicle to $1,200, household goods to $4,000, and tools
of a trade to $750, and the rights to receive Social Security
and other benefits.
2. State Law
Most states preclude the use of federal exemptions; others allow
a debtor to choose between state and federal. State exemptions
may include different value limitations and exempt different property.
G. THE TRUSTEE
After the order for relief, an interim trustee is appointed to
preside over the debtor’s property until the first meeting
of creditors, when a permanent trustee is elected. A trustee’s
duty is to collect and reduce to money the property of the estate
and distribute the proceeds.
1. Trustee’s Powers
A trustee has the same rights as (1) a lien creditor with priority
over an unperfected secured party and (2) a bona fide purchaser
of real property from the debtor.
2. Voidable Rights
Any reason that a debtor can use to obtain the return of his
or her property can be used by the trustee (fraud, duress, etc.)
3. Preferences
A trustee can recover payments made by a debtor (1) within ninety
days before the petition and (2) for a preexisting debt.
a. Insiders or Fraud
If a creditor is an insider (partner, corporate officer, relative)
or a transfer is fraudulent, a trustee may recover transfers
made within one year before filing.
b. Transfers That Are Not Preferences
Payment for services rendered within ten to fifteen days before
the payment; payment received in the ordinary course of business
(such as payment of a phone bill); transfer of property up to
$600; property sold to an innocent third party.
H. DISTRIBUTION OF PROPERTY
1. Secured Creditors
Within thirty days of the petition or before the first creditors’
meeting (whichever is first), a debtor must state whether he
or she will retain secured collateral (or claim it as exempt,
etc.). The trustee must enforce the statement within forty-five
days. If the collateral does not cover the debt, the secured
creditor is an unsecured creditor for the difference.
2. Unsecured Creditors
Paid in the order of priority. Each class is paid before the
next class is entitled to anything. The order of priority is—
a. Administrative expenses (court costs, trustee and attorney fees).
b. In an involuntary bankruptcy, expenses incurred by the debtor in the ordinary course of business from the filing of the petition to the appointment of the trustee or the issuance of an order for relief.
c. Unpaid wages, salaries, and commissions earned within ninety days of the petition, to $4,000 per claimant. A claim in excess is a claim of a general creditor (no. i below).
d. Unsecured claims for contributions to employee benefit plans, limited to services performed within 180 days before the petition and $4,000 per employee.
e. Claims by farmers and fishers, to $4,000, against storage or processing facilities.
f. Consumer deposits to $1,800 given to the debtor before the petition to buy, lease, or rent property or services that were not received.
g. Claims for paternity, alimony, maintenance, and support.
h. Taxes and penalties due to the government.
i. Claims of general creditors
3. Debtors
Any amount remaining is turned over to the debtor.
I. DISCHARGE
A discharge voids any judgment on a discharged debt and prohibits
any action to collect a discharged debt. A co-debtor’s liability
is not affected.
1. Exceptions—Debts That May Not Be Discharged
Claims for back taxes, amounts borrowed to pay back taxes, goods
obtained by fraud, debts that were not listed in the petition,
alimony, child support, student loans, certain cash advances,
and others.
2. Objections—Debtors Who May Not Receive a Discharge
Those who conceal property with the intent to hinder, delay,
or defraud a creditor; who fail to explain a loss of assets; or
who have been granted a discharge within six years of the filing
of the petition.
3. Revocation of Discharge
A discharge may be revoked within one year if the debtor was
fraudulent or dishonest during the bankruptcy proceedings.
J. REAFFIRMATION
A debtor’s agreement to pay an otherwise dischargeable debt
must be made before a discharge is granted and must usually be
approved by the court. Can be rescinded within sixty days or
before the discharge is granted.
III. REORGANIZATIONS (CHAPTER 11)
The creditors and debtor formulate a plan under which the debtor
pays a portion of the debts, is discharged of the rest, and continues
in business.
A. WHO IS ELIGIBLE FOR RELIEF UNDER CHAPTER 11
Any debtor (except a stockbroker or a commodities broker) who
is eligible for Chapter 7 relief. Used most commonly by corporate
debtors. The same principles apply that govern liquidation (automatic
stay, etc.).
B. WHY A CASE MAY BE DISMISSED
Creditors may prefer a workout (a privately negotiated settlement)
to bankruptcy proceedings, or there may be other reasons (inability
to effect a plan, unreasonable delay by the debtor that is prejudicial
to creditors, etc.).
C. DEBTOR IN POSSESSION
On entry of an order for relief, the debtor continues to operate
his or her business as a debtor in possession (DIP). The court
may appoint a trustee (or receiver) to operate the business if
that is in the best interests of the estate.
1. If Gross Mismanagement Is Shown
The court may appoint a trustee (or receiver) to operate the
business. This may also be done if it is in the best interests
of the estate.
2. DIP’s Role Is Similar to That of a Trustee in a Liquidation
The DIP can avoid pre-petition preferential payments and fraudulent
transfers and decide whether to cancel pre-petition executory
contracts.
2. Strong-Arm Clause
A DIP can avoid any obligation or transfer that could be avoided
by (1) a creditor who extended credit at the time of bankruptcy
and who consequently obtained (a) a lien or (b) a writ of execution
that was returned unsatisfied; and (2) a bona fide purchaser
of real property, if the transfer was perfected at the time of
the bankruptcy.
D. COLLECTIVE BARGAINING AGREEMENTS
Can be rejected if the debtor first proposes modifications to
the union and the union fails to adopt them without good cause.
The debtor must (1) provide the union with information needed
to evaluate the proposal and (2) confer in good faith to attempt
a mutually satisfactory agreement.
E. CREDITORS’ COMMITTEES
A committee of unsecured creditors is appointed to consult with
the trustee or DIP. Other committees may represent special-interest
creditors. Some small businesses can avoid creditors’ committeees.
F. THE REORGANIZATION PLAN
1. What the Plan Must Do
Conserve and administer the debtor’s assets in the hope
of a return to solvency; be fair and equitable (“in the
best interests of the creditors”); designate classes of claims
and interests; specify the treatment to be afforded the classes;
and provide an adequate means for execution.
2. Who Can File a Plan
Only debtor within the first 120 days (100 days in some cases)
after date of the order for relief. Any other party, if debtor
does not meet the deadline or fails to obtain creditor consent
within 180 days (or 160 days).
3. The Plan Is Submitted to Creditors for Acceptance
Each class adversely affected by a plan must accept it (two-thirds
of the total claims must approve). If only one class accepts,
the court may confirm it if it “does not discriminate unfairly”
against any creditors. The plan is binding on confirmation—the
debtor is given a discharge from all claims not within the plan
(except those that would be denied in a liquidation).
IV. INDIVIDUALS’ REPAYMENT PLANS (CHAPTER 13)
A. WHO IS ELIGIBLE
Individuals (not partnerships or corporations) with regular income
and unsecured debts of less than $100,000 or secured debts of
less than $350,000.
B. VOLUNTARY FILING ONLY
A Chapter 13 case can be initiated by the filing of a voluntary
petition only. A trustee is appointed.
C. AUTOMATIC STAY
On the filing of a petition, an automatic stay enjoins creditors
from taking action against co- obligors of the debtor. If a creditor
asks to vacate the stay against a co-debtor, unless written objection
is filed, twenty days later the stay against the co-debtor is
automatically terminated without a hearing.
D. THE REPAYMENT PLAN
The plan must provide for (1) turnover to the trustee of the
debtor’s future income, (2) full payment of all claims entitled
to priority, and (3) the same treatment of each claim within a
particular class.
1. Filing and Confirming the Plan
Only the debtor can file a plan, which the court will confirm
if (1) the secured creditors accept it, (2) it provides that creditors
retain their liens and the value of the property to be distributed
to them is not less than the secured portion of their claims,
or (3) the debtor surrenders the property securing the claim
to the creditors.
2. Payments under the Plan
The time for payment must be less than three years (five years,
with court approval). The payments must be timely, or the court
can convert the case to a liquidation or dismiss the petition.
Before completion of payments, the plan may be modified at the
request of the debtor, the trustee, or an unsecured creditor.
3. Objection to the Plan
Over the objection of the trustee or an unsecured creditor, the
court may approve a plan only if (1) the value of the property
to be distributed is equal to the amount of the claims, or (2)
all the debtor’s disposable income during the plan will be
used to make payments.
E. DISCHARGE
After completion of all payments, all debts provided for by the
plan are discharged. A discharge obtained by fraud can be revoked
within one year.
V. FAMILY-FARMER PLANS (CHAPTER 12)
Chapter 12 is nearly identical to Chapter 13. Eligible debtors
include a family farmer whose gross income is at least 50 percent
farm dependent and whose debts are at least 80 percent farm related
(total debt must not exceed $1.5 million), and a partnership or
closely held corporation (at least 50 percent owned by a farm
family).