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BANKRUPTCY AND REORGANIZATION

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CHAPTER 28 CHAPTER 28

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Federal Bankruptcy Law

• U.S. Constitution provides that “The Congress shall have the power. . .to establish. . .uniform laws on the subject of bankruptcies throughout the United States.”

• Bankruptcy law is federal law.

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Federal Bankruptcy Code

• Original Bankruptcy Act enacted 1878.

• Bankruptcy Reform Act (1978) completely revised law.

• Bankruptcy Abuse Prevention and Consumer Protection Act (2005) made it more difficult for consumers to escape debts.

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Types of Bankruptcy

• Chapter 7 – Liquidation

• Chapter 11 – Reorganization

• Chapter 12 – Adjustment of Debts of Family Farmer or Fisherman

• Chapter 13 – Adjustment of Debts of Individual with Regular Income

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Bankruptcy Courts

• Part of federal court system.

• Bankruptcy courts, not District Courts, have original jurisdiction over bankruptcy cases.

• One for each federal district.

• Judges appointed for 14-year terms.

• Judges assisted by bankruptcy trustees.

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Pre- and Post-Petition Counseling

• Debtor must receive pre-petition counseling within 180 days prior to filing petition.– Types and uses of credit, budget analysis.– Provided by nonprofit credit counseling

agencies.

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Filing the Petition

• Bankruptcy case commenced by filing of a petition.– Voluntary petition by debtor may be filed in

all types of bankruptcy.– Involuntary petition by creditor only for

Chapter 7 (liquidation) and Chapter 11 (reorganization).

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Schedules

• Debtor filing voluntary petition must submit:– List of secured and unsecured creditors– List of all property owned– Statement of debtor’s financial affairs– Statement of monthly income– Current income and expenses– Evidence of wages within 60 days of filing– Copy of most recent federal tax return

• Debtor’s attorney must investigate and certify accuracy.

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Procedures After Filing

• Order for Relief.

• Meeting of Creditors.– Debtor appears and answers questions.

• Creditors file Proof of Claim or Proof of Interest.

• Trustee appointed.

• Court grants discharge.

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Automatic Stay

• Filing of voluntary or involuntary petition automatically stays:– Legal actions to collect pre-collection debts.– Enforcing judgments obtained against

debtor.– Obtaining, perfecting, or enforcing liens

against property of debtor.– Nonjudicial collection efforts.

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Discharge

• If requirements met, court grants discharge of all or some debts.

• Debtor relieved of responsibility to pay the discharged debts.

• Some debts not discharged.– E.g., taxes owed, claims arising from fraud of

debtor, domestic support obligations, certain debts recently incurred, fraudulent transfers.

– Student loans generally not discharged.

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Reaffirmation Agreement

• Debtor and creditor may agree that debtor will pay debt discharged in bankruptcy.

• Must be entered before discharge granted.• Must be filed with court, and approved by court

or certified by debtor’s attorney.

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Bankruptcy Estate

• Includes all debtor’s legal and equitable interests in real, personal, tangible, and intangible property that exist when petition filed.

• Includes interest of debtor and the debtor’s spouse in community property.

• Certain property exempted.

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Exempt Property

• Property that debtor can keep.• Federal exemptions

– Homestead exemption of $20,200 in principal residence.

– Interest up to $3,225 in one vehicle.– Interest up to $10,775 in household items.– Life insurance policies.– Professional tools up to $2,025.– Etc.

• States may provide more liberal exemptions than federal law.

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Liquidation - Chapter 7

• Debtor keeps exempt assets.• Debtor’s nonexempt property is sold for cash.• Cash is distributed to the creditors.• Any unpaid debts are discharged.

• Debtor’s future income cannot be reached.

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Restrictions in 2005 Act

• Act added median income test and means test.– Debtors at or below state’s median income

may file.– Debtors above median income must satisfy

means test calculation.• Forces many debtors into Chapter 13 Debt

Adjustment bankruptcy, which requires payment of future income to pay pre-petition debts.

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Chapter 7 (continued)

• Any person (including individuals, partnerships, and corporations) may be debtor in Chapter 7 proceeding.

• Certain businesses (including banks, savings and loan associations, credit unions, insurance companies, and railroads) prohibited from filing bankruptcy under Chapter 7.

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Statutory Distribution of Property

• Nonexempt property distributed to debtor’s secured and unsecured creditors pursuant to the statutory priority established by the Bankruptcy Code.

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Distribution to Secured Creditors

• All secured creditors claims have priority over those of unsecured creditors.

• Oversecured secured creditor is paid amount of secured interest.

• Undersecured secured creditor becomes unsecured creditor for amount still owed.

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Priority of Distribution to Unsecured Creditors

• Domestic support.• Fees and expenses of administering the estate.• Secured claims of “gap” creditors.• Wages, salaries, commissions.• Contributions to employee benefit plans.• Farm producers and fishermen for storage or

processing.• Claims for cash deposited by consumers with debtor.• Certain tax obligations.• Claims of general unsecured creditors.

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Frequency of Bankruptcy Relief

• May file for Chapter 7 bankruptcy relief again 8 years after previous Chapter 7 relief.

• May file for Chapter 7 bankruptcy again 6 years after previous Chapter 12 or Chapter 13 relief.

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Acts that Bar Discharge

• Debtor lied about financial position when obtaining credit.

• Debtor transferred, concealed, removed, or destroyed property of estate with intent to defraud creditors.

• Debtor falsified, destroyed, or concealed records about financial condition.

• Debtor failed to appear at meeting of creditors.• Debtor failed to complete course on personal

financial management.

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Chapter 13 – Adjustment of Debts of Individual

• Rehabilitation form of bankruptcy.

• Court supervises plan for payment of unpaid debts by installments.

• Advantages:

– Debtor may avoid stigma, retain more property, incur fewer expenses.

– Creditor may recover greater percentage of debts.

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Chapter 13 Petition

• Voluntary filing of position by debtor with regular income.

• Debts must be primarily consumer debt.

• Amount of debt must not exceed certain dollar amounts – $336,900 unsecured debts.– $1,010,650 secured debts.

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Property of Chapter 13 Estate

• All nonexempt property of debtor at commencement of case, and

• Nonexempt property acquired before case is closed, including earnings and future income.

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Chapter 13 Plan of Payment

• Plan for payments in installments over 3 or 5 years.

• Plan submitted to secured creditors for acceptance.

• Secured creditors may accept plan.

• Court confirms plan, if it was proposed in good faith, is feasible, and in best interest of creditors.

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Chapter 13 Discharge

• Court discharges debtor from all unpaid unsecured debts after all payment required under plan are paid.

• Debtor cannot be discharged under Chapter 13 if has received discharge under Chapter 7, 11, or 12 within 4 years, or Chapter 13 within 2 years.

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Chapter 11 – Reorganization

• For individuals, partnerships, corporations, and other business entities.– Fast-track procedures for small businesses.

• Debtor reorganizes with new capital structure, to emerge from bankruptcy as viable concern.

• May be relieved of portion of debts, burdensome executory contracts and unexpired leases.– E.g., Collective bargaining, pension agreements.

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Debtor-in-Possession

• A debtor who is left in place to operate the business during the reorganization proceeding.

• The court may appoint a trustee to operate the debtor’s business only upon a showing of cause.

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Creditors’ Committee

• The creditors holding the seven largest unsecured claims are usually appointed to the creditors’ committee.

• Representatives of the committee appear at Bankruptcy Court hearings, participate in negotiation of a plan of reorganization, assert objections to the plan, etc.

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Automatic Stay in Chapter 11

• Filing of petition stays actions by creditors to recover debtor’s property.– E.g., foreclosure actions.

• Allows debtor to keep its assets to stay in business.

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Plan of Reorganization

• Sets forth proposed new capital structure for debtor when it emerges from reorganization bankruptcy.– Portion of unsecured debt to be paid.– Contracts and leases to be rejected.

• Debtor files first plan.

• Any party of interest may file a plan thereafter.

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Confirmation of Plan of Reorganization

• Plan of reorganization must be confirmed by the court before it becomes effective.

• Confirmation is either by:– The acceptance method, or– The “cram-down” method.

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Confirmation by Acceptance

The Bankruptcy Court confirms a plan of reorganization if:

• Plan is in the best interests of the creditors,• Plan is feasible, and• Each class of creditors votes to accept the

plan.

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Confirmation by Cram-Down Method

• Court confirms plan over objections of a class of creditors.

• At least one class of creditors must have voted to accept the plan.

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Chapter 12 –Family Farmer Bankruptcy

• Allows family farmers to reorganize financially.

• Gives family farmers added protection not available under Chapter 11.