BANKRUPTCY 101

Sponsor: Young Lawyers Division CLE Credit: 1.0

Thursday, May 12, 2016 2:35 p.m. - 3:35 p.m. Cascade Ballroom C

Kentucky International Convention Center Louisville, Kentucky

A NOTE CONCERNING THE PROGRAM MATERIALS

The materials included in this Kentucky Bar Association Continuing Legal Education handbook are intended to provide current and accurate information about the subject matter covered. No representation or warranty is made concerning the application of the legal or other principles discussed by the instructors to any specific fact situation, nor is any prediction made concerning how any particular judge or jury will interpret or apply such principles. The proper interpretation or application of the principles discussed is a matter for the considered judgment of the individual legal practitioner. The faculty and staff of this Kentucky Bar Association CLE program disclaim liability therefore. Attorneys using these materials, or information otherwise conveyed during the program, in dealing with a specific legal matter have a duty to research original and current sources of authority.

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TABLE OF CONTENTS The Presenters ................................................................................................................. i Introduction to Bankruptcy ............................................................................................... 1 What is this First Meeting of Creditors Notice I Received? Do I Need to Go? ................. 7 The Person I am Suing Filed for Bankruptcy – What Can I Do Now? .............................. 8 Do I Need to File a Proof of Claim? ............................................................................... 12 Everything We Discussed Related to and after the Filing of a Bankruptcy Is Privileged, Right? .................................................................................... 15 A Plaintiff Suing Me Has Filed for Bankruptcy, OR I Represent a Plaintiff Who Filed for Bankruptcy – What Are My Options? .......................................... 18 What Happens to the Agreement that I Had with the Person Who Filed for Bankruptcy? Does It Go Away? ....................................................................... 20 Have Received Money from a Company Who I Fear May File for Bankruptcy (or Has Filed for Bankruptcy) – What Should I Do? .................................... 22 If I File Bankruptcy, Do I Get to Keep Anything? ............................................................ 27

THE PRESENTERS

T. Kent Barber Barber Law, PLLC

3158 Arrowhead Drive Lexington, Kentucky 40503

(859) 296-4372 kbarber@barberlawky.com

T. KENT BARBER is the managing member of Barber Law, PLLC in Lexington and focuses his practice on bankruptcy and bankruptcy litigation on behalf of debtors, debtors-in-possession, trustees, creditors, and creditors' committees. He is a graduate of Morehead State University and received his J.D. from the University of Kentucky College of Law. Mr. Barber has served as chair of the Fayette County Bar Association Bankruptcy Section and was named a Rising Star in the area of bankruptcy by Super Lawyers in both 2014 and 2015. Ellen Arvin Kennedy Dinsmore & Shohl, LLP 250 West Main Street, Suite 1400 Lexington, Kentucky 40507 (859) 425-1020 Ellen.kennedy@dinsmore.com ELLEN ARVIN KENNEDY is a partner in the Lexington office of Dinsmore & Shohl, LLP and concentrates her practice in the areas of bankruptcy and restructuring. She received her B.A. from Centre College and her J.D. from the University of Kentucky College of Law. Ms. Kennedy is a member of the Kentucky and Fayette County Bar Associations, American Bankruptcy Institute, International Women's Insolvency & Restructuring Confederation, and Leadership Kentucky, 2014 Class.

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John M. Spires Dinsmore & Shohl, LLP

250 West Main Street, Suite 1400 Lexington, Kentucky 40507

(859) 425-1036 John.spires@dinsmore.com

JOHN M. SPIRES is an associate in the Lexington office of Dinsmore & Shohl, LLP where he focuses his practice in the area of bankruptcy. Mr. Spires received his B.A. from Wake Forest University and his J.D. from the University of Kentucky College of Law. He is a member of the Fayette County and Kentucky Bar Associations.

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BANKRUPTCY 101 T. Kent Barber, Ellen Arvin Kennedy and John M. Spires

I. INTRODUCTION TO BANKRUPTCY

A. The filing of a bankruptcy petition creates an estate consisting of all property owned by the debtor at the time of filing, together with certain post-petition acquisitions and certain prepetition transfers. 11 U.S.C. §541. A bankruptcy estate is comparable to a decedent’s estate and the duties of a trustee in bankruptcy are similar to those of the executor of a decedent’s estate. For starters, compare the caption of a bankruptcy pleading to the caption of a probate pleading.

B. Chapters and Eligibility

There are different types of bankruptcy cases, which create varying rights and obligations. Not all debtors are eligible for all types of bankruptcy cases, however. Eligibility depends on whether the debtor is an individual, entity or municipality, on the amount and type of debts the debtor has (i.e., business or consumer debts), and in some cases, on what type of business the debtor runs.

1. Chapter 7.

Also known as "liquidation" or "straight" bankruptcy, Chapter 7 is the most common type of bankruptcy and probably what most non-lawyers contemplate when they think of bankruptcy. The filing of a petition in Chapter 7 vests all property of the estate in a trustee, whose job is to collect and liquidate all assets, release exempt property back to the debtor and pay creditors to the extent of assets available.

a. The debtor keeps any property he can claim as exempt.

He receives a discharge and comes out of bankruptcy with a fresh start within a few months. His remaining property is either paid out to creditors or abandoned back to the debtor. 11 U.S.C. §554.

b. Property secured by a lien is often sold and the proceeds

paid to the secured creditor. This is particularly the case if the property is less than the value of the debt. However, the debtor may also reaffirm a loan agreement with a secured creditor under 11 U.S.C. §524(c). A re-affirmation agreement basically allows a debtor to keep the property subject to a loan because the debtor continues to pay the loan. Because a bankruptcy discharge is a valuable right possessed by debtors and there is significant concern that creditors may attempt to take advantage of debtors, courts scrutinize reaffirmation agreements and will not approve

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them unless they comply with a number of requirements, including approval of the agreement by debtor’s counsel.

c. Any "person" (11 U.S.C. §101(41)) may be a debtor under

Chapter 7 except for banks, railroads and insurance companies. 11 U.S.C. §109(b).

2. Chapter 9.

Only a "municipality" (11 U.S.C. §101(40)) may be a debtor under Chapter 9. 11 U.S.C. §109(c). These bankruptcies are rarely filed in Kentucky, but may become more common as government budgets are strained to the breaking point. There are no involuntary Chapter 9 cases.

To be a debtor under Chapter 9, a municipality must also (1) be authorized to be a debtor in bankruptcy, either by name, in its capacity as a municipality, or by a government officer or organization empowered to grant such authority (often the State governor); (2) be insolvent; (3) desire to effect a plan to adjust its debts; and (4) obtain the consent of a majority of its creditors by amount to the bankruptcy filing, or show that such consent is impracticable despite the municipality’s good faith efforts.

3. Chapter 11.

This Chapter is used primarily by businesses when the goal is to continue operating by shedding debt, selling off assets, and/or restructuring obligations.

a. The debtor files a plan that specifies how the

reorganization is to take place, including the amount each class of creditors is to be paid and the terms of payment.

b. Creditors are allowed to vote on the plan and the plan

usually must be approved by creditors before confirmation. 11 U.S.C. §1126.

c. At the time of soliciting approval by creditors, the debtor

must submit a disclosure statement in sufficient detail that creditors can make an informed choice as to whether to vote for the plan. 11 U.S.C. §1125.

d. If the plan does not have creditor approval, the debtor may

still confirm the plan (cram down) under 11 U.S.C. §1129(b). Confirmation under a cram down is difficult and rare.

e. The debtor has the exclusive right to file a plan for 120

days after the order for relief. If the debtor fails to file a plan within 120 days (or any later date as extended by the

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Court), any party in interest may file a plan. 11 U.S.C. §1121(c).

f. Any person who may be a debtor under Chapter 7,

together with railroads and certain banking institutions, may be a debtor under Chapter 11. 11 U.S.C. §109(d).

4. Chapter 12.

This is a reorganization chapter exclusively for a "family farmer or family fisherman with regular annual income." 11 U.S.C. §109(f). The terms "family farmer," "family fisherman," "family farmer with regular annual income," and "family fisherman with regular annual income" are defined in 11 U.S.C. §101(18)-(19B). This chapter was adopted in 1986 in response to the economic crisis in the farming community brought on by high interest rates and low prices. Chapter 11 wasn’t working for these farmers due to several factors, including (1) the high cost of administration in a Chapter 11 case, which is typically larger than cases involving family farms; and (2) the difficulty of confirming a plan. Chapter 13 wasn’t possible for these farmers due to the low debt ceiling for Chapter 13 cases.

a. Because family farms are few in number compared to the

population as a whole, there have been comparatively few Chapter 12 cases. However, the impact of this chapter in farming communities has been significant.

b. A "family farmer" must have aggregate debts not

exceeding $4,031,575, of which not less than 50 percent arise out of a farming operation. 11 U.S.C. §101(18).

c. The Chapter 12 plan must be filed within ninety days after

the order for relief (11 U.S.C. §1221) and cannot be longer than five years (11 U.S.C. §1222(c)).

d. There is no voting on the plan. Every Chapter 12

confirmation is a cram down and there are essentially three components to confirmability, to wit:

i. The plan must be feasible. ii. The plan must be filed in good faith. iii. The plan must be in the best interest of creditors,

meaning they receive more than they would in a hypothetical Chapter 7 liquidation.

e. There are no involuntary Chapter 12 cases.

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5. Chapter 13.

This type of case permits the adjustment of debts of an individual with regular income.

a. The individual, or individual and spouse, must have

unsecured debts of less than $383,175 and secured debts of less than $1,149,525. 11 U.S.C. §109(e).

b. The debtor must file a plan with the petition or within

fourteen days after the order for relief. FRBP 3015(b). c. The plan may be for not more than five years and most

plans are five years in duration. 11 U.S.C. §1322(d). d. There is no voting on the plan. Every Chapter 13

confirmation is a cram down and there are essentially three components to confirmability, to wit:

i. The plan must be feasible. ii. The plan must be filed in good faith. iii. The plan must be in the best interest of creditors,

meaning they receive more than they would in a hypothetical Chapter 7 liquidation.

e. Chapter 13 is extremely versatile and is useful for a variety

of situations.

i. The debtor can avoid foreclosure by curing the arrearage on his home mortgage in monthly payments over a reasonable period of time.

ii. The debtor can almost always keep all of his property.

iii. The debtor can pay certain nondischargeable debts

in full ahead of their general unsecured creditors. Examples of these would be taxes, domestic support obligations, and claims for death or injury caused while driving intoxicated.

iv. Subject to certain limitations imposed by BAPCPA,

the debtor can bifurcate secured claims and pay the secured portion at an interest rate approved by the court.

v. The debtor can strip off liens entirely if they are

completely "underwater."

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vi. The debtor does not have to pay out as much money up front to begin a Chapter 13 case because the attorney’s fees are paid through the plan.

vii. A debtor can obtain protection from creditors by

filing Chapter 13 at any time, although a discharge is available only if the case is filed more than two years after the filing of a previously discharged Chapter 13 or more than four years after the filing of any other previously discharged bankruptcy.

f. Only an individual, or an individual and spouse, can file

under Chapter 13. g. There are no involuntary Chapter 13 cases.

6. Involuntary bankruptcy filings.

Most bankruptcy filings are voluntary, but creditors may also force a debtor into bankruptcy under certain circumstances. Involuntary filings are governed by 11 U.S.C. §303.

a. An involuntary case may only be commenced under

Chapters 11 or 7 and only against a party that may be a debtor under each such chapter. 11 U.S.C. §303(a).

b. Involuntary cases generally require the filing of a petition

by three or more creditors of the debtor who hold non-contingent claims not subject to bona fide dispute that aggregate at least $15,325 more than the value of any lien securing such claims. 11 U.S.C. §303(b)(1). If there are fewer than twelve such creditors, however, one creditor may file an involuntary petition. 11 U.S.C. §303(b)(2). There are also particular rules for partnerships and foreign debtors.

c. The filing of an involuntary petition does not fully

implement all of the Bankruptcy Code provisions. A debtor who has a petition filed against it has the right to contest the petition (11 U.S.C. §303(d)) and therefore is only an "alleged debtor" until the petition is granted. The business of the debtor may be operated, and the debtor may continue to use, acquire, and dispose of property as usual until the petition is granted, unless the Court orders otherwise. 11 U.S.C. §303(f).

d. An involuntary bankruptcy filing is strong relief and has the

potential to be misused by over-aggressive creditors. Thus, if a court dismisses an involuntary case other than by consent of all creditors and the debtor, then the Court may

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compel the petitioners to pay the debtor’s costs and reasonable attorney’s fees. If the Court finds the petition to have been filed in bad faith, then it may award actual and punitive damages. 11 U.S.C. §303(i). The Court may require petitioning creditors to post a bond for these amounts. 11 U.S.C. §303(e).

C. Claims

There are five kinds of creditors who may have claims against a bankruptcy estate.

1. Administrative claims.

These are the claims arising out of administration of the estate, mostly attorney’s fees or payments owed to creditors that did business with the debtor after the filing of the bankruptcy case. See 11 U.S.C. §503. Unlike the other claims, administrative claims arise mostly after the order for relief. They are paid as a priority claim of the third order under 11 U.S.C. §507, behind trustee’s fees and domestic support obligations.

2. Secured claims.

These are the claims of creditors who possess a lien on property of the estate. Secured claimants have the right to receive their collateral or the value thereof in a bankruptcy case. However, if a secured claim is greater than the value of the creditor’s collateral, then the excess of the debt over the value of the collateral is an unsecured claim. 11 U.S.C. §506.

3. Priority claims.

These are the claims of certain unsecured creditors who Congress has deemed worthy of being paid ahead of general unsecured creditors. They include certain pre-petition wage and tax claims. They are listed in the order of their priority in 11 U.S.C. §507.

4. General unsecured claims.

These are claims held by unsecured, non-priority creditors of the debtor. They are paid behind priority claims.

5. Equity claims.

These are the claims of the equity security holders of a corporation or of the debtor who is an individual. They are always paid last.

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II. WHAT IS THIS FIRST MEETING OF CREDITORS NOTICE I RECEIVED? DO I NEED TO GO?

A. The first meeting of creditors is required by 11 U.S.C. §341, and is often

referred to as a 341 meeting. The meeting is required to be held within a reasonable time. The times for each chapter and the procedures for conducting the meeting are set out with specificity in Fed. R. Bankr. P. 2003(a). This meeting is not a hearing in front of a bankruptcy judge. It is conducted by the appointed Chapter 7 trustee, the Chapter 13 Trustee, or the United States Trustee. It may be held in a courtroom, a dedicated hearing room in the courthouse, or even outside the federal domain. Any creditors or interested parties may attend, with or without counsel, and after initial questioning by the presiding trustee, any creditor may ask questions regarding their claims or the debtor’s intentions for the case. However, attendance at the meeting is not mandatory, and a creditor’s rights will not be affected if the creditor does not participate.

B. At the 341 meeting, the trustee will confirm that the individual debtor or

corporate debtor representative is present, and will ask questions about the debtor’s financial history, his schedules of assets and debts, and his Statement of Financial Affairs. Prior to the conclusion of the meeting in a Chapter 7 case, the trustee must orally examine the debtor to ensure that (a) the debtor is aware of the potential consequences of seeking a discharge in bankruptcy, including the effect on credit reports; (b) the debtor’s understanding that he could have potentially filed for relief under other chapters; (c) the effect of receiving a discharge of debts in bankruptcy; and (d) the effect of reaffirming a debt. 11 U.S.C. §341(d).

C. At the meeting, the debtor or corporate representative will be placed

under oath, and must answer the questions of the trustee and any creditors present who have questions regarding their claims. Many of the questions will center on the contents of the debtor’s schedules of assets and debts and his Statement of Financial Affairs. These documents are submitted earlier and are signed by the debtor or corporate representative under penalty of perjury. It is very important for the debtor and counsel to carefully review the schedules and Statement of Financial Affairs prior to the meeting to make sure they are accurate. It’s not uncommon for the trustee to find, and the debtor to acknowledge, an error in the documents here and there, but if the schedules and Statement of Financial Affairs are incomplete, or obviously in disarray, the trustee will hold the meeting open and have a second meeting in order to go over the corrected documents and get his questions answered. In the Chapter 11 context, it’s quite common for the company CFO or accountant who had a hand in the creation of these documents to attend as well in order to answer questions regarding accounting procedures, or to explain the data contained in the schedules.

D. The 341 meeting is an excellent opportunity for a creditor to obtain

information from the debtor about the future treatment of the creditor’s claim, as well as the debtor’s business plans. A landlord can ask if the debtor will seek to keep his lease, or a secured creditor can ask if its

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collateral is insured and properly maintained. An unsecured creditor can inquire as to the chances of seeing a recovery on its claim, or whether the debtor will want to continue to do business with the creditor. A personal injury claimant can ask about the availability of insurance.

E. At the same time, the 341 meeting is not a substitute for a full-blown

deposition on a particular claim. Should the creditor need significant time to question the debtor, the trustee will likely cut off the questioning and suggest that the creditor conduct a deposition or written discovery through Fed. R. Bankr. P. 2004.

III. THE PERSON I AM SUING FILED FOR BANKRUPTCY – WHAT CAN I DO

NOW?

A. Once a party files for bankruptcy, the automatic stay of 11 U.S.C. §362 goes into effect. The automatic stay is extremely broad in scope and prohibits parties from commencing or continuing lawsuits or collection efforts against a debtor in bankruptcy or from attempts to collect property of the estate.

B. Generally speaking, once a creditor receives notice of a bankruptcy filing,

that creditor MUST STOP all efforts to collect on that debt. This obligation even extends to halting the continuation of pre-petition collection efforts. 11 U.S.C. §362.

Clay v. Credit Acceptance Corp. (In re Clay), 2011 Bankr. LEXIS 1760 (E.D. Ky. 2011); Clay v. Credit Acceptance Corp., No. 10-53848, 2011 WL 2312334 (E.D. Ky. 2011) – The Bankruptcy Court found an automatic stay violation where the creditor mailed a complaint and summons to the Circuit Clerk before a bankruptcy petition was filed, but the creditor failed to contact the Clerk to halt docketing of the complaint and service of summons.

C. If the automatic stay is willfully violated, any individual harmed by the

violation shall recover actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages. 11 U.S.C. §362(k).

In re Kelly, 2014 Bankr. LEXIS 4475 (N.D. Ohio 2014); In re Kelly, No. 14-32333, 2014 WL 5449639 (N.D. Ohio 2014) – The Bankruptcy Court held that willfulness did not require the specific intent to violate the stay, but only knowledge of the bankruptcy filing and the commission of deliberate conduct that violates the stay.

D. What options does a creditor have once a bankruptcy case is filed and

the automatic stay goes into effect?

1. Make sure your claim is covered by the automatic stay.

a. The automatic stay only prevents the prosecution of claims that arise prior to bankruptcy. It does not stop the

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prosecution of claims arising after a bankruptcy case is filed. Bellini Imports, Ltd. v. Mason & Dixon Lines, Inc., 944 F.2d 199 (4th Cir. 1991). Nonetheless, actual collection of a judgment on any claim against property of a bankruptcy estate is still prohibited by the automatic stay. Id.

b. The automatic stay generally does not stay litigation or

collection efforts against non-debtor parties that may also be liable on a claim against a debtor (such as co-defendants, guarantors, or sureties). 3-362 Collier on Bankruptcy 362.03[3][d] (2012); Lynch v. Johns-Manville Sales Corp., 710 F.2d 1194 (6th Cir. 1983). There is an exception, however, in Chapter 13 cases, where 11 U.S.C. §1301 provides that a creditor cannot collect a debt from a non-debtor who is liable on the claim along with the Chapter 13 debtor, except under specified circumstances.

2. Exceptions to the automatic stay.

Certain types of actions and claims are excepted from the automatic stay. See 11 U.S.C. §362(b). The most commonly litigated exceptions are the so-called "police power" exceptions, which permit governmental authorities to continue criminal or regulatory proceedings against a debtor. There are also exceptions regarding domestic relations, including exceptions allowing courts to continue proceedings to enter divorce decrees, child custody arrangements, or create or modify support obligations.

3. Relief from the automatic stay.

Even when the automatic stay unquestionably applies, a creditor can seek relief from it under 11 U.S.C. §362(d). The most common grounds for relief are "cause," including lack of adequate protection, or with respect to property of the estate, the debtor lacks equity in such property and the property is not necessary for a successful reorganization.

a. Most often, stay relief is granted to a secured creditor

whose debt is greater than the value of the property it secures.

b. In determining whether a prepetition cause of action

should be permitted to continue, courts balance the following factors: (1) judicial economy; (2) trial readiness; (3) the resolution of preliminary bankruptcy issues; (4) the creditor's chance of success on the merits; (5) the cost of defense or other potential burden to the bankruptcy estate; and (6) the impact of the litigation on other creditors.See In re United Imports Inc., 203 B.R. 162 (Bankr. D. Neb. 1996).

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c. Stay relief can also be granted to permit a party to proceed only against liability insurance held by the debtor. If such insurance is present, this is an effective way for a creditor to realize value on its claim against a debtor. Hunter v. Lake Cumberland Reg'l Hosp., LLC, 2012 U.S. Dist. LEXIS 146141 (E.D. Ky. 2012); Hunter v. Cumberland Reg’l Hosp., LLC, , No. 11-316-GFVT, 2012 WL 4601717 (E.D. Ky. 2012) (holding that discharge of debtor did not discharge insurance companies that may be liable to compensate claims against the debtor).

4. Non-dischargeability.

11 U.S.C. §523 provides that claims for certain types of debts are non-dischargeable for individual debtors in bankruptcy (corporations and other entities generally do not receive discharges).

a. Many of the types of claims that are non-dischargeable are

well-known. For example:

i. Student loan debts, unless refusal to grant a discharge would expose the debtor or his dependents to an undue hardship.

ii. Certain domestic support obligations. iii. Governmental fines or penalties that are not related

to actual pecuniary loss. iv. Personal injury or wrongful death claims arising

from a DUI. b. A claim is also not discharged if it is not disclosed.

Pursuant to 11 U.S.C. §521, a debtor must disclose all claims against it. If such claim is not listed or scheduled in time to permit timely filing of a proof of claim, the claim is not discharged unless the creditor had notice or actual knowledge in time to file such a proof of claim.

There is an exception, however, in "no-asset" cases (i.e., cases where there are no non-exempt assets, and the trustee has nothing to distribute). In such cases, a creditor whose claim is not listed is not prejudiced by the debtor’s failure to list their claim, so even unlisted claims are discharged. See Zirnhelt v. Madaj (In re Madaj), 149 F.3d 467 (6th Cir. 1998).

c. Moreover, certain types of claims are excepted from

discharge if there has been improper conduct by a debtor. These claims are those arising from:

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i. Fraud or false pretenses (11 U.S.C. §523(a)(2)). ii. Fraud or defalcation while acting in a fiduciary

capacity, embezzlement, or larceny (11 U.S.C. §523(a)(4)).

iii. Willful and malicious injury committed by the debtor

(11 U.S.C. §523(a)(6)). In such cases, the creditor would have the burden of proving improper conduct by a debtor. However, if a finding of fraud, breach of fiduciary duty, or willful and malicious conduct has already been made against a debtor prior to bankruptcy, the debtor will be barred from re-litigating the issue by collateral estoppel. In re Livingston, 372 Fed. Appx. 613 (6th Cir. 2010).

d. According to Federal Rule of Bankruptcy Procedure

4007(a), a party must file an adversary complaint to determine the non-dischargeability of a debt. With respect to a claim covered by 11 U.S.C. §§523(a)(2), (a)(4), or (a)(6), the complaint must be filed no later than sixty days after the initial date set for the meeting of creditors under 11 U.S.C. §341 (though that deadline may be extended and Rule 4007(d) provides a limited exception to this rule). Fed. R. Bankr. P. 4007(c).

If no adversary complaint is timely filed with respect to a debt arising under 11 U.S.C. §§523(a)(2), (a)(4), and (a)(6), the debt will be discharged. 11 U.S.C. §523(c).

e. With respect to all other types of non-dischargeability

claims, the complaint may be filed at any time, and a case may even be re-opened to permit the filing of such a complaint. Fed. R. Bankr. P. 4007(b). Alternatively, the dischargeability of such a claim may be litigated in a state court proceeding to collect such a debt. 4-523 Collier on Bankruptcy 523.03 (2016).

5. Objection to discharge.

Objections to discharge are governed by 11 U.S.C. §727. An objection to discharge is similar to non-dischargeability under §523, discussed above. The distinction is that a ruling that a claim is non-dischargeable under §523 only covers that specific claim – any claims not determined to be non-dischargeable are still discharged. Under §727, the debtor is entirely denied a discharge.

a. A global denial of discharge is a harsh remedy and is

sparingly granted. The circumstances warranting a denial of discharge are described in §727(a) and generally

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concern fraudulent or criminal conduct by a debtor, including:

i. Intentionally transferring, removing, destroying,

mutilating, or concealing, or permitting to be transferred, removed, destroyed, mutilated, or concealed, property of the debtor or the estate.

ii. Intentionally transferring, removing, destroying,

mutilating, or concealing any books or records of the debtor.

iii. Making false oaths, presenting false claims, making

or receiving improper payments, or withholding books or records from a trustee.

iv. Failing to adequately explain loss or deficiency of

assets. v. Refusing to obey Court orders or testify in Court. vi. The debtor has previously been granted a

discharge, under certain circumstances. b. The trustee, a creditor, or the U.S. Trustee may request a

denial of discharge. 11 U.S.C. §727(c)(1). c. Discharges may also be revoked through the criteria and

procedures in 11 U.S.C. §727(d)- (e). 6. Once a debtor is discharged, the "discharge injunction" of 11

U.S.C. §524 goes into place, and the automatic stay ends. The discharge injunction operates as a court order prohibiting attempts to collect a discharged debt. Violations of the discharge injunction are punished by contempt sanctions, which can include actual damages, attorney’s fees, and in egregious cases, punitive damages.

IV. DO I NEED TO FILE A PROOF OF CLAIM?

A. Filing a proof of claim is the pre-petition creditor’s means of obtaining a distribution from a debtor’s bankruptcy estate. Filing a proof of claim is often necessary to obtain a distribution, but not always.

1. The filing of a proof of claim is authorized by 11 U.S.C. §501. 2. If a proof of claim is filed, it is deemed allowed (i.e., entitled to

distribution from the estate based on its priority) unless a party in interest objects. 11 U.S.C. §502; see also Fed. R. Bankr. P. 3001(f) (a proof of claim is prima facie evidence of its validity and amount).

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3. If filing is necessary, it should be done on Official Form 410. This form was amended in December 2015, so even if you are familiar with the proof of claim process, you should review the new form. Failure to complete the form correctly may result in a secured or priority claim failing to receive its proper priority.

4. If an objection to a claim is filed, then the Court must resolve the

objection as a contested matter. B. Necessity for Filing a Proof of Claim

Under Fed. R. Bankr. P. 3002, the default rule is that a proof of claim is required for unsecured creditors and equity security holders, except as stated in Rules 1019(3), 3003, 3004, and 3005.

1. Rule 1019(3) states that claims filed prior to conversion of a case

to Chapter 7 are deemed filed in the Chapter 7 case and need not be re-filed.

2. Rule 3003 applies to Chapter 9 and Chapter 11 cases. It states

that claims in such cases listed in the schedules and not marked as "disputed, contingent or unliquidated" are deemed allowed unless objected to, and no filing of a POC is needed. All creditors (even secured creditors) not fitting that description must file a proof of claim. See also 11 U.S.C. §§925, 1111(a).

a. Of course, if the debtor’s description of the claim in its

schedules is inaccurate, the creditor should file a proof of claim to correct the record; the proof of claim will supersede the schedules. Fed. R. Bankr. P. 3003(c)(4).

b. If a Chapter 11 case is converted to a Chapter 7, a proof of

claim must then be filed, if the creditor did not file one in the Chapter 11 case. Rule 1019(3) applies only to filed proofs of claim.

3. Rule 3004 permits a debtor or trustee to file a claim for a creditor if

the creditor does not file a timely proof of claim. The debtor or trustee must exercise this right within thirty days of the proof of claim deadline. See also 11 U.S.C. §501(c). The debtor or trustee will often wish to exercise this right when there is a non-dischargeable debt or a secured debt that should be paid through a Chapter 13 plan.

4. Rule 3005 permits a proof of claim to be filed by a guarantor,

surety, endorser, or other co-debtor of the debtor, if the creditor does not file a proof of claim.

5. There is nothing in the Bankruptcy Code expressly requiring a

secured creditor to file a proof of claim in a Chapter 7, 12, or 13 case. But filing of a proof of claim by a secured creditor in such

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cases is still advisable. First, despite the language of the Code, some courts have rejected the liens of secured claimants who did not file proofs of claim. Second, if any portion of the secured creditor’s claim is unsecured, then the failure to file a proof of claim will prevent the creditor from receiving distributions from the estate; the creditor could only claim the value of its collateral. 9-3002 Collier on Bankruptcy 3002.01[2] (2016).

C. Time for Filing Proof of Claim

The time for filing a proof of claim depends on the Chapter under which the case was filed.

1. In a Chapter 7, 12, or 13 case, the proof of claim must be filed

within ninety days after the first date set for the 341 meeting. Fed. R. Bankr. P. 3002(c). The court is required to deliver notice of this deadline to all creditors under Fed. R. Bankr. P. 2002(f). This notice is regularly sent at the outset of a bankruptcy case.

2. In a Chapter 9 or 11 case, the Court will set the deadline for filing

of proofs of claim. Fed. R. Bankr. P. 3003(c)(3). D. Content of Proof of Claim

The required contents of a proof of claim are governed by Fed. R. Bankr. P. 3001(c). Generally speaking, the creditor will want to attach any documents that support its claim, such as contracts, security agreements, leases, complaints, invoices, A/R records, or any other document that one might use to evidence a claim. If the claim is based on a writing, then in most cases, the writing must be attached. Fed. R. Bankr. P. 3001(c)(1).

1. Fed. R. Bankr. P. 3001(c)(2) contains special requirements in

individual cases for claimants seeking interest or fees, claimants with claims secured by the debtor’s property, and claimants with claims secured by the debtor’s principal residence. Failure to comply with these rules can result in sanctions.

2. Fed. R. Bankr. P. 3001(c)(3) contains special requirements for

claims based on open-ended or revolving consumer credit agreements.

3. When filing a proof of claim, make certain to redact all confidential

or sensitive information in accordance with Fed. R. Bankr. P. 9037. Under that Rule, except under specified circumstances, a party cannot file in the public record documents containing an individual’s:

a. Social security number. b. EIN.

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c. Birthdate. d. Name of an individual known to be a minor. e. Financial account number. Failure to comply with Rule 9037 can result in sanctions.

E. There are potential consequences that come with filing a proof of claim.

While the law on the issue is currently in a state of flux due to recent decisions by the U.S. Supreme Court, you may submit yourself to the jurisdiction of the Bankruptcy Court by filing a proof of claim. By submitting yourself to Bankruptcy Court jurisdiction, you may also waive any right to a jury trial that you have with respect to your claim against the debtor. These consequences should be considered before a proof of claim is filed.

V. EVERYTHING WE DISCUSS RELATED TO AND AFTER THE FILING OF A

BANKRUPTCY IS PRIVILEGED, RIGHT?

A. The attorney-client privilege is one of the most widely known legal principles. Outside of bankruptcy it is well-settled that only the client holds the attorney-client privilege. Moore v. Eason (In re Bazemore), 216 B.R. 1020, 1023 (Bankr. S.D. Ga. 1998). Most are quick to assume that this privilege is unaffected by bankruptcy, and everything that is discussed between an attorney and a client related to a bankruptcy case is privileged.

B. This is not always the case. Once a debtor files a bankruptcy petition, "the

relationship between an attorney and his client changes as the Bankruptcy Code provides for the appointment of a Trustee who succeeds to many of the interests of the debtor." In re Miller, 247 B.R. 704, 708 (Bankr. N.D. Ohio 2000) (citing Gresk v. Brown (In re Brown), 227 B.R. 875, 879 (Bankr. S.D. Ind. 1998)); In re Wittmer, No. 96-60815,2011 WL 6000799, at *2 (Bankr. N.D. Ohio Nov. 30, 2011); In re Wittmer, 2013 Bankr. LEXIS 2962 (Bankr. N.D. Ohio July 22, 2013) .

C. Issues of privilege are determined using federal common law.

1. "The Federal Rules of Evidence require the court to use federal common law in addressing a claim of privilege except with respect to a claim or defense for which state law supplies the rule of decision." In re Horvath, 2015 WL 2195060, at *5 (Bankr. N.D. Ohio May 7, 2015) (citing Fed. R. Evid. 501; Fed. R. Bankr. P. 9017).

2. Where the trustee seeks to determine information relating to

potential claims and assets of the bankruptcy estate, federal common law applies. Horvath, 2015 WL 21905060, at *5 (citing Foster v. Hill (In re Foster), 188 F.3d 1259, 1264-65 (10th Cir. 1999)); Moore v. Eason (Bazemore), 216 B.R. 1020, 1022-23

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(Bankr. S.D. Ga. 1998) (citing Fed. R. Bankr. P. 2004 and Fed. R. Evid. 501).

3. The burden of establishing the protection of the attorney-client

privilege rests with the person or entity asserting it. Horvath, 2015 WL 21905060, at *5 (citing United States v. Dakota, 197 F.3d 821, 825 (6th Cir. 1999) (citing In re Grand Jury Investigation No. 83–2–35, 723 F.2d 447, 450 (6th Cir. 1983)).

D. Once a bankruptcy is filed, the trustee may, under certain circumstances,

control or even waive the attorney-client privilege. Whether he can or cannot depends on whether the case is an individual or corporate case.

1. Individual cases.

When determining whether a trustee can waive an individual’s attorney-client privilege, there are three different approaches:

a. Some courts have held that, as a matter of law, the trustee

succeeds to the attorney-client privilege of an individual debtor. In re Smith, 24 B.R. 3, 4 (Bankr. S.D. Fla. 1982).

b. On the opposite end of the spectrum are those which hold

that the privilege never passes. See, e.g., In re Tippy Togs of Miami, Inc., 237 B.R. 236, 239 (Bankr. S.D. Fla. 1999).

c. The third approach, adopted by the Northern District of

Ohio, holds that an individual debtor's attorney-client privilege does transfer to the trustee and the trustee has the power to waive the privilege when, on balance, the trustee's duty to maximize the value of the debtor's estate and represent the interests of the estate outweigh the policies underlying the attorney-client privilege and the harm to the debtor upon a disclosure. Horvath, 2015 WL 2195060, at *6; see also In re Wittmer, 2011 WL 6000799, at *3 (Bankr. N.D. Ohio Nov. 30, 2011) ("Here, the Trustee and debtors are not in an adversarial relationship. Further, the Trustee does not seek to use the information obtained directly against the debtors. In fact, if successful, the Trustee could recover monies on behalf of the estate that may benefit the debtors.").

d. Courts have held that when an individual case is converted

from a Chapter 11 to a Chapter 7, the Chapter 7 Trustee succeeds to the individual’s privilege as to post-petition communications between the Debtor and counsel having to do with the administration of the estate, including the disclosure and recovery of assets. In re Bame, 251 B.R. 367, 374 (Bankr. D. Minn. 2000) citing Whyte v. Williams (In re Williams), 152 B.R. 123 (Bankr. N.D. Tex. 1992).

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2. Corporations.

Outside of bankruptcy, officers and directors of a corporation maintain the right to assert or waive the attorney-client privilege on behalf of the corporation and to control who has access to privileged communications. These rights may change greatly upon the filing of a corporate bankruptcy.

a. Chapter 11.

In a Chapter 11 case, the corporation generally remains as a "debtor in possession," unless a trustee is appointed. As a debtor in possession, the corporation’s board of directors and management remain in control – literally "in possession" – of the company’s assets. Courts have held that this control extends to the continued right to assert, or waive, the corporation’s attorney-client privilege.

b. Chapter 7.

In a Chapter 7 liquidation bankruptcy, a Chapter 7 trustee is appointed and the debtor corporation’s board and management is removed from control. The U.S. Supreme Court held in CFTC v. Weintraub, 471 U.S. 373 (1985), that it’s the Chapter 7 trustee alone who controls the ability to assert, or waive, the corporation’s attorney-client privilege. This means that the Chapter 7 trustee is given access to all of the corporation’s attorney-client privileged communications prior to bankruptcy or conversion to Chapter 7.

c. Chapter 11 Trustee.

The answer is less clear in the relatively few Chapter 11 cases in which the court appoints a Chapter 11 trustee. Several courts, however, have extended the Supreme Court’s decision in Weintraub and held that the appointed Chapter 11 trustee, like a Chapter 7 trustee, takes control of the debtor’s assets and therefore has authority to assert or waive the corporation’s attorney-client privilege and to access privileged communications.

E. Trustees may seek to waive the privilege and seek emails and other

documents between counsel and the client before and after the bankruptcy was filed. This will most often happen in corporate cases when a case is converted or a trustee is appointed and the successor prosecutes claims against the former officers, directors, or insiders of the Debtor. This may also occur in individual cases when a trustee is attempting to find hidden assets. Parties should also carefully consider issues raised by multiple representations/common interest privilege and what communications may be disclosed when a trustee is appointed.

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F. Duty of candor to court.

Practitioners must also remember their duty to conduct a proper investigation and their duty of candor to the bankruptcy court. These duties may sometimes conflict with the attorney-client privilege and clients who wish to hide assets or liabilities in the bankruptcy filing. In re Thomas, 337 B.R. 879, 892 (Bankr. S.D. Tex. 2006) subsequently aff'd, 223 F. App'x 310 (5th Cir. 2007).

VI. A PLAINTIFF SUING ME HAS FILED FOR BANKRUPTCY, OR I REPRESENT

A PLAINTIFF WHO FILED FOR BANKRUPTCY – WHAT ARE MY OPTIONS?

A. The automatic stay prevents attempts to collect from a debtor, but the reverse is not true. The automatic stay does not prevent the continuation of a pre-petition claim or cause of action by a debtor. See Farley v. Henson, 2F.3d 273 (8th Cir. 1991). To the contrary, such claims can and often are continued to benefit the debtor’s estate.

Litigation counsel who prosecute such claims must be specially employed by the bankruptcy court pursuant to 11 U.S.C. §327(e). As counsel, your client would then be the trustee – not the debtor.

B. If the claim existed at the time the bankruptcy case was filed, it is property

of the debtor’s estate under 11 U.S.C. §541. Generally speaking, claims arising post-petition are not property of the estate, except in a chapter 13 case. See 11 U.S.C. §1306 (providing that property or wages acquired post-petition by a debtor are also property of the estate); but see 11 U.S.C. §327(e) (re-vesting all property of the estate in the debtor unless the plan or the order confirming the plan provide otherwise).

1. This is significant because, once a claim is property of the estate,

it is not the debtor’s claim anymore. It is now controlled by the trustee, and the trustee may dispose of it as he sees fit.

2. This presents favorable opportunities for defendants sued by

bankrupt debtors. Frequently trustees in bankruptcy lack the financial resources or the motivation to pursue a debtor’s claims, and simply want to obtain a quick return on the claim. Thus, defense counsel would be well-advised to attempt to settle a pre-petition claim with a trustee.

3. Finally, note the definition of "claim" for bankruptcy purposes is

extremely broad. 11 U.S.C. §101(5) defines "claim" as a "right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured." This means that a cause of action can become property whether or not formal litigation on that claim has commenced, or even before the claim becomes non-contingent.

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C. Disclosure of Claims

Pursuant to 11 U.S.C. §521, a debtor must disclose all claims it holds against other parties. But what happens if a debtor does not disclose those claims?

1. If a debtor does not disclose a claim against a party, then the

debtor may be judicially estopped from continuing to pursue the claim. Judicial estoppel occurs where (1) the debtor assumes a position contrary to the one asserted under oath in the bankruptcy proceedings (i.e., by not disclosing the claim); (2) the bankruptcy court adopts the contrary position either as a preliminary matter or as part of a final disposition (i.e., by granting the debtor a discharge); and (3) the omission did not result from mistake or inadvertence. In determining whether the plaintiff's conduct resulted from mistake or inadvertence, a court must consider whether: (1) the debtor lacked knowledge of the factual basis of the undisclosed claims; (2) the debtor had a motive for concealment; and (3) the evidence indicates an absence of bad faith. See White v. Wyndham Vacation Ownership, Inc., 617 F.3d 472 (6th Cir. 2010).

In other words, a debtor who does not disclose a claim in his bankruptcy may not be able to continue to proceed with it after his bankruptcy case. And again, the definition of "claim" for bankruptcy purposes can include claims for harm that has occurred, but as to which no litigation has yet been filed.

2. But the judicial estoppel of a debtor does not bar a trustee from

litigating an undisclosed claim, once the trustee becomes aware of the claim, if the trustee chooses to pursue it for the benefit of creditors. See Stephenson v. Malloy, 700 F.3d 265 (6th Cir. 2012). Judicial estoppel in those circumstances simply means that a debtor will receive no proceeds of the claim if the trustee is successful; rather, the trustee’s recoveries will go to the debtor’s creditors. Flugence v. Axis Surplus Ins. Co. (In re Flugence), 738 F.3d 126 (5th Cir. 2013).

D. Removal of Pending Action

One option a defendant to a case brought by a bankrupt debtor has is to remove the action to bankruptcy court to be litigated in connection with a bankruptcy case. This may be advisable when the defendant sees the bankruptcy court as a more favorable forum.

Removal is governed by 28 U.S.C. §1452. This section states that "A party may remove any claim or cause of action in a civil action other than a proceeding before the United States Tax Court or a civil action by a governmental unit to enforce such governmental unit’s police or regulatory power, to the district court for the district where such civil

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action is pending, if such district court has jurisdiction of such claim or cause of action under section 1334 of this title."

1. Any party can remove – unlike in ordinary civil litigation, both

plaintiffs and defendants can remove cases under §1452. 2. Any claim or cause of action can be removed – it is not necessary

to remove an entire lawsuit. 3. Certain claims cannot be removed. 4. To remove, there must be jurisdiction under 28 U.S.C. §1334. Generally, jurisdiction under this section is broad and encompasses all actions "related to" a bankruptcy case.

E. The bottom line regarding claims possessed by a debtor is that it is

imperative for counsel for both plaintiffs and defendants to review bankruptcy court records to determine whether a plaintiff has filed for bankruptcy. For plaintiffs, a bankruptcy filing could result in loss of control of a cause of action. For defendants, a bankruptcy filing may present favorable opportunities to settle a claim or limit exposure through a judicial estoppel argument. Finally, plaintiff’s counsel must advise their clients of the issues presented by a bankruptcy filing while they possess a claim against another party. Bankruptcy filings can easily be uncovered through the federal courts’ PACER system.

VII. WHAT HAPPENS TO THE AGREEMENT THAT I HAD WITH THE PERSON

WHO FILED FOR BANKRUPTCY? DOES IT GO AWAY?

A Executory Contracts/Leases

All assets of the Debtor are included in the bankruptcy estate. 11 U.S.C. §541. This includes "executory" contracts and leases. Contract clauses that purport to terminate a contract or lease due to a bankruptcy are generally not enforceable. 11 U.S.C. §365(e)(1). Also, the automatic stay prevents a non-debtor party to a contract from taking action against the debtor’s property or terminating a contract absent bankruptcy court order.

B. Definition of Executory Contract

An executory contract is one where performance is due on both sides of the contract. Examples include real estate leases, equipment leases, a contract to build a house, or intellectual property leases. Executory contracts are treated differently from general unsecured claims in three ways:

1. First, the debtor gets to decide whether to perform or refuse to

perform under the contract (i.e "assume" or "reject" the contract).

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2. Second, the non-debtor party must continue to perform while the debtor is deciding whether to perform.

3. Third, if the debtor decides to assume the lease the debtor must

"cure" all defaults, including the payment in full of outstanding amounts owed.

C. Non-debtor Party Must Continue to Perform even though the Debtor is in

Breach of the Contract

Prior to assumption or rejection, an executory contract in bankruptcy is enforceable by the debtor against the non-debtor party, but not against the debtor by the non-debtor party. U.S. Postal Serv. v. Dewey Freight Sys., Inc., 31 F.3d 620, 624 (8th Cir. 1994) ("After a debtor commences a Chapter 11 proceeding, but before executory contracts are assumed or rejected under §365(a), those contracts remain in existence, enforceable by the debtor but not against the debtor.") (citing NLRB v. Bildisco & Bildisco, 465 U.S. 513, 532 (1984)); In re Monarch Capital Corp., 163 B.R. 899, 907 (Bankr. D. Mass. 1994); In re Gunter Hotel Assocs., 96 B.R. 696, 699-700 (Bankr. W.D. Tex. 1988) (collecting authorities).

1. What to do?

In some instances, the debtor has a deadline for determining whether to assume or reject an executory contract or lease.

a. In a Chapter 7, a debtor has sixty days from the

bankruptcy filing to determine whether to assume or reject. 11 U.S.C. §365(d)(1).

b. In a Chapter 11, a debtor has until the confirmation of a

Chapter 11 plan to determine whether to assume or reject. 11 U.S.C. §365(d)(2). However, non-residential real property leases must be assumed or rejected within by the earlier of 120 days after the order for relief (usually the petition date) or the entry of the Chapter 11 confirmation order, though this deadline may be extended.

2. Counterparties to contracts and leases do have some options:

a. Contracts and leases that expire after the petition date are not extended due to the bankruptcy filing and cannot be assumed or assigned after they expire.

b. If the debtor is in default of a lease, the debtor cannot

require a lessor to provide services or supplies "incidental to such lease" before assumption until the lessee is compensated for such services. 11 U.S.C. §365(b)(4).

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3. The non-debtor party may file a motion to compel assumption or rejection.

The determination of what constitutes a reasonable time to assume or reject is within the bankruptcy court's discretion based on the particular facts of each case. The factors examined by the court may include (1) the nature of the interests at stake; (2) the balance of hurt to the litigants; (3) the good to be achieved; (4) the safeguards afforded to the litigants; (5) whether the action to be taken is so in derogation of Congress' scheme that the court may be said to be arbitrary; (6) the debtor's failure or ability to satisfy post-petition obligations; (7) the damage that the non-debtor will suffer beyond the compensation available under the Bankruptcy Code, (8) the importance of the contract to the debtor's business and reorganization; (9) whether the debtor has sufficient time to appraise its financial situation and the potential value of the assets in formulating a plan; (10) whether there is a need for judicial determination as to whether an executory contract exists; (11) whether exclusivity has been terminated; and (12) "above all," the purpose of Chapter 11, to permit successful rehabilitation of debtors. In re Adelphia Commc'ns Corp., 291 B.R. 283, 292-93 (Bankr. S.D.N.Y. 2003) (internal citations omitted).

D. What Happens upon Assumption or Rejection?

1. Upon assumption, the debtor must cure defaults under the lease or contract and must provide adequate assurance of future performance.

2. The rejection of an executory contract or unexpired lease is treated as a breach of such contract or lease resulting in a pre-petition unsecured claim. 11 U.S.C. §365(g). See 11 U.S.C. §365(h) for the resulting consequences when the debtor is the lessor.

3. Even if an executory contract or unexpired lease is rejected, the

debtor must pay the reasonable value of any contractual benefits during such period, as an administrative claim. In re Res. Tech. Corp., 254 B.R. 215, 221 (Bankr. N.D. Ill. 2000).

VIII. I HAVE RECEIVED MONEY FROM A COMPANY WHO I FEAR MAY FILE FOR

BANKRUPTCY (OR HAS FILED FOR BANKRUPTCY) – WHAT SHOULD I DO?

A. Payments received by a party before the petition is filed may be

recovered for the benefit of a debtor’s creditors under certain circumstances.

B. The primary means of recovery of pre-petition payments is through a

preference under 11 U.S.C. §547. The purposes of the preference statute are to facilitate the goal of equal distribution among creditors by forcing creditors who were "preferred" during the pre-bankruptcy period to

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disgorge those preferential payments. The preference section also prevents creditors from hastening a debtor’s slide into bankruptcy by demanding and obtaining payments in advance of bankruptcy. 5-547 Collier on Bankruptcy 547.01 (2016).

1. The elements of a preference claim under 11 U.S.C. §547(b) are

as follows and must all be met:

a. A transfer of an interest of the debtor in property; b. To or for the benefit of a creditor; c. For or on account of an antecedent debt owed by the

debtor before the transfer was made; d. Made while the debtor was insolvent; e. Made on or within ninety days before the date of the filing

of the petition, or between ninety days and one year before the date of the filing of the petition if the creditor was an insider of the debtor;

f. That enables the creditor to obtain more than he would

have received in a Chapter 7 liquidation, the transfer had not been made, and the creditor received payment to the extent provided by the Bankruptcy Code;

g. A textbook preference is a payment of money to an

existing unsecured creditor less than ninety days before the filing of the petition;

h. Payments to fully secured creditors are generally not

preferential because the fully secured creditor would have the right to full payment of its secured claim in a Chapter 7 case. Yoppolo v. Comerica Bank (In re Norwalk Furniture Corp.), 428 B.R. 419, 425 (Bankr. N.D. Ohio 2009);

i. A debtor is presumed to have been insolvent on and

during the ninety days pre-petition. 11 U.S.C. §547(f). Thus, unless the presumption is rebutted, that element will always be met in a preference case against a non-insider; and,

j. Preference litigation is mechanical, and it does not depend

upon whether a debtor actually intended to prefer or benefit a creditor. Many preference defendants claim that they have "done nothing wrong." Often they are correct, but preference liability is not fault-based.

2. There are a number of defenses to preference actions that are

discussed in 11 U.S.C. §547(c):

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a. Substantially contemporaneous exchanges.

The transfer was intended to be and was a substantially contemporaneous exchange for new value given to the debtor (for example – a sale of a car to the debtor for which the debtor immediately pays).

b. Ordinary course of business.

The transfer was a payment for a debt incurred in the ordinary course of business, and was paid in the ordinary course of business between the debtor and creditor or made according to ordinary business terms (for example – a payment made in the same form and same business terms as prior payments between a debtor and creditor with a standing business relationship).

c. Purchase money security interests.

The transfer of a security interest in property to secure a loan of funds used to purchase the property, if the security interest was perfected within thirty days of the debtor receiving the property (for example – a security interest in a car granted to a lender of funds used to purchase the car).

d. New value.

The transfer is followed by a subsequent transfer of new value from the creditor to the debtor

e. Security interest in receivables. f. Unavoidable statutory liens (for example, mechanic’s

liens). g. Payments for domestic support obligations (for example,

alimony, maintenance, or child support). h. Payments that aggregate less than $600 in a consumer

case, or $6,225 in a non-consumer case.

3. In an action to recover a preference, the trustee bears the burden of proving all of the elements of a preference under 11 U.S.C. §547(b). The creditor bears the burden of proving any affirmative defenses under 11 U.S.C. §547(c). 11 U.S.C. §547(g).

4. Tips for avoiding preference liability on the front end if you are

concerned that a person or company may file for bankruptcy.

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a. If possible, obtain the counterparty’s agreement to pre-pay its debts. If they do, any payments you recover from them will not be on account of an antecedent debt, so a preference claim would fail.

b. Obtain payment at the time you perform goods or services

for the counterparty. This would likely render the transaction a contemporaneous exchange and therefore unavoidable.

c. Continue to adhere to existing terms of your business

relationship and/or to standard industry terms – accept payment in only one form, issue invoices in a consistent fashion, and demand that they be paid within consistent timeframes.

d. Obtain collateral. Secured creditors are better insulated

from preferences. e. Be cautious in entering into settlements or debt

restructuring agreements. A creditor with a business relationship with a potential debtor may be tempted to demand payment of outstanding invoices or enter into a payment plan before continuing to do business. The problem is that these arrangements are usually outside of the ordinary course of business, thereby eliminating that potential defense.

5. If you fear that a counterparty may file for bankruptcy and they

offer to pay a debt to you, should you take the money?

YES. Money in hand is always better than the alternative, and even if your counterparty does end up filing for bankruptcy, you may have valid defenses to the preference claim or the claim may never be pursued.

C. The other often-used method of recovering pre-petition payments is the

fraudulent conveyance statute, 11 U.S.C. §548. Unlike preferences, the idea behind fraudulent conveyance law is to prevent debtors from shielding assets from creditors by transferring them out of their possession pre-bankruptcy.

1. A transfer is fraudulent under 11 U.S.C. §548(a)(1) when made

within two years before the filing of a bankruptcy petition where either of the following two criteria is met:

a. The transfer was made with actual intent to hinder, delay,

or defraud the debtor’s creditors; or b. The debtor received less than reasonably equivalent value

in exchange for the transfer while insolvent, with

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unreasonably small capital, while incurring debts beyond the debtor’s ability to repay, or made the transfer to an insider under an employment contract and outside the ordinary course of business.

2. Additionally, certain transfers from partnership debtors to general

partners of such debtors, and from debtors to self-settled trusts or similar devices, may be avoided under §548. 11 U.S.C. §548(b), (e).

3. With respect to proving actual fraud, courts generally rely on

"badges of fraud." These badges include (1) inadequacy of consideration; (2) secret or hurried transactions not in the usual mode of doing business; (3) use of dummies or fictitious parties; (4) a close relationship between the parties; (5) the transferor's continued relationship with the property, for example, in the form of ongoing mortgage, tax and insurance payments on the property; and (6) each party's awareness of the transferor's increasing financial difficulty. BankEast v. Shirley (In re Shirley), 2011 Bankr. LEXIS 3496, at *10-*11 (E.D. Tenn. Sept. 12, 2011); BankEast v. Shirley (In re Shirley), No. 09-35259, 2011WL 4054773 (E.D. Tenn. Sept. 12, 2011)..

4. With respect to proving lack of reasonably equivalent value, a

trustee need not show a dollar-for-dollar equivalence, only that the transfer was reasonably equivalent. This often requires expert testimony as to the value of property the debtor received in return for the transfer.

a. There is no reasonably equivalent value issue where

payments from a debtor reduce that debtor’s debt in an amount equal to the value of the transfer. Lisle v. John Wiley & Sons, Inc. (In re Wilkinson), 196 Fed. App’x 337,342 (6th Cir. 2006).

b. Reasonably equivalent value issues are prevalent where a

debtor has made payments that benefit third parties, but only result in indirect benefit to a debtor. A common example is the debtor’s payment of tuition for his children. Cases are split with regard to whether such incidental benefit or "peace of mind" qualifies as reasonably equivalent value.

5. The Trustee bears the burden of proof on all elements of a

fraudulent conveyance claim. In re Butcher, 51 B.R. 61, 65 (E.D. Tenn. 1985).

D. Even if you lose or settle a preference or fraudulent conveyance claim,

you may assert a claim against the bankruptcy estate for any amounts that you had to pay to the trustee. 11 U.S.C. §502(h).

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IX. IF I FILE BANKRUPTCY, DO I GET TO KEEP ANYTHING?

A. The first question asked by many debtors is if they will be able to keep certain property if they file for bankruptcy. The answer depends on the type of bankruptcy filed and the value of the debtor’s property.

1. In a Chapter 7, debtors typically give up their property in exchange

for a discharge. However, to further the goals of providing debtors a "fresh start" the Bankruptcy Code allows debtors to keep certain property, up to a certain value.

2. In a Chapter 13, debtors typically retain their property in exchange

for making payments to creditors for a period of three or five years.

3. In a Chapter 11, debtors may be entitled to keep their property,

but this depends on the value of the property and the payments being made to creditors during the course of the debtor’s chapter 11 plan.

B. Excluded Property

Property may be excluded from the debtor’s estate under the provisions of 11 U.S.C. §541. Examples of property excluded from a bankruptcy estate are an individual debtor’s post-petition income in a Chapter 7 (11 U.S.C. §541(a)(6)) or an interest in certain trust and retirement plans (11 U.S.C. §541(b)(1)-(9)). From a practical standpoint, most of a consumer debtor’s property will fall within the definition of estate property, and the practitioner must focus on applying exemptions to allow the debtor to retain as much property as possible.

However, property is not excluded from the estate based on a clause in a contract or other document that purports to limit the debtor’s ability to transfer property or to deprive the debtor of property based on a bankruptcy filing. These so-called ipso facto clauses are not enforceable in bankruptcy, except in the case of property of a debtor as beneficiary of a spendthrift trust. 11 U.S.C. §541(c).

C. Exemptions

Under the Bankruptcy Code, a debtor may be able to use exemptions allowed under state law, or the exemptions set forth in the Bankruptcy Code itself. KRS 427.170 permits debtors to use the federal exemptions in advance of the effective date of BAPCPA. Federal exemptions tend to be more generous than those allowed by Kentucky law.

1. Examples of different types of property that may be exempted

under the Bankruptcy Code include:

a. Real property used as a residence (11 U.S.C. §522(d)(1));

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b. One motor vehicle (11 U.S.C. §522(d)(2)); c. Household goods and furnishings (11 U.S.C. §522(d)(3)); d. Certain life insurance contracts or cash value (11 U.S.C.

§522(d)(7) and (8)); e. And certain retirement funds (11 U.S.C. §522(d)(12) (Note:

The applicable sections of the Internal Revenue Code include 26 U.S.C. §§401, 403, 408, 408A, 414, 457, 501(a)).

f. In addition, debtors are entitled to a "wildcard" exemption –

an exemption which can be used to protect any type of property (11 U.S.C. §522(d)(1), (5)).

The amounts of the federal exemptions are adjusted every three years. 11 U.S.C. §104(b).

2. It may be possible to engage in pre-bankruptcy planning with

debtors to allow them to convert non-exempt assets to exempt assets or otherwise maximize property which they may retain in a Chapter 7 case.

3. The trustee or any other party in interest may object to the

exemptions claimed by a debtor, but pursuant to Bankruptcy Rule 4003(b), must do so within thirty days after the meeting of creditors is concluded. In addition, even exempt property is subject to claims for certain debts including taxes, secured debts and domestic support obligations. 11 U.S.C. §522(c).

D. Retirement Plans

Typically in a Chapter 7 or Chapter 13, debtors retain amounts in pensions and retirement plan funds. 1. Funds covered by ERISA are included: 401(k); 403(b); IRAs

(Roth, SEP, and SIMPLE); Keoghs; profit-sharing plans; money purchase plans, and defined-benefit plans.

2. The amount of retirement funds that can be exempted are capped

at a certain amount (currently $1,245,475) and any amount over that limit can be used to pay back creditors. Also, retirement funds paid as income are not exempt. In a Chapter 7 the retirement funds could take amounts over and above the amount needed for your support to repay creditors. The retirement funds are included in a Chapter 13 debtor’s income which will determine the debtor’s monthly plan payment.

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E. Abandonment of Estate Property

When a debtor’s property is properly exempted, it remains in possession of the debtor and title re-vests in him or her once it is abandoned in a Chapter 7 or once a plan is confirmed in a Chapter 13. 11 U.S.C. §§554, 1327. Property remains subject to the control of a debtor’s trustee throughout the life of a debtor’s case, even if no objection to their exemption is raised. Abandonment is automatic upon the closing of a bankruptcy case. 11 U.S.C. §554(c).

X. QUESTIONS?

Ellen Arvin Kennedy John M. Spires Dinsmore & Shohl LLP 250 West Main Street, Suite 1400 Lexington, KY 40507 Phone: (859) 425-1000 Email: ellen.kennedy@dinsmore.com john.spires@dinsmore.com T. Kent Barber Barber Law PLLC 2200 Burrus Drive Lexington, KY 40513 Phone: (859) 296-4372 Email: kbarber@barberlawky.com

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