Bankruptcy

“One could always begin again in America, even again and again. Bankruptcy, which in the fixed society of Europe was the tragic end of a career, might be merely a step in personal education.” John A. Krout and Dixon Ryan Fox, The Completion of Independence

 The Bankruptcy Code is divided into eight chapters ◦ Chapters 1, 3, and 5 are administrative rules that apply to all types of bankruptcy proceedings ◦ Chapters 7, 9, 11, 12, and 13 are substantive rules that apply to specific types of bankruptcies ◦ Substantive chapters have one of two objectives  Rehabilitation or liquidation

 To preserve as much of the debtor’s property as possible  To divide the debtor’s assets fairly between the debtor and the creditors  To divide the debtor’s assets fairly among the creditors

 Filing a petition ◦ Any individual, partnership, corporation, or other business organization that:  Lives, conducts business, or owns property in the United States can file under the Code ◦ Debtor: Someone who cannot pay his debts and files for protection under the Bankruptcy Code ◦ Voluntary petition: Filed by a debtor to initiate a bankruptcy case ◦ Involuntary petition: Filed by creditors to initiate a bankruptcy case

 Any debtor has the right to file for bankruptcy  Requirements before filing ◦ Within 180 days before filing:  Debtor must undergo credit counseling with an approved agency ◦ Debtors may file under Chapter 7 if they earn less than the median income in their state or:  They cannot afford to pay back at least $7,025 over five years

 Must meet all the following requirements ◦ Debtor must owe at least $14,425 in unsecured claims to the creditors who file ◦ If the debtor has at least 12 creditors, three or more must sign the petition  If fewer than 12 creditors, any one can file ◦ The creditors must allege either that a custodian for the debtor’s property has been appointed in the prior 120 days or that:  Debtor has generally not been paying debts

 Once a voluntary petition is filed or an involuntary petition approved: ◦ Bankruptcy court issues an order for relief  Order for relief: Official acknowledgement that a debtor is under the jurisdiction of the bankruptcy court

 Responsible for gathering the bankrupt’s assets and dividing them among creditors  U.S. Trustee: Oversees the administration of bankruptcy law in a region

 After the court issues an order for relief: ◦ U.S. Trustee calls a meeting of all of the creditors  After the meeting, unsecured creditors must submit a proof of claim ◦ Proof of claim: Form stating the name of an unsecured creditor and the amount of the claim against the debtor  Secured creditors do not file proofs of claim unless the claim exceeds the value of their collateral

 Automatic stay: Prohibits creditors from collecting debts that the bankrupt incurred before the petition was filed

 The new legal entity created when a debtor files a bankruptcy petition ◦ Debtor’s existing assets pass into the estate

 Exempt property ◦ Code permits individual debtors to keep some property for themselves ◦ Debtors can take advantage of state exemptions only if:  They have lived in that state for two years prior to the bankruptcy ◦ Can exempt only $146,450 of any house that was acquired during 40 months before bankruptcy

 Voidable preferences ◦ Preference: When a debtor unfairly pays creditors immediately before filing a bankruptcy petition  Two forms of preferences  Payment – Debtor gives a creditor cash that would otherwise end up in bankruptcy estate  Lien – Security interest in debtor’s property

 Voidable preferences ◦ The trustee can void a transfer that meets all of the following requirements:  Transfer was to a creditor of the bankrupt  It was to pay an existing debt  Creditor received more than she would have received during the bankruptcy process  Debtor’s liabilities exceeded assets at the time of the transfer  Transfer took place in the 90-day period before the filing of the petition ◦ Trustee can void a transfer to an insider

 Fraudulent transfer ◦ If it is made within a year before a petition is filed and its purpose is to:  Hinder, delay, or defraud creditors ◦ Trustee cannot void pre-petition payments made in the ordinary course of business

 Claims are placed in one of three classes ◦ Secured claims ◦ Priority claims (seven subcategories) ◦ Unsecured claims (three subcategories)  Trustee pays the bankruptcy estate to the various classes of claims in order of rank  Secured claims ◦ Creditors whose loans are secured by specific collateral are paid first ◦ Different from other claims because they are paid by selling a specific asset

 Priority claim subcategories ◦ Alimony and child support ◦ Administrative expenses ◦ Gap expenses  Gap period: Period between the time that a creditor files an involuntary petition and the court issues the order for relief ◦ Payments to employees ◦ Employee benefit plans ◦ Consumer deposits ◦ Taxes ◦ Intoxication injuries

 Unsecured claim subcategories ◦ All of these subcategories have an equal claim and must be paid together  Secured claims that exceed the value of the available collateral  Priority claims that exceed the priority limits  All other unsecured claims

 Fresh start: After the termination of a bankruptcy case: ◦ Creditors cannot make a claim against the debtor for money owed:  Before the initial bankruptcy petition was filed  Discharge: Debtor no longer has an obligation to pay a debt ◦ Debtor must complete an approved course on financial management before receiving a discharge

 Debts that cannot be discharged ◦ Income taxes and property taxes ◦ Money obtained fraudulently ◦ Some loans for luxury goods ◦ Recent cash advances on credit cards ◦ Debts omitted from Schedule of Assets and Liabilities ◦ Money obtained through violation of fiduciary duty

 Debts that cannot be discharged ◦ Alimony and child support debt ◦ Debts from intentional and malicious injury ◦ Fines and penalties ◦ Liability for injuries caused while operating a vehicle under the influence of alcohol ◦ Liability for breach of duty ◦ Violation of securities laws ◦ Student loans

 Circumstances that prevent debts from being discharged: ◦ Business organizations ◦ Revocation ◦ Dishonesty or bad faith behavior ◦ Repeated filings for bankruptcy

 Reaffirm: To promise to pay a debt even after it is discharged  To be valid, the reaffirmation must: ◦ Not violate laws for fraud, duress or unconscionability ◦ Be filed in court ◦ Include the detailed disclosure statement ◦ Be approved by the court if the debtor is not represented by an attorney

 Debtor in possession: Acts as trustee ◦ Operates the business ◦ Develops a plan of reorganization  Creditors’ committee ◦ Protects the interests of its constituency ◦ Plays a role in developing the plan of reorganization

 Plan of reorganization ◦ Provides for the payment of debts and the continuation of the business ◦ Debtor has 120 days to come up with a plan that is acceptable to the creditors

 Confirmation of the plan ◦ Disclosure statement – Provides creditors and shareholders with enough information to make an informed judgment ◦ Confirmation hearing is held to determine whether it should accept the plan ◦ The court will approve a plan if a majority of each class votes in favor of it

 Discharge ◦ Debtor now owns the assets in the bankrupt estate  Free of all obligations except those listed in the plan  Small-business bankruptcy ◦ Process for business with less than $2 million  Exclusive right to file a plan for 180 days  Plan and disclosure statement must be filed within 300 days  Court must confirm or reject within 45 days  If these deadlines are not met, the case can be converted to a Chapter 7 case, or it may be dismissed

 Purpose of Chapter 13 is to rehabilitate an individual debtor ◦ Available only to debtors with less than $360,475 in unsecured debts or $1,081,400 in secured debts  Beginning a Chapter 13 case ◦ Creditors cannot use an involuntary petition to force a debtor into Chapter 13  A trustee is appointed to supervise the debtor, who remains in possession of all assets

 Plan of payment ◦ Debtor must file a payment within 15 days after filing the petition ◦ Debtor must:  Commit some future earnings to pay off debts  Promise to pay all secured and priority claims  Treat all remaining classes equally

 Plan of payment ◦ To confirm a plan, court must ensure that:  Creditors have the opportunity to voice their objections  Unsecured creditors receive as much if the bankruptcy estate is liquidated under Chapter 7  Plan is feasible  Plan does not extend beyond 3 years  Debtor is acting in good faith with a reasonable effort to pay obligations

 Discharge ◦ Debtor is washed clean of all pre-petition debts except those:  Provided for in the plan  Unlike Chapter 7, debts are not permanently discharged