P A R T P A R T Credit Introduction to Credit and Secured Transactions Security Interests in Personal Property Bankruptcy 6 McGraw-Hill/Irwin Business Law, 13/e © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

Bankruptcy PA E TR HC 30 “Bankruptcy or credit default is not an issue.” Bernie Ebbers, said a few months before the bankruptcy of WorldCom (press conference, Feb. 2002)

Learning Objectives  The Bankruptcy Act  Chapter 7 – liquidation  Discharge in bankruptcy  Chapter reorganizations  Chapter 12 – family enterprises  Chapter 13 – consumer debt

 The U.S. Constitution guarantees the right to file for bankruptcy  Federal Bankruptcy Act creates a procedure for insolvent debtors, with proceedings for:  Straight bankruptcy (liquidations)  Reorganizations  Family farms, commercial fishing operations  Consumer debt adjustments Overview

 All bankruptcy proceedings begin by filing a petition, either voluntary or involuntary  Voluntary petition by an individual, partnership, or corporate debtor  Involuntary petition by creditors of a debtor in attempt to reach debtor’s assets  Filing a bankruptcy petition operates as an automatic stay against all legal proceedings against debtor or the property Bankruptcy Act Procedure

 Once bankruptcy petition filed, court must first determine relief should be ordered  Automatic for a voluntary petition  For involuntary petition, relief granted and interim trustee appointed only if debtor not paying debts or custodian appointed  Unsecured creditors must file a proof of claim within a certain time to participate in the bankruptcy proceedings Order of Relief

 In a straight bankruptcy, the debtor must disclose all property s/he owns and transfer the bankruptcy estate to a bankruptcy trustee  Trustee segregates property debtor may keep and then administers, liquidates, distributes remainder of the estate  Bankruptcy estate includes all of debtor’s legal and equitable interests in property  Some exemptions allowed Liquidation (Chapter 7)

 Debtor may void or redeem some liens against exempt properties  Debtor and creditors may engage in ordinary business transactions  If debtor transfers property or incurs a debt with intent to hinder, delay, or defraud creditors, transfer is voidable by the trustee  Criminal penalties also possible Liquidation (Chapter 7)

 Chapter 11, available to individuals and companies, offers a procedure in which the debtor’s financial affairs can be reorganized rather than liquidated  Trustee develops a reorganization plan for handling creditor claims and the various interests of persons such as shareholders  A contract between debtor and creditors Chapter 11 Reorganization

 Reorganization plan must be confirmed by court before becoming effective and:  Divides creditors into classes, states how each will be satisfied and which claims are adversely affected; and provides equal treatment to each creditor in a class, unless creditors in a class consent otherwise  If confirmed, debtor must implement plan The Bankruptcy Plan

 Individuals who fit particular criteria and do not want to be declared bankrupt have a right to file a voluntary petition for federal bankruptcy protection under Chapter 13  After filing, the debtor submits a plan of payment to secured creditors for acceptance  If acceptable to creditors and court, plan approved and court appoints a trustee to carry out the plan Chapter 13 – Consumer Debt

 Debtor who fulfills duties under a plan may be discharged, relieving person of further responsibility for dischargeable debts and giving person a fresh start  Corporation or partnership not eligible  Certain debts, including educational loans, are not dischargeable in bankruptcy  See In Re Gerhardt Discharge

Test Your Knowledge  True=A, False = B  All bankruptcy proceedings begin by filing a voluntary bankruptcy petition  Once a voluntary bankruptcy petition has been filed, the automatic stay prevents a creditor from filing suit against the debtor for repossession of the property.  Chapter 11 is available only to business enterprises

Test Your Knowledge  True=A, False = B  A reorganization plan under Chapter 11 requires unanimous consent by all creditors before it becomes effective  To participate in the estate of a bankrupt debtor, unsecured creditors must file a proof of claim within a certain time, usually six months after the first meeting of creditors

Test Your Knowledge  Multiple Choice  Days before filing for reorganization, Bernie gave six of his properties to friends in return for an agreement that they would sell the property back to him in five years. Has Bernie done anything wrong?  (a) Yes, he must have sold the properties for at least $1 minimum value  (b) Yes, he engaged in fraudulent transfer  (c) No, properties given to friends are exempt from inclusion in the bankruptcy estate  (d) None of the above

Test Your Knowledge  Multiple Choice  In JimCo’s reorganization, the bankruptcy court forced dissenting creditors whose claims would be impaired to accept the reorganization plan. The court:  (a) Improperly abused its power and will be reversed on appeal  (b) Prioritized execution of the plan  (c) Engaged in a cram down  (d) none of the above

Thought Questions  Why did the founding fathers incorporate bankruptcy into the U.S. Constitution as a constitutional guarantee? What is your opinion of the current bankruptcy laws? What are the ethical choices in declaring bankruptcy?