25-1 Chapter 28 Bankruptcy and Reorganization

Introduction to Bankruptcy and Reorganization  Bankruptcy Reform Act of 1978  Debtor friendly  Bankruptcy Abuse Prevention and Consumer Protection Act of 2005  Creditor friendly Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 28-2

Types of Bankruptcy ChapterType of Bankruptcy Chapter 7Liquidation Chapter 11Reorganization Chapter 12Adjustment of Debts of a Family Farmer or Fisherman with Regular Income Chapter 13Adjustment of Debts of an Individual with Regular Income Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 28-3

Bankruptcy Law  U.S. Bankruptcy Courts: Special federal courts that hear and decide bankruptcy cases  Part of federal court system  One for each federal district  Judges appointed for 14-year terms  Judges assisted by bankruptcy trustees Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 28-4

Bankruptcy Procedure  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 Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 28-5

Bankruptcy Procedure  Filing the Petition  Voluntary petition  filed by the debtor  Chapters 7, 11, 12, and 13 cases  Involuntary petition  Filed by the creditor  Chapters 7 and 11 cases only  The 2005 act requires attorney certification of the information in the bankruptcy petition Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 28-6

Bankruptcy Procedure  Order for relief: An order that occurs upon the filing of either a voluntary petition or an unchallenged involuntary petition, or an order that is granted after a trial of a challenged involuntary petition  Proof of claim: A document required to be filed by a creditor that states the amount of his or her claim against the debtor  Proof of interest: A document required to be filed by an equity security holder that states the amount of his or her interest against the debtor Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 28-7

Bankruptcy Procedure  Automatic stay: The suspension of certain legal actions by creditors against a debtor or the debtor’s property that include:  Instituting or maintaining legal actions to collect prepetition debts  Enforcing judgments obtained against the debtor  Obtaining, perfecting, or enforcing liens against property of the debtor  Nonjudicial collection efforts Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 28-8

Bankruptcy Procedure  Discharge: A court order that relieves a debtor of the legal liability to pay his or her debts that were not paid in the bankruptcy proceeding  All or part of a debt can be discharged  Some debts are not discharged  Reaffirmation agreement: An agreement entered into by a debtor with a creditor prior to discharge, whereby the debtor agrees to pay the creditor a debt that would otherwise be discharged in bankruptcy Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall. 28-9

Exhibit 28.1: Debts that cannot be discharged in bankruptcy Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Bankruptcy Estate  Bankruptcy estate: The debtor’s property and earnings that comprise the estate of a bankruptcy proceeding  Includes interest of debtor and the debtor’s spouse in community property  Exempt property: Property that may be retained by the debtor pursuant to federal or state law that does not become part of the bankruptcy estate Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Exhibit 28.2: Federal Exemptions from the Bankruptcy Estate Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Bankruptcy Estate  State Exemptions: States may  Give debtors the option of choosing between federal and state exemptions  Require debtors to follow state law  Homestead exemption: Equity in a debtor’s home that the debtor is permitted to retain Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 7—Liquidation  Chapter 7—Liquidation: A form of bankruptcy in which the debtor’s nonexempt property is sold for cash, the cash is distributed to the creditors, and any unpaid debts are discharged  Also termed as straight bankruptcy  Debtor’s future income cannot be reached  Abusive filing: A Chapter 7 filing that is found to be an abuse of Chapter 7 liquidationbankruptcy Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 7—Liquidation  Median income test: If a debtor’s median family income is at or below the state’s median family income for a family the same size as the debtor’s family, the debtor can receive Chapter 7 relief  Categories:  Median family income equal to or below the state’s median family income  Median family income higher than the state’s median family income Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 7 – Liquidation  Statutory Distribution of Property  Oversecured secured creditor  Undersecured secured creditor  Chapter 7 discharge: The termination of the legal duty of an individual debtor to pay unsecured debts that remain unpaid upon the completion of a Chapter 7 proceeding  The debtor is not responsible for paying prepetition debts out of postpetition income Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Exhibit 28.3: Priority of Unsecured Creditor Claims Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 7 – Liquidation  Acts that bar discharge  Debtor lied about financial position when obtaining credit  Debtor transferred, concealed, removed, or destroyed 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 Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 13 – Adjustment of Debts of an Individual with Regular Income  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 Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 13 – Adjustment of Debts of an Individual with Regular Income  Filing a Chapter 13 petition  Voluntary filing of petition by debtor with regular income  Cannot be filed involuntarily by a creditor  Debts must be primarily consumer debt  Amount of debt must not exceed certain dollar amounts  $360,475 in unsecured debts  $1,081,400 in secured debts Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 13 – Adjustment of Debts of an Individual with Regular Income  Property of a Chapter 13 Estate  All nonexempt property of debtor at commencement of case  Nonexempt property acquired before case is closed  Earnings and future income Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 13 – Adjustment of Debts of an Individual with Regular Income  Chapter 13 Plan of Payment  Must be filed within 90 days after the order for relief  Must be accepted by secured and unsecured creditors or approved by the court  During the plan period, unsecured creditors might not receive full payment of the debt owed to them Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 13 – Adjustment of Debts of an Individual with Regular Income  Confirmation of a Chapter 13 plan of payment  Conditions  The plan was proposed in good faith  The plan passes the feasibility test  The plan is in the best interests of the creditors  The debtor has paid all domestic support obligations owed  The debtor has filed all applicable federal, state, and local tax returns Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 13 – Adjustment of Debts of an Individual with Regular Income  Chapter 13 Discharge: A discharge in a Chapter 13 case that is granted to the debtor after the debtor’s plan of payment is completed  Cannot be discharged under Chapter 13 if the debtor has received discharge under  Chapter 7, 11, or 12 within 4 years, or  Chapter 13 within 2 years Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 11 – Reorganization  Chapter 11: A bankruptcy method that allows the reorganization of the debtor’s financial affairs under the supervision of the bankruptcy court  For individuals, partnerships, corporations, and other business entities  Debtor reorganizes with new capital structure  May be relieved of portion of debts, burdensome executory contracts and unexpired leases Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 11 – Reorganization  Debtor-in-possession: A debtor who is left in place to operate the business during the reorganization proceeding  Creditors’ committee: A committee of unsecured creditors that is appointed by the court to represent the class of unsecured claims  Committee may be appointed to represent secured creditors and equity holders Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 11 – Reorganization  Executory contract: A contract or lease that has not been fully performed  Unexpired lease  A debtor may reject executory contracts and unexpired leases in bankruptcy  Chapter 11 Plan of Reorganization: Sets forth a proposed new capital structure for a debtor to assume when it emerges from Chapter 11 reorganization bankruptcy Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 11 – Reorganization  Confirmation of a Chapter 11 Plan of Reorganization  Acceptance method is used to confirm the plan if:  The plan is in the best interests of the creditors  The plan is feasible  Each class of creditors accepts the plan  Cram-down provision: A provision whereby the court confirms a plan of reorganization over an objecting class of creditors if certain requirements are met Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 11 – Reorganization  Small Business Bankruptcy  Total debts of less than $2,343,300  Fast-track form of Chapter 11 reorganization bankruptcy is used for resolution Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall