Chapter 28
Bankruptcy Law and
Consumer Debt Adjustment
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Federal Bankruptcy Law
• Article I, section 8, clause 4 of
the U.S. Constitution provides
that “The congress shall have
the power. . .to establish. .
.uniform laws on the subject of
bankruptcies throughout the
United States.”
• Bankruptcy law is federal law.
• There are no state bankruptcy
laws.
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The Federal Bankruptcy Code
• Congress enacted the original
Bankruptcy Act in 1878.
– Amended by the Chandler Act
(1938).
• Bankruptcy Reform Act (1978)
completely revised the law.
– This is the Bankruptcy Code.
– Bankruptcy Amendments and
Federal Judgeship Act (1984)
amended the Code.
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Types of Bankruptcy
• The Bankruptcy Code is
divided into chapters.
• The most common forms of
bankruptcy are provided by
the following chapters:
– Chapter 7 – Liquidation Bankruptcy
– Chapter 11 – Reorganization
Bankruptcy
– Chapter 12 – Family Farmer
Bankruptcy
– Chapter 13 – Consumer Debt
Adjustment
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The Fresh Start
• The primary purpose of
federal bankruptcy law is to
discharge the debtor from
burdensome debts.
• The law gives debtors a fresh
start by freeing them from
legal responsibility for past
debts.
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Bankruptcy Courts
• Bankruptcy courts decide
core proceedings regarding
bankruptcy cases.
– allowing creditor claims
– deciding preferences
– confirming plans of
reorganization
• The jurisdiction of the
bankruptcy courts became
effective on July 10, 1984.
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Jurisdiction of the Bankruptcy
Courts (continued)
• Noncore proceedings
concerning the debtor are
resolved in federal or state
court.
– decisions on personal injury
– divorce
– other civil proceedings
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Chapter 13 Consumer Debt
Adjustment
• A rehabilitation form of
bankruptcy that permits the
courts to supervise the
debtor’s plan for the
payment of unpaid debts by
installments.
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Filing the Petition
• A Chapter 13 proceeding can be
initiated only by the voluntary filing
of a petition by the debtor.
– Must allege insolvency or inability to
pay debts as they become due
– Extension gives longer period to pay
debt
– Composition provides for reduction of
debt
• Creditors cannot file an
involuntary petition to place a
debtor in Chapter 13 bankruptcy.
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Automatic Stay
• The filing of a Chapter 13
petition automatically stays:
– Liquidation bankruptcy
proceedings
– Judicial and non-judicial
actions by creditors to collect
prepetition debts from the
debtor
– Collection activities against codebtors and guarantors of
consumer debts
– Obtaining, perfecting, or
enforcing liens
– Attempts to set off debts
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The Plan of Payment
• A Chapter 13 is a form of
reorganization bankruptcy.
• The debtor must file a
proposed plan of payment
on how the debts are to be
rescheduled.
• The debtor’s plan of
payment must be filed within
15 days of filing the petition.
• Payments must begin within
30 days of filing plan.
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Confirmation of the Plan
• The plan may modify the rights of
unsecured creditors and some
secured creditors.
• The plan must:
– Be proposed in good faith
– Pass the feasibility test
– Be in the interests of the creditors
• Plan confirmation
– Automatic if secured creditors accept plan.
– Court may confirm and allow creditor to
retain lien.
– Vote of unsecured creditors not necessary.
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Discharge
• A discharge is granted to a
debtor in a Chapter 13
consumer debt adjustment
bankruptcy only after all the
payments under the plan are
completed by the debtor.
• Even if the debtor does not
complete the payments
called for in the plan, the
court may grant the debtor a
hardship discharge.
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Liquidation Bankruptcy - Chapter 7
• The most familiar form of
Bankruptcy.
– The debtor’s nonexempt
property is sold for cash,
– The cash is distributed to the
creditors, and
– Any unpaid debts are
discharged.
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Liquidation Bankruptcy - Chapter 7
(continued)
• Any person (including individuals,
partnerships, and corporations)
may be debtors in a Chapter 7
proceeding.
• Certain businesses (including
banks, savings and loan
associations, credit unions,
insurance companies, and
railroads) are prohibited from filing
bankruptcy under Chapter 7.
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Bankruptcy Procedure
•
•
•
•
•
Filing a petition
Order for relief
Meeting of the creditors
Appointment of a trustee
Proof of claims
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Filing a Petition
• Voluntary petition
– Filed by debtor.
– Only needs to state that filer has
debts.
– Must include schedules showing
creditors, property owned, financial
affairs, current income and expenses,
and be sworn to.
• Involuntary petition
– Filed by any creditor.
– Placed debtor in bankruptcy.
– If more than 12 creditors, must be filed
by 3 of them.
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Order for Relief
• Filing a voluntary petition or
an unchallenged involuntary
petition constitutes an order
for relief.
• If involuntary petition is
challenged, court will decide
if relief should be granted.
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Meeting of Creditors
• Within 10 to 30 days of the
court granting the order for
relief, the court will call a first
meeting of creditors
• Judge will not be present
• Debtor must answer
questions, but can have
counsel
• Bankruptcy trustee is elected
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Bankruptcy Trustee
• Takes possession of property
• determines secured,
unsecured, and exempt
property
• Examines claims
• Invests, manages, sells, or
disposes of property
• Distributes the proceeds of
the estate
• Reports to the court
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The Bankruptcy Estate
• An estate created upon the
commencement of a
Chapter 7 proceeding.
• It includes all the debtor’s
legal and equitable interests
in real, personal, tangible,
and intangible property,
wherever located, that exist
when the petition is filed,
minus exempt property.
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Exempt Property
• Property that may be retained by
the debtor pursuant to federal or
state law.
• Debtor’s property that does not
become part of the bankruptcy
estate.
• The Bankruptcy Code also permits
states to enact their own
exemptions.
• Many states require the debtor to
file a Declaration of Homestead
prior to bankruptcy.
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Statutory Distribution of Property
• Nonexempt property of the
bankruptcy estate must be
distributed to the debtor’s
secured and unsecured
creditors pursuant to the
statutory priority established
by the Bankruptcy Code.
– A secured creditor’s claim to
the debtor’s property has
priority over the claims of
unsecured creditors.
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Distribution to Secured Creditors
• All secured creditors claims
have priority over those of
unsecured creditors
• Secured creditors may:
– Accept collateral as full
payment
– Foreclose on collateral and use
proceeds to pay debt
– Allow trustee to retain
collateral, dispose of it, and
remit proceedings of sale
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Distribution to unsecured Creditors
• The statutory priority of unsecured
creditors is:
– Fees and expenses of administering the
estate.
– Secured claims of “gap” creditors.
– Wages, salaries, commissions.
– Contributions to employee benefit plans.
– Farm producers and fishermen for storage
or processing.
– Claims for cash deposited by consumers
with debtor.
– Child support, alimony, spousal support.
– Certain tax obligations.
– Claims of general unsecured creditors.
– Any balance is returned to debtor.
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Discharge
• The termination of the legal
duty of a debtor to pay
debts that remain unpaid
upon the completion of a
bankruptcy proceeding.
• Only individuals may be
granted a discharge.
– Not all debts are dischargeable
in bankruptcy.
• Discharge is not available to
partnerships and
corporations.
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Acts That Bar Discharge
Certain acts by the debtor may
bar discharge:
• Making false representations
about his or her financial position
when he or she obtained an
extension of credit
• Transferring, concealing, or
removing property from the estate
with the intent to hinder, delay, or
defraud creditors
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Acts That Bar Discharge (continued)
• Falsifying, destroying, or
concealing records of his or
her financial condition
• Failure to account for any
assets
• Failure to submit to
questioning at the meeting
of the creditors (unless
excused)
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Fraudulent and Preferential
Transfers
• The Bankruptcy Code
prevents debtors from
making unusual payments or
transfers of property on the
eve of bankruptcy that
would unfairly benefit the
debtor or some creditors at
the expense of others.
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Voidable Transfers (continued)
• The following transfers may
be avoided by the
bankruptcy court:
– Preferential transfers within 90
days before bankruptcy
– Preferential liens
– Preferential transfers to
insiders
– Fraudulent transfers
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Reorganization Bankruptcy - Chapter
11
• A bankruptcy method that
allows reorganization of the
debtor’s financial affairs
under the supervision of the
Bankruptcy Court.
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Reorganization Bankruptcy – Chapter
11 (continued)
• Chapter 11 is used primarily
by businesses to reorganize
their finances under the
protection of the Bankruptcy
Court.
• The debtor usually emerges
from bankruptcy a “leaner”
business, having restructured
and discharged some of its
debts.
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Reorganization Proceeding
• Chapter 11 is available to
individuals, partnerships,
corporations, nonincorporated associations,
and railroads.
• Chapter 11 is not available to
banks, savings and loan
associations, credit unions,
insurance companies,
stockbrokers, or commodities
brokers.
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Debtor-in-Possession
• A debtor who is left in place
to operate the business
during the reorganization
proceeding.
• The court may appoint a
trustee to operate the
debtor’s business only upon a
showing of cause.
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Creditors’ Committee
• The creditors holding the
seven largest unsecured
claims are usually appointed
to the creditors’ committee.
• Representatives of the
committee appear at
Bankruptcy Court hearings,
participate in the negotiation
of a plan of reorganization,
assert objections to the plan,
etc.
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Automatic Stay
• The result of the filing of a
voluntary or involuntary
petition.
• The suspension of certain
actions by creditors against
the debtor or the debtor’s
property.
• Relief from stay – asked for by
a secured creditor.
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Plan of Reorganization
• A plan that sets forth a
proposed new capital
structure for the debtor to
have when it emerges from
reorganization bankruptcy.
• The debtor has the exclusive
right to file the first plan of
reorganization.
• Any party of interest may file
a plan thereafter.
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Executory Contracts
• A contract that has not been
fully performed.
• Chapter 11 reorganization
bankruptcy permits a debtor
(with court approval) to
assume or reject executory
contracts.
– e.g., leases for office space,
and sales and purchase
contracts.
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Rejection of Collective Bargaining
Agreements
•
A collective bargaining
agreement may be
rejected or modified as an
executory contract if:
1.
2.
3.
It is necessary to the reorganization,
The debtor acted in good faith, and
The balance of the equities favors
rejection or modification of the
agreement.
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Confirmation of a Plan of
Reorganization
• A plan of reorganization must
be confirmed by the court
before it becomes effective.
• Confirmation is either by:
– The acceptance method, or
– The “cram down” method
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Confirmation by the Acceptance
Method
•
1.
2.
3.
4.
The Bankruptcy Court must
approve a plan of
reorganization if:
The plan is in the best interests of
each class of claims and
interests,
The plan is feasible,
At least one class of claims votes
to accept the plan, and
Each class of claims and
interests is non-impaired.
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Confirmation by the Cram Down
Method
• A method of confirmation of
a plan of reorganization
where the court forces an
impaired class to participate
in the plan of reorganization.
• The plan must be fair to the
impaired class:
– Secured Creditors
– Unsecured Creditors
– Equity Holders
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Discharge
• Upon confirmation of a plan
of reorganization, the debtor is
granted a discharge of all
claims not included in the
plan.
• The plan is binding on all
parties once it is confirmed.
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Family Farmer Bankruptcy Chapter 12
• Chapter 12 is a reorganization
provision of the Bankruptcy
Code.
• Allows family farmers to
reorganize financially.
• Gives family farmers added
protection not available under
Chapter 11.
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