Bankruptcy and Reorganization Chapter 32 Chapter 32: Bankruptcy and Reorganization Bankruptcy and Reorganization Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Overview LO32-1: What are the goals of the Bankruptcy Act? LO32-2: What is the basic set of procedures for bankruptcy cases? LO32-3: What specific types of relief are available through bankruptcy?

Chapter 32 Hypothetical Case 1 Julius Talbert owes Tom Finnegan $10,000 on an unsecured promissory note. The note became due and payable three months ago. Last week, Finnegan received notice from federal bankruptcy court that Talbert had filed for Chapter 7 bankruptcy. Finnegan would like to forego participation in the bankruptcy proceedings and instead file a civil lawsuit against Talbert for the $10,000 owed (plus associated interest, court costs, and attorney's fees). Once Finnegan secures a civil judgment against Talbert, he plans to execute on the judgment by seizing any nonexempt property Talbert owns in satisfaction of the debt. Does Tom Finnegan have the legal right to pursue civil litigation against Julius Talbert for the $10,000 owed on the promissory note? Chapter 32 Hypothetical Case 1: Julius Talbert owes Tom Finnegan $10,000 on an unsecured promissory note. The note became due and payable three months ago. Last week, Finnegan received notice from federal bankruptcy court that Talbert had filed for Chapter 7 bankruptcy. Finnegan would like to forego participation in the bankruptcy proceedings and instead file a civil lawsuit against Talbert for the $10,000 owed (plus associated interest, court costs, and attorney's fees). Once Finnegan secures a civil judgment against Talbert, he plans to execute on the judgment by seizing any nonexempt property Talbert owns in satisfaction of the debt. Does Tom Finnegan have the legal right to pursue civil litigation against Julius Talbert for the $10,000 owed on the promissory note? [Instructor: See Specific Types of Relief Available in Chapter 32]

Chapter 32 Hypothetical Case 2 Go to Bankruptcy Exemptions—What Do I Keep When I File for Bankruptcy? and research the Chapter 7 bankruptcy exemptions allowed in your particular state ("exemptions" represent property the debtor is allowed to keep, even though he/she is filing for Chapter 7 liquidation bankruptcy). Based on your research, are your state's Chapter 7 exemptions more or less generous than the federal bankruptcy exemptions outlined in Exhibit 32-4 of the textbook? Although bankruptcy is primarily a matter of federal jurisdiction (delegated to the federal government in Article I, Section 8 of the United States constitution), the federal government does allow the individual states to craft their own Chapter 7 exemptions for individuals filing in their particular state. If the state chooses to enact its own Chapter 7 exemptions, the state can then require those filing in its jurisdiction to use the state exemptions, or it can allow the bankrupt debtor to choose the federal exemptions outlined in Exhibit 32-4 of the textbook. If the state chooses not to enact its own Chapter 7 exemptions, the federal exemptions apply by default. In your reasoned opinion, should Chapter 7 bankruptcy exemptions be uniformly applied in all states (by applying the federal bankruptcy exemptions in every state), or do you favor the idea of allowing the individual states to craft their own Chapter 7 exemptions? Chapter 32 Hypothetical Case 2: Go to http://www.thebankruptcysite.org/bankruptcy-exemptions and research the Chapter 7 bankruptcy exemptions allowed in your particular state ("exemptions" represent property the debtor is allowed to keep, even though he/she is filing for Chapter 7 liquidation bankruptcy). Based on your research, are your state's Chapter 7 exemptions more or less generous than the federal bankruptcy exemptions outlined in Exhibit 32-4 of the textbook? Although bankruptcy is primarily a matter of federal jurisdiction (delegated to the federal government in Article I, Section 8 of the United States constitution), the federal government does allow the individual states to craft their own Chapter 7 exemptions for individuals filing in their particular state. If the state chooses to enact its own Chapter 7 exemptions, the state can then require those filing in its jurisdiction to use the state exemptions, or it can allow the bankrupt debtor to choose the federal exemptions outlined in Exhibit 32-4 of the textbook. If the state chooses not to enact its own Chapter 7 exemptions, the federal exemptions apply by default. In your reasoned opinion, should Chapter 7 bankruptcy exemptions be uniformly applied in all states (by applying the federal bankruptcy exemptions in every state), or do you favor the idea of allowing the individual states to craft their own Chapter 7 exemptions? [Instructor: See Specific Types of Relief Available in Chapter 32]

Bankruptcy Law Bankruptcy Act: Purpose is to provide debtors with opportunity to realize a fresh financial start Offers protection to creditors A matter of federal jurisdiction United States Constitution Article I, Section 8: "Congress shall have the power . . . To establish . . . uniform laws on the subject of bankruptcies throughout the United States" The purpose of the Bankruptcy Act is to provide debtors with an opportunity to realize a fresh financial start, while simultaneously protecting the interests of creditors. Bankruptcy law is a matter of federal jurisdiction. According to Article I, Section 8 of the United States Constitution, "Congress shall have the power . . . To establish . . . uniform laws on the subject of bankruptcies throughout the United States."

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Most comprehensive change to bankruptcy law in over 25 years Effect: More difficult for individual debtor to qualify for Chapter 7 (liquidation) bankruptcy Reasons for its passage: Increased number of bankruptcy filings Significant creditor losses associated with bankruptcy filings Debtor abuse of bankruptcy protection rights Debtor ability to repay The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 is the most comprehensive change to bankruptcy law in over 25 years. The principle effect of the act is that it is now substantially more difficult for an individual debtor to qualify for Chapter 7 (liquidation) bankruptcy. Reasons cited for the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 include an increased number of bankruptcy filings, significant creditor losses associated with bankruptcy filings, debtor abuse of bankruptcy protection rights, and debtor ability to repay.

Types of Bankruptcy Relief by Chapter Chapter 7: Sale of nonexempt assets, and distribution of money to creditors Chapter 9: Adjustment of municipalities' debts Chapter 11: Reorganization of debtor's financial affairs under supervision of bankruptcy court Chapter 12: Reorganization of family farmers' debts Chapter 13: Reorganization of individual's debts Chapter 15: Recognition of insolvency proceedings pending in foreign country, and relief for foreign debtors Types of bankruptcy relief include Chapter 7, Chapter 9, Chapter 11, Chapter 12, Chapter 13, and Chapter 15 bankruptcy. Chapter 7 involves the sale of nonexempt assets and distribution of the sale proceeds to creditors. Chapter 9 involves the adjustment of municipal debts. With Chapter 11, the debtor's financial affairs are reorganized under the supervision of the bankruptcy court. Chapter 12 bankruptcy is the reorganization of family farm debt, while Chapter 13 bankruptcy is the reorganization of an individual's debts. Finally, Chapter 15 bankruptcy recognizes insolvency proceedings pending in foreign countries, and relief for foreign debtors.

Attributes of Bankruptcy Cases Procedural rules for bankruptcy cases set forth in federal bankruptcy rules Cases filed in federal district courts and referred to bankruptcy judges Bankruptcy judges appointed and serve 14-year terms; judges make decisions regarding administration of bankruptcy proceedings Bankruptcy appeals proceed to federal district court judge Procedural rules for bankruptcy cases are set forth in federal bankruptcy rules. Cases are filed in federal district courts and referred to bankruptcy judges. Bankruptcy judges are appointed and serve 14-year terms; judges make decisions regarding the administration of bankruptcy proceedings. Bankruptcy appeals proceed to a federal district court judge.

Bankruptcy Procedures Bankruptcy petition filed Court grants automatic stay, freezing creditor actions outside bankruptcy court against debtor's estate Court determines whether order of relief should be granted Creditors meet with debtor Payment plan created and approved, usually by creditors and court Payment plan carried out through actions of trustee and debtor Debts remaining after plan executed usually discharged Bankruptcy proceedings begin with the filing of a bankruptcy petition. Upon the filing of a petition, the court grants an automatic stay, freezing creditor actions outside the bankruptcy court against the debtor's estate. The court determines whether an order of relief should be granted. Creditors are allowed to meet with the debtor, and a payment plan is created and approved, usually by creditors and the court. The payment plan is then carried out through actions of the trustee and the debtor. Debts remaining after the plan is executed are usually discharged.

Chapter 7: Voluntary Versus Involuntary Petition Voluntary petition: Debtor files Involuntary petition: Creditor(s) file, forcing debtor into bankruptcy 12 or more creditors: Three or more creditors with unsecured claims totaling at least $14,425 must sign involuntary petition Less than 12 creditors: Single creditor with claim totaling at least $14,425 can file involuntary petition Chapter 7 bankruptcy can be either voluntary or involuntary. The debtor files a voluntary petition. A creditor or creditors file an involuntary petition, effectively forcing the debtor into bankruptcy. If there are 12 or more creditors, three or more creditors with unsecured claims totaling at least $14,425 must sign the involuntary petition; if there are less than 12 creditors, a single creditor with a claim totaling at least $14,425 can file the involuntary petition.

Required Schedules for Chapter 7 Liquidation Schedule A: All real property Schedule B: All personal property Schedule C: Exempt property listed in Schedules A and B Schedule D: Secured creditors and their addresses Schedule E: Unsecured priority claims Schedule F: Unsecured nonpriority claims Schedule G: Executory contracts and expired leases Schedule H. List of co-debtors Schedule I: Statement of debtor's current income Schedule J: Statement of current expenditures The debtor is required to file the following schedules for Chapter 7 liquidation bankruptcy: Schedule A, all real property; Schedule B, all personal property; Schedule C, exempt property listed in Schedules A and B; Schedule D, secured creditors and their addresses; Schedule E, unsecured priority claims; Schedule F, unsecured nonpriority claims; Schedule G, executory contracts and expired leases; Schedule H, a list of co-debtors; Schedule I, a statement of the debtor's current income; and Schedule J, a statement of current expenditures.

Federal Bankruptcy Exemptions Up to $22,975 for residence (homestead exemption) Interest in motor vehicle up to $3,675 Interest in jewelry up to $1,550 $1,225 of any property debtor chooses (wild-card exemption) Federal bankruptcy exemptions allow a debtor to keep certain property in Chapter 7 liquidation bankruptcy. Exemptions include up to $22,975 for a residence (known as the homestead exemption); an interest in a motor vehicle up to $3,675; an interest in jewelry up to $1,550; and $1,225 of any property the debtor chooses (referred to as the wild-card exemption).

Federal Bankruptcy Exemptions (cont'd) Up to $2,300 in tools of trade and professional books Any unmatured life insurance contract owned by debtor Professionally prescribed health aids Right to receive certain personal injury awards up to $22,975 Retirement funds in IRA/SEP up to $1,245,475 per person Other federal bankruptcy exemptions include up to $2,300 in tools of the trade and professional books; any unmatured life insurance contract owned by the debtor; professionally prescribed health aids; the right to receive certain personal injury awards up to $22.975; and retirement funds in an IRA or SEP up to $1,245,475 per person.

Voidable Transfers Preferential payments: Trustee can recover (and include in bankruptcy estate) payments made by insolvent debtor that give preferential treatment to one creditor over another, if debtor made such payments within 90 days of bankruptcy filing Fraudulent transfers: Trustee can recover (and include in bankruptcy estate) transfers made with intent to defraud creditors, if debtor made such transfers within two years of bankruptcy filing Preferential payments and fraudulent transfers are referred to as voidable transfers. In terms of preferential payments, the bankruptcy trustee can recover (and include in the bankruptcy estate) payments made by the insolvent debtor that give preferential treatment to one creditor over another, if the debtor made such payments within 90 days of the bankruptcy filing. With fraudulent transfers, the trustee can recover (and include in the bankruptcy estate) transfers made with the intent to defraud creditors, if the debtor made such transfers within two years of the bankruptcy filing.

Classes of Priority Claims Among Unsecured Creditors Class 1: Alimony/child support Class 2: Court costs, trustee fees, attorney, fees, other costs associated with administration of bankruptcy estate Class 3: Unsecured claims in involuntary bankruptcy that arise through debtor's ordinary business expenses, from date of filing petition to date of trustee appointment Class 4: Unsecured claims for unpaid wages, salaries, and commissions earned within 180 days of filing of petition Class 5: Unsecured claims for contributions to employee retirement plans Classes of priority claims among unsecured creditors are arranged in the following order, in descending order of priority: Class 1: Alimony and child support obligations; Class 2: Court costs, trustee fees, attorney, fees, and other costs associated with administration of the bankruptcy estate; Class 3: Unsecured claims in involuntary bankruptcy that arise through the debtor's ordinary business expenses, from the date of the filing of the petition to the date of trustee appointment; Class 4: Unsecured claims for unpaid wages, salaries, and commissions earned within 180 days of the filing of the petition; Class 5: Unsecured claims for contributions to employee retirement plans.

Classes of Priority Claims Among Unsecured Creditors (cont'd) Class 6: Unsecured claims by farmers and fishers against grain operators of grain storage facilities /fish storage/processing facilities Class 7: Claims for deposits given to debtor in connection with property/services never given Class 8: Certain taxes and penalties due government Class 9: Claims in bankruptcies related to federal depository institutions Class 10: Unsecured claims for personal injuries and deaths caused by debtor's operation of motor vehicle under influence of alcohol/drugs Continuing with the classes of priority claims among unsecured creditors (again, in descending order of priority), Class 6 includes unsecured claims by farmers and fishers against grain operators of grain storage facilities, or fish storage or processing facilities; Class 7 represents claims for deposits given to a debtor in connection with property or services never provided by the debtor; Class 8 includes certain taxes and penalties due the government; Class 9 involves claims in bankruptcies related to federal depository institutions; Class 10 involves unsecured claims for personal injuries and deaths caused by the debtor's operation of a motor vehicle while under the influence of alcohol or drugs.

Nondischargeable Debts Under Bankruptcy Code Claims for back taxes/government fines within three years of bankruptcy filing Claims for liabilities against debtor for his/her obtaining money/property under false pretenses, false representation, or fraud Claims by creditors not listed on schedule and who did not have notification of bankruptcy proceedings Claims based on fraud, embezzlement, and larceny by debtor while he/she acting in fiduciary capacity Alimony, child support, and certain property settlements Nondischargeable debts under the federal bankruptcy code include claims for back taxes or government fines incurred within three years of the bankruptcy filing; claims for liabilities against the debtor for his or her receipt of money or property under false pretenses, false representation, or fraud; claims by creditors, not listed on the schedule, who did not have notification of the bankruptcy proceedings; claims based on fraud, embezzlement, and larceny by the debtor while he or she was acting in a fiduciary capacity; and alimony, child support, and certain property settlements.

Nondischargeable Debts Under Bankruptcy Code (cont'd) Claims of willful/malicious conduct by debtor that caused injury to another person/property Specific student loans, unless payment of loans would impose undue hardship on debtor Judgments against debtor for claims resulting from debtor's driving under the influence Debts not discharged in previous bankruptcies Claims for money borrowed to pay tax to federal government that would be nondischargeable Cash advances on credit card Nondischargeable debts under the bankruptcy code also include claims of willful or malicious conduct by the debtor that caused injury to another person or property; specific student loans, unless payment of such loans would impose an undue hardship on the debtor; judgments against the debtor for claims resulting from the debtor's driving under the influence; debts not discharged in previous bankruptcies; claims for money borrowed to pay taxes to the federal government that would be nondischargeable; and cash advances on a credit card.

Chapter 32 Hypothetical Case 3 Effective October 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) represents the most sweeping change to the United States Bankruptcy Code in almost 40 years. Applauded by the credit card industry, which had lobbied the United States Congress for several years before its enactment, BAPCPA makes it extremely difficult, if not impossible, for middle income Americans to file for Chapter 7 (liquidation) bankruptcy. (Traditionally, the United States Bankruptcy Court used Chapter 7 for debtor rehabilitation, allowing the debtor to discharge preexisting debts in return for his/her relinquishment of nonexempt property, and the nonexempt property was used to partially satisfy creditor claims.) Instead, BAPCPA channels bankrupt debtors into Chapter 13 (reorganization) bankruptcy, with strict restrictions against debt forgiveness. BAPCPA has come under criticism, in part because it allows no exceptions for unanticipated medical expenses (a Harvard University study concluded that more than 50 percent of bankruptcies are attributable to unpaid medical bills), loss of employment, or financial difficulties resulting from dissolution of marriage. Chapter 32 Hypothetical Case 3: Effective October 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) represents the most sweeping change to the United States Bankruptcy Code in almost 40 years. Applauded by the credit card industry, which had lobbied the United States Congress for several years before its enactment, BAPCPA makes it extremely difficult, if not impossible, for middle income Americans to file for Chapter 7 (liquidation) bankruptcy. (Traditionally, the United States Bankruptcy Court used Chapter 7 for debtor rehabilitation, allowing the debtor to discharge preexisting debts in return for his/her relinquishment of nonexempt property, and the nonexempt property was used to partially satisfy creditor claims.) Instead, BAPCPA channels bankrupt debtors into Chapter 13 (reorganization) bankruptcy, with strict restrictions against debt forgiveness. BAPCPA has come under criticism, in part because it allows no exceptions for unanticipated medical expenses (a Harvard University study concluded that more than 50 percent of bankruptcies are attributable to unpaid medical bills), loss of employment, or financial difficulties resulting from dissolution of marriage. [Instructor: See Specific Types of Relief Available in Chapter 32]

Chapter 32 Hypothetical Case 3 (cont'd) BAPCPA critics argue that individuals so affected should be allowed to file Chapter 7 (liquidation) bankruptcy protection. Critics further contend that without such a change in BAPCPA, the only real discharge for many debtors will be death. From a legal standpoint, should the United States Congress rewrite BAPCA and create exceptions for unanticipated medical expenses, loss of employment, or financial difficulties resulting from dissolution of marriage (and allow the bankrupt debtor to file for Chapter 7 bankruptcy protection)? From an ethical standpoint, should not our society give these people a break? Are not such people, and their financial situations, substantially different from consumers who max out their credit cards on mad shopping sprees? For reference, see Bankruptcy Overhaul Enacted—New Rules for Bankruptcy Implemented. Chapter 32 Hypothetical Case 3 (cont'd): BAPCPA critics argue that individuals so affected should be allowed to file Chapter 7 (liquidation) bankruptcy protection. Critics further contend that without such a change in BAPCPA, the only real discharge for many debtors will be death. From a legal standpoint, should the United States Congress rewrite BAPCA and create exceptions for unanticipated medical expenses, loss of employment, or financial difficulties resulting from dissolution of marriage (and allow the bankrupt debtor to file for Chapter 7 bankruptcy protection)? From an ethical standpoint, should not our society give these people a break? Are not such people, and their financial situations, substantially different from consumers who max out their credit cards on mad shopping sprees? [Instructor: See Specific Types of Relief Available in Chapter 32]

Chapter 32 Hypothetical Case 4 Foster Williams, a 43-year-old California resident, lost his job two years ago and has not been able to find work since. He was diagnosed with colon cancer one year ago, and his medical bills have piled up. Williams has more than $75,000 in credit card debt, a $450,000 mortgage, $275,000 in medical bills, and $50,000 in back child support and alimony payments to his ex-wife, Karina Chatsworth. Last month, Williams filed for bankruptcy under Chapter 7. He has never filed for bankruptcy before. Chatsworth filed suit last week to try to get the child support and alimony payments she is owed before Williams's bankruptcy proceedings are complete. Is it permissible under bankruptcy law for Chatsworth to pursue the back child support and alimony payments while Williams's bankruptcy proceedings are ongoing? Explain your answer. Chapter 32 Hypothetical Case 4: Foster Williams, a 43-year-old California resident, lost his job two years ago and has not been able to find work since. He was diagnosed with colon cancer one year ago, and his medical bills have piled up. Williams has more than $75,000 in credit card debt, a $450,000 mortgage, $275,000 in medical bills, and $50,000 in back child support and alimony payments to his ex-wife, Karina Chatsworth. Last month, Williams filed for bankruptcy under Chapter 7. He has never filed for bankruptcy before. Chatsworth filed suit last week to try to get the child support and alimony payments she is owed before Williams's bankruptcy proceedings are complete. Is it permissible under bankruptcy law for Chatsworth to pursue the back child support and alimony payments while Williams's bankruptcy proceedings are ongoing? Explain your answer. [Instructor: See Specific Types of Relief Available in Chapter 32]