Bankruptcy and its English Origin In early English law, those unable to pay their debts went to debtor’s prison. The goal of English bankruptcy law was to protect creditors. In response to England’s harsh treatment of debtors, American bankruptcy law has traditionally been lenient on debtors. – Some think American bankruptcy law is TOO lenient and is often abused.

Bankruptcy Abuse In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), which makes the bankruptcy process more difficult. Before filing, individual debtors must now submit to credit counseling. If debtors earn more than their state’s median income, they must pay back some of their debt.

Overview 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. These substantive chapters all have as their goal either rehabilitation or liquidation.

Rehabilitation or Liquidation The objective of Chapters 11 and 13 of the Bankruptcy Code is rehabilitation of the debtor. When debtors are unable to develop a feasible plan for rehabilitation, Chapter 7 allows for liquidation (also known as straight bankruptcy). Chapters 9 and 12 are for specialized types of debtors and are not covered in this textbook.

Bankruptcy Chapters

Goals The Bankruptcy Code has three primary goals: – 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.

Chapter 7 -- Liquidation 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. Petitions may be voluntary or involuntary.

Ch Voluntary Petition May be filed by any debtor; not necessary to be insolvent or for liabilities to exceed assets. Filed by providing a petition, list of creditors, schedule of assets and liabilities, claim of exemptions, schedule of income and expenditures, and a statement of financial affairs.

New Rules under BAPCPA Within 180 days before filing, a 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 $6,000 over five years.

Ch Involuntary Petition An involuntary petition must meet all the following requirements: – The debtor must owe at least $12,300 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 the debtor has generally not been paying debts.

Trustee The trustee is responsible for gathering the bankrupt’s assets and dividing them among creditors. In order to help insure impartiality, the U.S. Attorney General appoints a U.S. Trustee in each region of the country to oversee bankruptcy cases. – Creditors have the right to elect their own trustee, but often just allow the U.S. Trustee to select one. The U.S. Trustee calls a meeting of creditors after the order for relief. – After this meeting, unsecured creditors must submit proofs of their claims.

Automatic Stay An automatic stay prohibits creditors from collecting debts that the bankrupt incurred before the petition was filed. The purpose of the automatic stay is to give the debtor time and space to make a rational plan for paying debts without pressure from creditors.

Exempt Property The Code permits individual debtors (but not organizations) to keep some property for themselves. The Code allows each state to designate the property and value of assets that can be exempt, and most states have done so. – State codes are generally more lenient than the federal Code. – Some states’ generous exemptions have led to abuse (and now, reform!)

Exempt Property (Reforms) Now, under the BAPCPA, debtors can only take advantage of state exemptions if they have lived in that state for two years prior to the bankruptcy. And they can only exempt $125,000 of any house that was acquired during 40 months before the bankruptcy.

Voidable Preferences A preference is a transfer of money or property just before filing bankruptcy. The trustee can void a transfer that meets all of the following requirements: – The transfer was to a creditor of the bankrupt. – It was to pay an existing debt. – The creditor received more than she would have received during the bankruptcy process. – The debtor’s liabilities exceeded assets at the time of the transfer. – The transfer took place in the 90-day period before the filing of the petition.

Fraudulent Transfers A transfer is fraudulent if it is made within a year before a petition is filed and its purpose is to hinder, delay, or defraud creditors. A trustee cannot void pre-petition payments made in the ordinary course of business.

Payment of Claims The trustee pays the bankruptcy estate to the various classes of claims in the following order of rank: – Secured Claims – Priority Claims (seven subcategories) – Unsecured Claims (three subcategories) All creditors with Secured Claims are paid before any in the Priority Claims category, etc.

Priority Claim Subcategories Alimony and Child Support. Administrative Expenses -- fees to the trustee, lawyers, and accountants. Gap Expenses -- expenses incurred in the ordinary course of business during the period between the filing of an involuntary petition and the order for relief. Payments to Employees -- back wages to the debtor’s employees for work performed during the 180 days prior to the date of the petition; limited to $10,000 to each employee.

Priority Claim Subcategories Employee Benefit Plans -- what the debtor owes to employee pension, health, or life insurance plans for the 180 days prior to the petition; included in the $10,000 limit above. Consumer Deposits -- any individual who has put down a deposit with the bankrupt for consumer goods will get a refund of up to $2,225. Taxes --income taxes for the three years prior to filing and property taxes for one prior year. Drunken injuries --the claims of anyone injured by a bankrupt who was driving a vehicle while drunk or on drugs.

Unsecured Claim Subcategories All three of these unsecured 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.

Discharge Once a bankruptcy estate is distributed, the debts are discharged, meaning that creditors cannot make claims on the debtor for money owed before filing. A debtor must complete an approved course on financial management before receiving a discharge. There are some circumstances that prevent debts from being discharged, such as repeated bankruptcy filings, dishonesty, and conduct of some kinds of business.

Discharge (cont’d) Debts that cannot be discharged include (among others): – Income taxes and property taxes – Money obtained fraudulently or illegally – Some loans for luxury goods – Recent cash advances on credit cards – Alimony and child support debt – Fines and penalties – Some student loans

Reaffirmation To reaffirm a debt means the debtor promises to pay even after discharge. To be valid, the reaffirmation must: – Not violate laws for fraud, duress or unconscionability. – Be filed in court. – Include the detailed disclosure statement. – Clearly state that the debtor has the right to rescind within 60 days. – Not impose undue hardship on the debtor.

Chapter 11-- Reorganization Chapter 11 does not require a trustee; the petitioner (called debtor in possession) serves as the trustee. He: – Operates the business, and – Develops a plan of reorganization. A creditors’ committee watches over the interests of the creditors. A committee of equity security holders may be appointed to watch out for the interests of the shareholders.

Plan of Reorganization The debtor has 120 days to come up with a plan that is acceptable to the creditors. The creditors will usually only accept a reorganization plan that they believe will be better for them than liquidation. If they reject the debtor’s proposal, the creditors or shareholders may submit alternative plans.

Confirmation of the Plan A 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 A confirmed plan is binding on the debtor, creditor and shareholders. A typical plan of reorganization gives some current assets to the creditors and promises to pay them a portion of future earnings. The debtor now owns the assets in the bankrupt estate, free of all obligations except those listed in the plan.

Small Business Bankruptcy A small business with less than $2 million in debt may qualify for different rules for Chapter 11 bankruptcy proceedings. – For the first 180 days after the order for relief, the debtor has the exclusive right to file a plan – The court must confirm or reject the plan within 45 days – If these deadlines are not met, the case can be converted to a Chapter 7 case, or it may be dismissed.

Chapter Consumer Reorganization The purpose of Chapter 13 is to rehabilitate an individual debtor. – Available only to debtors with less than $307,675 in unsecured debt or $922,975 in secured debt. Creditors cannot use an involuntary petition to force a debtor into Ch. 13. A trustee is appointed to supervise the debtor, who remains in possession of all assets.

Ch Plan of Payment Plan of payment must be submitted by the debtor within 15 days after filing the petition. The plan must: – Be feasible, – Not extend beyond 3 years in most cases and no more than 5 years in any case, and – Show that the debtor is acting in good faith with a reasonable effort to pay obligations. If the plan does not pay the debts in full, it must allocate all of the debtor’s disposable income for the next five years to the creditors.

Discharge Once confirmed, the plan is binding on all creditors. The debtor is washed clean of all pre- petition debts except those provided for in the plan, but (unlike under Chapter 7), the debts are not permanently discharged until the debtor fully complies with the plan. If the debtor’s circumstances change during the plan payment period, the debtor, creditors or trustee may petition the court to change the payment plan.

“As in many areas of law, bankruptcy law must balance between competing interests. When an individual or business files for bankruptcy protection, generally neither debtor or creditor comes out whole.”