© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Chapter 28 Bankruptcy Law and Consumer Debt Adjustment

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman The Federal Bankruptcy Code Congress enacted the original Bankruptcy Act in –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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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 co- debtors and guarantors of consumer debts –Obtaining, perfecting, or enforcing liens –Attempts to set off debts

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Bankruptcy Procedure Filing a petition Order for relief Meeting of the creditors Appointment of a trustee Proof of claims

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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)

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Reorganization Bankruptcy - Chapter 11 A bankruptcy method that allows reorganization of the debtor’s financial affairs under the supervision of the Bankruptcy Court.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Reorganization Proceeding Chapter 11 is available to individuals, partnerships, corporations, non- incorporated associations, and railroads. Chapter 11 is not available to banks, savings and loan associations, credit unions, insurance companies, stockbrokers, or commodities brokers.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Rejection of Collective Bargaining Agreements A collective bargaining agreement may be rejected or modified as an executory contract if: 1. It is necessary to the reorganization, 2. The debtor acted in good faith, and 3. The balance of the equities favors rejection or modification of the agreement.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman Confirmation by the Acceptance Method The Bankruptcy Court must approve a plan of reorganization if: 1. The plan is in the best interests of each class of claims and interests, 2. The plan is feasible, 3. At least one class of claims votes to accept the plan, and 4. Each class of claims and interests is non-impaired.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 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.