CHAPTER 28 BANKRUPTCY AND REORGANIZATION 2010 Pearson Education

Federal Bankruptcy Law • 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. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 2

Federal Bankruptcy Code • Original Bankruptcy Act enacted 1878. • Bankruptcy Reform Act (1978) completely revised law. • Bankruptcy Abuse Prevention and Consumer Protection Act (2005) made it more difficult for consumers to escape debts. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 3

Types of Bankruptcy • Chapter 7 – Liquidation • Chapter 11 – Reorganization • Chapter 12 – Adjustment of Debts of Family Farmer or Fisherman • Chapter 13 – Adjustment of Debts of Individual with Regular Income © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 4

Bankruptcy Courts • Part of federal court system. • Bankruptcy courts, not District Courts, have original jurisdiction over bankruptcy cases. • One for each federal district. • Judges appointed for 14 -year terms. • Judges assisted by bankruptcy trustees. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 5

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. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 6

Filing the Petition • Bankruptcy case commenced by filing of a petition. – Voluntary petition by debtor may be filed in all types of bankruptcy. – Involuntary petition by creditor only for Chapter 7 (liquidation) and Chapter 11 (reorganization). © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 7

Schedules • Debtor filing voluntary petition must submit: – List of secured and unsecured creditors – List of all property owned – Statement of debtor’s financial affairs – Statement of monthly income – Current income and expenses – Evidence of wages within 60 days of filing – Copy of most recent federal tax return • Debtor’s attorney must investigate and certify accuracy. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 8

Procedures After Filing • Order for Relief. • Meeting of Creditors. – Debtor appears and answers questions. • Creditors file Proof of Claim or Proof of Interest. • Trustee appointed. • Court grants discharge. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 9

Automatic Stay • Filing of voluntary or involuntary petition automatically stays: – Legal actions to collect pre-collection debts. – Enforcing judgments obtained against debtor. – Obtaining, perfecting, or enforcing liens against property of debtor. – Nonjudicial collection efforts. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 10

Discharge • If requirements met, court grants discharge of all or some debts. • Debtor relieved of responsibility to pay the discharged debts. • Some debts not discharged. – E. g. , taxes owed, claims arising from fraud of debtor, domestic support obligations, certain debts recently incurred, fraudulent transfers. – Student loans generally not discharged. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 11

Reaffirmation Agreement • Debtor and creditor may agree that debtor will pay debt discharged in bankruptcy. • Must be entered before discharge granted. • Must be filed with court, and approved by court or certified by debtor’s attorney. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 12

Bankruptcy Estate • Includes all debtor’s legal and equitable interests in real, personal, tangible, and intangible property that exist when petition filed. • Includes interest of debtor and the debtor’s spouse in community property. • Certain property exempted. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 13

Exempt Property • Property that debtor can keep. • Federal exemptions – Homestead exemption of $20, 200 in principal residence. – Interest up to $3, 225 in one vehicle. – Interest up to $10, 775 in household items. – Life insurance policies. – Professional tools up to $2, 025. – Etc. • States may provide more liberal exemptions than federal law. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 14

Liquidation - Chapter 7 • • Debtor keeps exempt assets. Debtor’s nonexempt property is sold for cash. Cash is distributed to the creditors. Any unpaid debts are discharged. • Debtor’s future income cannot be reached. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 15

Restrictions in 2005 Act • Act added median income test and means test. – Debtors at or below state’s median income may file. – Debtors above median income must satisfy means test calculation. • Forces many debtors into Chapter 13 Debt Adjustment bankruptcy, which requires payment of future income to pay pre-petition debts. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 16

Chapter 7 (continued) • Any person (including individuals, partnerships, and corporations) may be debtor in Chapter 7 proceeding. • Certain businesses (including banks, savings and loan associations, credit unions, insurance companies, and railroads) prohibited from filing bankruptcy under Chapter 7. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 17

Statutory Distribution of Property • Nonexempt property distributed to debtor’s secured and unsecured creditors pursuant to the statutory priority established by the Bankruptcy Code. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 18

Distribution to Secured Creditors • All secured creditors claims have priority over those of unsecured creditors. • Oversecured creditor is paid amount of secured interest. • Undersecured creditor becomes unsecured creditor for amount still owed. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 19

Priority of Distribution to Unsecured Creditors • • • Domestic support. 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. • Certain tax obligations. • Claims of general unsecured creditors. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 20

Frequency of Bankruptcy Relief • May file for Chapter 7 bankruptcy relief again 8 years after previous Chapter 7 relief. • May file for Chapter 7 bankruptcy again 6 years after previous Chapter 12 or Chapter 13 relief. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 21

Acts that Bar Discharge • Debtor lied about financial position when obtaining credit. • Debtor transferred, concealed, removed, or destroyed property of 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. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 22

Chapter 13 – Adjustment of Debts of Individual • 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. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 23

Chapter 13 Petition • Voluntary filing of position by debtor with regular income. • Debts must be primarily consumer debt. • Amount of debt must not exceed certain dollar amounts – $336, 900 unsecured debts. – $1, 010, 650 secured debts. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 24

Property of Chapter 13 Estate • All nonexempt property of debtor at commencement of case, and • Nonexempt property acquired before case is closed, including earnings and future income. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 25

Chapter 13 Plan of Payment • Plan for payments in installments over 3 or 5 years. • Plan submitted to secured creditors for acceptance. • Secured creditors may accept plan. • Court confirms plan, if it was proposed in good faith, is feasible, and in best interest of creditors. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 26

Chapter 13 Discharge • Court discharges debtor from all unpaid unsecured debts after all payment required under plan are paid. • Debtor cannot be discharged under Chapter 13 if has received discharge under Chapter 7, 11, or 12 within 4 years, or Chapter 13 within 2 years. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 27

Chapter 11 – Reorganization • For individuals, partnerships, corporations, and other business entities. – Fast-track procedures for small businesses. • Debtor reorganizes with new capital structure, to emerge from bankruptcy as viable concern. • May be relieved of portion of debts, burdensome executory contracts and unexpired leases. – E. g. , Collective bargaining, pension agreements. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 28

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. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 29

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 negotiation of a plan of reorganization, assert objections to the plan, etc. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 30

Automatic Stay in Chapter 11 • Filing of petition stays actions by creditors to recover debtor’s property. – E. g. , foreclosure actions. • Allows debtor to keep its assets to stay in business. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 31

Plan of Reorganization • Sets forth proposed new capital structure for debtor when it emerges from reorganization bankruptcy. – Portion of unsecured debt to be paid. – Contracts and leases to be rejected. • Debtor files first plan. • Any party of interest may file a plan thereafter. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 32

Confirmation of Plan of Reorganization • 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. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 33

Confirmation by Acceptance The Bankruptcy Court confirms a plan of reorganization if: • • • Plan is in the best interests of the creditors, Plan is feasible, and Each class of creditors votes to accept the plan. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 34

Confirmation by Cram-Down Method • Court confirms plan over objections of a class of creditors. • At least one class of creditors must have voted to accept the plan. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 35

Chapter 12 – Family Farmer Bankruptcy • Allows family farmers to reorganize financially. • Gives family farmers added protection not available under Chapter 11. © 2010 Pearson Education, Inc. , publishing as Prentice-Hall 36