CHAPTER 28 BANKRUPTCY DAVIDSON KNOWLES FORSYTHE Business Law
CHAPTER 28 BANKRUPTCY DAVIDSON, KNOWLES & FORSYTHE Business Law: Cases and Principles in the Legal Environment (8 th Ed. )
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. HISTORICAL BACKGROUND l Constitutional provisions allowing “honest debtors” make “fresh start. ” l Constitution allows Congress establish uniform bankruptcy law. l Constitution does not require Congress provide bankruptcy law or relief. © 2004 West Legal Studies in Business A Division of Thomson Learning 2
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. HISTORICAL BACKGROUND l Constitution seemingly calls for exclusive federal control, but bankruptcy laws tend to coexist with state law. l State law determines whether debtor chooses between state and federal exemptions. l For most of twentieth century, bankruptcy governed by Federal Bankruptcy Act. © 2004 West Legal Studies in Business A Division of Thomson Learning 3
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. BANKRUPTCY REFORM ACT l l l Provides for fair and equitable treatment of creditors in distribution of debtor’s property. Gives “honest debtor” a “fresh start. ” Passed to modernize bankruptcy coverage. Meets demands of credit-intensive, consumeroriented society. Had technical problems and declared unconstitutional. © 2004 West Legal Studies in Business A Division of Thomson Learning 4
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. BANKRUPTCY AMENDMENTS AND FEDERAL JUDGESHIP ACT OF 1984 l Intended to clarify jurisdictional authority of the bankruptcy courts. l Resolve constitutional problems discovered in the Bankruptcy Reform Act. l More sensitive to creditors. l Reduce/eliminate debtor abuses. © 2004 West Legal Studies in Business A Division of Thomson Learning 5
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. BANKRUPTCY AMENDMENTS & FEDERAL JUDGESHIP ACT OF 1984 l Changes aim of balancing protection and ensuring purpose of bankruptcy. l Three major types of bankruptcies are: – Chapter 7, Liquidation. – Chapter 11, Reorganization. – Chapter 13, Adjustments of Debts of an Individual with Regular Income. – Chapter 12, Adjustments of Debts of a Family Farmer with Regular Annual Income (expired). © 2004 West Legal Studies in Business A Division of Thomson Learning 6
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. BANKRUPTCY AMENDMENTS & FEDERAL JUDGESHIP ACT OF 1984 l Bankruptcy Reform Act established separate system of bankruptcy courts within each U. S. district court. l Supreme Court declared the Act unconstitutional placing entire area of bankruptcy in doubt. l Bankruptcy courts continued to operate under an “emergency rule” for two years before Congress intervened. © 2004 West Legal Studies in Business A Division of Thomson Learning 7
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. BANKRUPTCY AMENDMENTS & FEDERAL JUDGESHIP ACT OF 1984 l Act corrected constitutional problems identified by U. S. Supreme Court. – Changed appointment of bankruptcy judges. – Grants original and exclusive jurisdiction for all bankruptcy matters to the U. S. District Court, which: l l Gave them discretion to refer cases to bankruptcy court for adjudication. Bring case back to the District court with its motion or on motion of any party to the proceedings. © 2004 West Legal Studies in Business A Division of Thomson Learning 8
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY REFORM ACT OF 1994 l Created a National Bankruptcy Review Commission. l Increased the compensation for trustees and debt limits for Chapter 13 debtors. l Provides for adjustments in dollar amounts based on the Consumer Price Index. l Recognizes bankruptcy fraud as a crime. l Small business investment companies not eligible for relief in bankruptcy. © 2004 West Legal Studies in Business A Division of Thomson Learning 9
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 7: LIQUIDATION, A “STRAIGHT BANKRUPTCY” l Liquidation of debtor’s assets to obtain discharge from debts. l Liquidation is a financial and legal option, to help people flooded in debt. l Two types of Chapter 7 bankruptcies: – Voluntary Bankruptcy Petition initiated by debtor. – Involuntary Bankruptcy Petition initiated by creditor. © 2004 West Legal Studies in Business A Division of Thomson Learning 10
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 7: LIQUIDATION, A “STRAIGHT BANKRUPTCY” l Five exception for filing voluntary bankruptcy petition: – Railroads. – Government units. – Banks. – Savings and loan associations. – Insurance companies. © 2004 West Legal Studies in Business A Division of Thomson Learning 11
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 7: LIQUIDATION, A “STRAIGHT BANKRUPTCY” l Seven exceptions subjected to an involuntary petition: – – – – Railroads. Government units. Banks. Savings and loan associations. Insurance companies. Farmers. Charitable corporations. © 2004 West Legal Studies in Business A Division of Thomson Learning 12
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 7: LIQUIDATION, A “STRAIGHT BANKRUPTCY” l Filing Fees. – Connected to the various bankruptcy chapters are established by law. © 2004 West Legal Studies in Business A Division of Thomson Learning 13
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 7: LIQUIDATION, A “STRAIGHT BANKRUPTCY” l Voluntary Bankruptcy Petition – Debtor does not need to be insolvent for filing. – Law now permits bankruptcy judge to hold hearing to determine need of debtor for relief being sought. – If judge feel abuse of Chapter 7, petition can be dismissed. – Law requires for debtors to know of Chapter 13 repayment plans before filing Chapter 7. © 2004 West Legal Studies in Business A Division of Thomson Learning 14
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 7: LIQUIDATION, A “STRAIGHT BANKRUPTCY” l Involuntary Bankruptcy Petition. – May be forced by creditors if: Debtor Conduct: Debtor appointed a receiver or is not paying debts within 120 days before filing. l Number of Petitioning Creditors: Prescribed number of creditors sign the filing. l Debt Requirement: l – Debt among the creditors who sign the petition is $10, 000 or more. – Debtor successfully contests the bankruptcy petitioning creditors liable for damages. © 2004 West Legal Studies in Business A Division of Thomson Learning 15
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY PROCEEDING l Once bankruptcy petition filed, order for relief issued and trustee appointed to administer debtor’s estate. l Trustee: Represents debtors estate and protect interests of unsecured creditors. l Automatic Stay Provision: Creditors must cease any action to collect debts once bankruptcy is filed. © 2004 West Legal Studies in Business A Division of Thomson Learning 16
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY PROCEEDING l Creditors’ Meeting. – Trustee holds meeting with debtor and creditors to ask questions regarding debtor’s financial affairs. l The Debtor. – Must submit detailed financial schedules listing property and debts which creditors may review. – Debtor must cooperate with and surrender all property to trustee. © 2004 West Legal Studies in Business A Division of Thomson Learning 17
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY PROCEEDING l Secured Creditors Must make a selection: – Take their collateral in full satisfaction of claim. – Dispose of collateral and surrender any surplus to trustee. – Dispose of collateral and participate as unsecured creditors. – Have trustee dispose of collateral, paying secured creditor the proceeds realized and allowing creditor participate as unsecured creditor for any balance owed. © 2004 West Legal Studies in Business A Division of Thomson Learning 18
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY PROCEEDING l Exemptions. – Bankruptcy law provides that certain assets may be retained by debtor. – Exempted assets intended to provide “fresh start. ” Some states require resident debtor to use only state’s exemptions, other states allow debtor to choose state or federal. l Exemptions allow varying amounts of cash, equity in residence, clothing, tools of debtor’s trade, insurance and certain benefits be retained. l © 2004 West Legal Studies in Business A Division of Thomson Learning 19
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY PROCEEDING l Allowable Claims. – Creditors must file claims within six months of creditor’s meeting. – Two types of not allowable claims: Claims which would otherwise be unenforceable against the debtor. l Claims including interest extending beyond the petition date. l © 2004 West Legal Studies in Business A Division of Thomson Learning 20
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY PROCEEDING l Allowable Claims. – Two types of partially allowable claims: Damages based on a violation or termination of a lease. l Damages based on breach of employment contract. l © 2004 West Legal Studies in Business A Division of Thomson Learning 21
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY PROCEEDING l Recovery of Property. – Trustee may void certain transfers made by debtor and recover property for benefit of unsecured creditors. – Two major categories of improper transfers include: Voidable Preferences: payments to some creditors at expense of other creditors. l Fraudulent Conveyance: transfer by a debtor that involves actual or constructive fraud. l © 2004 West Legal Studies in Business A Division of Thomson Learning 22
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY PROCEEDING l Distribution of Assets. – Once trustee gathered and liquidated all available assets and claims, the estate is distributed to creditors. – Estate distributed in priority set forth in the Bankruptcy Reform Act. – Following payment of priority claims, creditors receive pro rata distribution of balance of proceeds from the debtor’s property. © 2004 West Legal Studies in Business A Division of Thomson Learning 23
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY PROCEEDING l Discharge Decision. – Granted only to an honest debtor. – Denied discharge if debtor: Made a fraudulent conveyance. l Does not have adequate records. l Refuses to cooperate with court. l Received discharge in the previous six years. l – Denial of discharge means unpaid portion of debts continue and are enforceable after proceedings. © 2004 West Legal Studies in Business A Division of Thomson Learning 24
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. THE BANKRUPTCY PROCEEDING l Discharge Decision. – Some classes of debts are not affected by a – – – discharge. Goods or services that are incurred within 40 days are presumed non-dischargeable. Creditor or trustee may request revocation of discharge. Debtor may voluntarily reaffirm a debt in spite of discharge. © 2004 West Legal Studies in Business A Division of Thomson Learning 25
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. OTHER BANKRUPTCY PLANS l In addition to liquidation proceedings under Chapter 7, Bankruptcy Reform Act also provides: – Reorganization under Chapter 11. – Repayment plan for family farmers under Chapter 12. (expired bills pending in Congress to reactivate Chapter 12). – Wage earner’s repayment plan under Chapter 13. – Non-bankruptcy Alternatives. © 2004 West Legal Studies in Business A Division of Thomson Learning 26
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 11: REORGANIZATION PLANS l Corporations and individuals may use reorganization plans under chapter 11 to restructure debt without liquidation of assets. l Creditors receive more than they would if liquidation occurred under Chapter 7. l Objecting creditors may be forced to accept the plan. l A reorganization may be voluntary or involuntary. © 2004 West Legal Studies in Business A Division of Thomson Learning 27
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 11: REORGANIZATION PLANS l The Proceedings. – Petition filed court will do: Enter an order for relief. l Appoint a trustee, if requested by any interested party. l Appoint creditor committees to represent the creditors. l – Automatic stay also applies. © 2004 West Legal Studies in Business A Division of Thomson Learning 28
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 11: REORGANIZATION PLANS l The Proceedings (cont’d). – Debtor-in-possession is permitted to retain possession and control of assets/business. – Committees of creditors meet with the trustee/debtor to discuss treatment of proceedings. – No one asks for a trustee, court may appoint an examiner to investigate the debtor’s business activities and potential. © 2004 West Legal Studies in Business A Division of Thomson Learning 29
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 11: REORGANIZATION PLANS l The Plan. – First 120 days after order of relief only debtor may propose reorganization plan. – Any party can propose a plan under: If trustee appointed, any party can propose plan at any time until plan is approved by court. l If debtor fails to propose a plan within 120 days. l If debtor proposes plan within 120 days, but not accepted by all creditors within 180 days of order of relief. l © 2004 West Legal Studies in Business A Division of Thomson Learning 30
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 11: REORGANIZATION PLANS l The Plan (cont’d). – Small-business debtors using “fast-track” reorganization must file plan within 100 days plans by others must be filed within 160 days. – Court will examine in reviewing plan: Sell any assets. l Merger, consolidation or dives. l Satisfy, or modify, any liens or claims. l Issue new stock to generate funds. l © 2004 West Legal Studies in Business A Division of Thomson Learning 31
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 11: REORGANIZATION PLANS l The Plan (cont’d). – Court confirm plan only if: Plan proposed in good faith. l Payments made are subject to approval by court. l Each class of creditors has accepted plan or will receive or retain property of value. l Class of claims impaired, at least one has accepted plan. l Confirmation of plan not likely to be followed by liquidation. l © 2004 West Legal Studies in Business A Division of Thomson Learning 32
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 11: REORGANIZATION PLANS l The Plan (cont’d). – Creditors holding at least 2/3 of dollar amount of claims for given class of debt must vote for plan to be accepted. – If at least one class of creditors accepts plan, the court may confirm it. – Confirmed reorganization plans binds debtor and all creditors. – Court may order conversion to liquidation if it believes plan cannot be completed. © 2004 West Legal Studies in Business A Division of Thomson Learning 33
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 11: REORGANIZATION PLANS l Chapter 11 as a Corporate Strategy. – Corporation have availed by using Chapter 11 to escape/avoid onerous debts or obligations. – The court can approve collective bargaining agreement as debtor’s reorganization plan if: Debtor has made proposal to authorized representatives and assures affected parties are treated fairly and equitably. l Authorized representatives of employees has rejected proposal without good cause. l Balance of equities, favors rejection of collective bargaining despite action of authorized representatives. l © 2004 West Legal Studies in Business A Division of Thomson Learning 34
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 13: REPAYMENT PLANS l Allows debtor with regular source of income to adjust debts in a manner that will repay all creditors. l Only to debtors less than $1 million of debt, maximum of $750, 000 secured debts, and maximum of $250, 000 unsecured debts. l Debt ceiling for Chapter 13 proceedings are adjusted for inflation every three years. l Only voluntary petitions are permitted. © 2004 West Legal Studies in Business A Division of Thomson Learning 35
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 13: REPAYMENT PLANS l The Proceedings. – Debtor files voluntary petition seeking relief. – Court issues order of relief, an automatic stay will take effect. – Trustee will be appointed and perform investigation duties only if debtor operates a business. – Trustee carries out plan proposed by debtor if approved by court. © 2004 West Legal Studies in Business A Division of Thomson Learning 36
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 13: REPAYMENT PLANS l The Plan. – Plan must provide: l Equal treatment to each class of creditor claims. l Some provisions for clearing up any defaulted debts or payments on debts. l Not call for payments beyond three-year period, unless court feels longer period necessary. © 2004 West Legal Studies in Business A Division of Thomson Learning 37
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 13: REPAYMENT PLANS l The Plan (cont’d). – Court approves plan if: Fair to all parties. l In best interest of creditors. l Debtor can conform. l Pays at least as much as under Chapter 7. l – Approved plan is binding on all parties with or without consent and results in discharge once plan completed. © 2004 West Legal Studies in Business A Division of Thomson Learning 38
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 13: REPAYMENT PLANS l The Plan (cont’d). – Court may grant discharge before plan completed if: Debtor cannot complete the plan owing to circumstances beyond control. l General creditors have received at least as much as they would have received in liquidation. l Court does not feel it is practical to alter the plan. l © 2004 West Legal Studies in Business A Division of Thomson Learning 39
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 13: REPAYMENT PLANS l 1984 Bankruptcy Amendments. – Recent law allows unsecured creditor to block debtor’s proposed repayment plan if: Plan calls for payment of 100% of creditor’s claim. l Plan calls for debtor to pay 100% of income not necessary to support immediate family for at least three years. l – Creditor challenges proposed plan, has no right to “approve” or vote on plan. © 2004 West Legal Studies in Business A Division of Thomson Learning 40
BUSINESS LAW: Cases & Principles Davidson • Knowles • Forsythe 8 th Ed. CHAPTER 13: REPAYMENT PLANS l 1984 Bankruptcy Amendments (cont’d). – Begin payments before plan confirmed by court. – Plan may be modified after it is confirmed, to increase debtor’s payments. © 2004 West Legal Studies in Business A Division of Thomson Learning 41
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