1. C H A P T E R
30
Bankruptcy
Success is not built on success.
It's built on failure. It's built on
frustration. Sometimes its built on
catastrophe.
Sumner Redstone
Executive Chairman and
Founder of Viacom
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2. Learning Objectives
• Explain purpose of bankruptcy code
and types of bankruptcy
proceedings (Chapters 7, 11, 12, 13)
• Describe process by which property
in a debtor’s estate is distributed to
creditors and the debtor is granted
discharge in bankruptcy
• Identify dischargeable debts
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3. Overview
• When debtors
are faced with
financial ruin,
the right to file
for bankruptcy is
guaranteed by
the U.S.
Constitution
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4. The Bankruptcy Code
• The federal Bankruptcy Code provides an
organized procedure for insolvent debtors
and is supervised by a federal court
• Primary proceedings include:
1. Straight bankruptcy (liquidations)
2. Reorganizations
3. Family farms and commercial fishing
operations
4. Consumer debt adjustments
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5. The Bankruptcy Code
• All bankruptcy proceedings begin by
filing a petition, either voluntary or
involuntary
– A voluntary petition may be filed by an
individual, partnership, or corporate
debtor
– An involuntary petition may be filed by
creditors of a debtor in an attempt to
reach debtor’s assets in lieu of payment
on debts
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6. The Automatic Stay
• Filing a bankruptcy petition operates as
an automatic stay, halting creditor action
against a debtor or property, including:
– Beginning or continuing judicial proceedings
against the debtor
– Actions to repossess the debtor’s property;
– Actions to create, perfect, or enforce a lien
against the debtor’s property; and
– Setoff of indebtedness owed to debtor before
commencement of the bankruptcy proceeding
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7. Order of Relief
• Once a bankruptcy petition has been
filed, the court must first determine
whether relief should be ordered
– This step automatic for a voluntary
petition or no-contest of involuntary
petition
– If debtor contests involuntary petition,
then a trial is held on question of whether
court should grant relief.
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8. Creditor Claims
• To participate in the estate of a bankrupt
debtor, unsecured creditors must file a
proof of claim within a certain time,
usually six months after the first meeting
of creditors
• Bankruptcy Code declares ten types of
claims to have priority over other claims
– Priority claims are paid after secured
creditors but before other unsecured
creditors are paid
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9. Liquidation (Chapter 7)
• In a liquidation proceeding (straight
bankruptcy), the debtor must disclose all
property s/he owns and surrender this
bankruptcy estate to a bankruptcy trustee
– Trustee segregates property that debtor
may keep and then administers, liquidates,
and distributes the remainder of the estate
• Relative rights of creditors established by
law
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10. The Bankrupt’s Filings
• Bankrupt person required to
file a list of assets, liabilities,
and creditors, plus a
statement of bankrupt’s
financial affairs
• Failure to file the information
within 45 days of petition
results in automatic dismissal
– Extension of time possible
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11. Trustee Duties in Chapter 7
• Creditors meet and may elect a trustee
• Whether appointed or elected, the
trustee:
– Sets aside property a debtor may keep
– Takes possession of debtor’s property and
has it appraised
– Examines creditor claims, objecting if
necessary
– Separates unsecured property from the
secured and otherwise exempt property
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12. Trustee Duties in Chapter 7
• The trustee also:
– Operates debtor’s business if necessary
– Sells debtor’s nonexempt property as soon
as possible and consistent with best interests
of creditors
– Keeps an accurate account of all property
and money received and promptly deposits
money into the estate’s accounts
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13. The Bankruptcy Estate
• Bankruptcy estate includes all of debtor’s
legal and equitable interests in property
• Exemptions permit the bankrupt person
to retain a minimum amount of assets
considered necessary to life and an
ability to continue to earn a living
– Exemptions vary from state to state
Texas is a “homestead” state
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14. In Re Rogers
• Issue and Opinion:
– Does homestead exemption cap in Bankruptcy
Abuse Prevention and Consumer Protection Act
apply to a homestead interest established within
1,215-day period before bankruptcy
• Statutory text & legislative history indicate that “interest”
refers to vested economic interests in property acquired
by a debtor within specific period preceding petition
– Debtor acquired title to property as inheritance
long before the statutory period
– Debtor entitled to full homestead exemption
under Texas state law
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15. Liens and Business Transactions
• Debtor may void some liens against
exempt properties that impair the
exemptions
• Debtors may redeem exempt personal
property from secured creditors by
paying the full value of the collateral at
the time the property is redeemed
• A debtor and creditors may engage in
ordinary business transactions
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16. Fraudulent Transfers
• If a debtor transfers
property or incurs an
obligation with intent to
hinder, delay, or defraud
creditors, the transfer is
voidable by the trustee
– Includes transfers of
property for less than
reasonable value
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17. In re Bernard Madoff
Investment Securities LLC
• Facts:
– A Trustee sought to avoid monies paid out to
certain investors pursuant to a Ponzi scheme as
preferential and fraudulent transfers
• Opinion:
– “Breadth and notoriety” of Madoff Ponzi scheme
leave no basis for disputing the application of the
Ponzi scheme presumption to this case, particularly
in light of Madoff’s criminal admission
– BLMIS’s fraudulent intent is established as a matter
of law and trustee sufficiently pled actual fraud
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18. Discharge
• A bankrupt person not guilty of dishonest
acts and who fulfilled duties as a
bankrupt is entitled to a discharge in
bankruptcy
• A discharge relieves the bankrupt person
of further responsibility for dischargeable
debts and gives him a fresh start.
• A corporation or partnership is not
eligible for a discharge in bankruptcy
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19. Discharge
• Certain debts, such as educational loans,
are not dischargeable in bankruptcy
– In re Gerhardt: court denied the request of a
debtor that his student loans be discharged
because their repayment would constitute an
undue hardship to him
Gerhardt is a professional
cellist and had over $77,000 in
student loan debt at the time of
the bankruptcy petition
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20. Dismissal for Abuse
• Bankruptcy Code permits court to
dismiss cases for abuse of process if
debtor acted in bad faith or had
present or future means to pay a
significant portion of their current debts
– Means test determines debtor’s ability to repay
general unsecured claims
– In re Siegenberg: court dismissed a Chapter 7
case on the grounds it was filed in bad faith.
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21. Chapter 11 Reorganization
• Chapter 11 offers a procedure in which
the debtor’s financial affairs can be
reorganized rather than liquidated
because creditors would benefit more
from the continuation of a bankrupt
debtor’s business than from the
liquidation of debtor’s property
• Chapter 11 is available to individuals
and business enterprises
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22. Trustee Duties Under Chapter 11
• Rather than liquidating the debtor’s
estate, a trustee for a Chapter 11
proceeding develops a plan for handling
creditor claims and the various interests
of persons such as shareholders
• Reorganization plan is essentially a
contract between a debtor and its
creditors and may involve
recapitalization or giving creditors some
equity
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23. The Bankruptcy Plan
• Plan must: (1) divide creditors into classes;
(2) set forth how each creditor will be
satisfied; (3) state which claims, or classes of
claims, are impaired or adversely affected
by the plan; & (4) provide equal treatment
to each creditor in a particular class, unless
creditors in the class consent to other
treatment
• In re Made In Detroit, Inc. : plan not feasible,
therefore court unable to confirm plan
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24. The Bankruptcy Plan
• A reorganization plan must be confirmed
by the court before it becomes effective
• Plans may be confirmed by voluntary
agreement of creditors or a cram down:
– Court forces dissenting creditors whose claims
would be impaired to accept the plan if the
court finds it is fair and equitable to the
creditors
• If confirmed, debtor must implement plan
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25. Bankruptcy & Ethics
• Bankruptcy petitions have been filed
to avoid obligations under divorce
judgments, collective bargaining
agreements, and mass tort and
product liability litigation (asbestos,
breast implant, and birth control
device litigation)
• These cases aren’t merely a matter of
economics, but are a matter of ethics
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26. Chapter 12 Bankruptcy
• Chapter 12 is modeled after Chapter 13
and is available only for family farmers
and fishermen with regular income
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27. Chapter 13 – Consumer Debt
• Chapter 13 gives individuals who do not
want to be declared bankrupt the right to
file a voluntary petition for bankruptcy
protection, obtaining the opportunity to
pay debts in installments and free of such
problems as garnishments and
attachments of property by creditors
– Must be an individual with regular incomes
owing less than a specific amount of debt
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28. Chapter 13 – Consumer Debt
• In re Burt: court agreed with Ford Motor
Credit’s objection to the confirmation of a
proposed Chapter 13 plan that would cram
down the creditor’s secured interest in truck
– Cram-down refers to bifurcation of an under-secured
creditor’s claim into secured and unsecured portions, so
a creditor’s claim is allowed as secured only up to the
value of collateral securing its debt
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29. Chapter 13 – Consumer Debt
• After filing, the debtor submits a plan of
payment to secured creditors for
acceptance
– 3-5 year payment plan
• If acceptable to creditors and the court,
the court will approve the plan and
appoint a trustee to carry out the plan
– In re Burt: unacceptable plan because it was
a “cram-down” of creditor’s secured interest
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30. Test Your Knowledge
• True=A, False = B
– All bankruptcy proceedings begin by filing
a voluntary bankruptcy petition
– Once a voluntary bankruptcy petition has
been filed, the automatic stay prevents a
creditor from filing suit against the debtor
for repossession of the property.
– Chapter 11 is available only to business
enterprises
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31. Test Your Knowledge
• True=A, False = B
– A reorganization plan under Chapter 11
requires unanimous consent by all
creditors before it becomes effective
– To participate in the estate of a bankrupt
debtor, unsecured creditors must file a
proof of claim within a certain time,
usually six months after the first meeting of
creditors.
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32. Test Your Knowledge
• Multiple Choice
– Days before filing for reorganization,
Bernie gave six of his properties to friends
in return for an agreement that they
would sell the property back to him in five
years. Has Bernie done anything wrong?
a) Yes, he must have sold the properties for at
least $1 minimum value
b) Yes, he engaged in fraudulent transfer
c) No, properties given to friends are exempt
from inclusion in the bankruptcy estate
d) None of the above
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33. Test Your Knowledge
• Multiple Choice
– In JarlCo’s reorganization, the bankruptcy
court forced dissenting creditors whose
claims would be impaired to accept the
reorganization plan. The court:
a) Improperly abused its power and will be
reversed on appeal
b) Prioritized execution of the plan
c) Engaged in a cram down
d) none of the above
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34. Thought Questions
• Why was the right to file for banruptcy
protection incorporated into the U.S.
Constitution? What is your opinion of
the bankruptcy process?
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Notas del editor
In a contested involuntary petition, relief is granted and interim trustee appointed only if debtor is not paying debts, or if within 120 days of filing a custodian was appointed or took possession of debtor’s property
For the ten classes of priority claims, see page 781-782.
The hyperlink is to the Fifth Circuit’s opinion on the Findlaw.com website. Court concluded that a debtor was entitled to claim a homestead exemption in property which she acquired more than 1,215 days before filing for bankruptcy, but which she began to use as her homestead within that period. Key facts were that Rogers had inherited the property before marriage and a subsequent marriage and divorce complicated the situation. Court: “This case involves a question of first impression in this circuit: the statutory interpretation of the newly enacted homestead exemption cap, 11 U.S.C. § 522(p)(1), found in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”). The issue is whether the homestead exemption cap applies to a homestead interest established within the 1,215-day period preceding the filing of the bankruptcy petition despite the fact that the debtor acquired title to the property before that statutory period. The bankruptcy court answered this question in the negative, and the district court affirmed. For the reasons discussed below, we affirm.”
Hyperlink is to the court’s opinion on the Leagle.com website.
Hyperlink is to the case opinion on the Findlaw.com website. Jonathan Gerhardt, principal cello, has been a member of the Louisiana Philharmonic Orchestra since 1995. Nondischargeable debts include, among others, debts that: 1. Are due as a tax or fine to the United States or any state or local unit of government. 2. Result from liabilities for obtaining money by false pretenses or false representations. 3. Were incurred by the debtor’s purchase of more than $500 in luxury goods or services on credit from a single creditor within 90 days of filing a petition (presumed to be nondischargeable). 4. Are cash advances in excess of $750 obtained by use of a credit card or a revolving line of credit at a credit union and obtained within 70 days of filing a bankruptcy petition (presumed to be nondischargeable). 5. Were not scheduled in time for proof and allowance because the creditor holding the debt did not have notification of the proceeding even though the debtor was aware that he owed money to that creditor. 6. Were created by the debtor’s larceny or embezzlement or by the debtor’s fraud while acting in a fiduciary capacity. 7. Were for a domestic support obligation (unless excepting it from discharge would impose an undue hardship on the debtor’s dependents). 8. Are due for willful or malicious injury to a person or his property. 9. Are educational loans. 10. Are judgments arising out of a debtor’s operation of a motor vehicle while legally intoxicated. 11. Are debts incurred to pay a tax to the United States that would not be dischargeable. 12. Are property settlements arising from divorce or separation proceedings other than support provisions that are priority claims.
Hyperlink is to the court’s opinion in pdf. The “means test” has three elements: (1) a definition of “current monthly income”— which is the total income a debtor is presumed to have available; (2) a list of allowed deductions from the current monthly income for the purpose of supporting the debtor and his family and for repayment of higher priority debts; and (3) defined “trigger points” at which the income remaining after the allowed deductions would trigger the presumption of abuse. In re Siegenberg: court dismissed a Chapter 7 case on the grounds it was filed in bad faith. Commencing in 2000, when she was hired by Mariah Carey, a prominent entertainer, Nicole Siegenberg worked as a costumer in the entertainment business. Her duties were to buy clothes for and costume her employer. In 2004, she lost her job. Since 2004, Siegenberg was employed only sporadically on temporary jobs such as television pilots. During the 2004 to 2006 period she incurred substantial debts. Siegenberg filed a Chapter 7 bankruptcy on Nov. 29, 2006. The United States Trustee (UST) filed a motion to dismiss Siegenberg’s Chapter 7 petition as filed in bad faith and sought a one year bar against refiling. Court: In considering whether a Chapter 7 case should be dismissed because granting relief would be an abuse of the provisions of Chapter 7, courts may consider (a) whether the debtor filed the petition in bad faith; or (b) whether the totality of the circumstances of the debtor’s financial situation demonstrates abuse…. Siegenberg has used her credit cards in various efforts to extricate herself and her family from financial difficulties. She also used her credit cards for tens of thousands of dollars in personal expenditures, the purchase of consumer goods and services, and to obtain unexplained cash advances. The record contains significant evidence of these ostensibly excessive expenditures and contains only patchy, incomplete, and unconvincing evidence that most of these expenditures were made to further Siegenberg’s business efforts. I believe it is appropriate to grant the UST’s motion to dismiss Siegenberg’s Chapter 7 petition, and to impose a one-year bar on future bankruptcy filings by or against Siegenberg.
Hyperlink is to the appellate court’s opinion in pdf. Court: “In summary, the Debtor failed to show at confirmation that it had exit financing to fund its plan. The proposed financing had so many contingencies that Debtor’s Plan was conditional at best. Thus, the Debtor’s Plan is not feasible under 1129(a)(11), and the Court must deny confirmation of Debtor’s Plan.”
The following companies filed for bankruptcy protection from product liability claims for products they manufactured and sold: Dow Corning Inc. (breast implants), A. H. Robins Company (birth-control devices), Johns-Manville (asbestos)
Only individuals with regular incomes (including business sole proprietors) who owe individually (or with a spouse) liquidated, unsecured debts of less than $360,475 and secured debts of less than $1,081,400 may file for bankruptcy relief
If a class of creditors or shareholders reject a plan, it can only be confirmed if it is “fair and equitable” under the requirements of Section 1129 (b) of the Bankruptcy Code; the requirements are known as the “cram-down” provisions. The phrase “fair and equitable” means that the plan must not be unfairly discriminatory with respect to each claim that has not accepted the plan.
False. All bankruptcy proceedings begin by filing a petition , either voluntary or involuntary, such as when creditors force a debtor into bankruptcy to reach the assets. True. False. Chapter 11 is available to individuals and business enterprises
False. A reorganization plan must be confirmed by the court before it becomes effective and the court may force creditors to accept the plan. True.
The correct answer is (b).
The correct answer is (c).
Opportunity to discuss the history of bankruptcy, the continued viability of the constitutional guarantee (if viable), and the latest revisions to consumer bankruptcy protection under Chapter 13. One reason bankruptcy was important to the founding fathers was that a person who got into debt in Europe and England went to debtor’s prison to work off the debt and the colonists wanted to avoid that bit of European civilization. The old print is captioned, “Whoever wants everything has nothing.” Is bankruptcy a result of wanting everything or just poor management skills?
