Chapter 30

 

 

 

 

 

 

 

 

Bankruptcy Law

 

p  See Separate Lecture Outline System

 

Introduction

 

      Bankruptcy law is designed to accomplish two main goals: to provide relief and protection to debtors who have “gotten in over their heads” and to provide a fair means of distributing a debtor’s assets among credi­tors.  Thus, the law attempts to protect the rights of debtor and creditor, although it is fair to say that current bankruptcy law is more debtor-oriented than its predecessor.

 

 

Additional Background—

 

Bankruptcy—A Creditor’s Remedy?

 

   Originally, bankruptcy represented a creditor’s remedy, not debtor’s relief.  In Great Britain, in the sixteenth century, creditors used the bankruptcy laws to obtain all of the property of a merchant be­hind in the payment of debts.  At the time, only merchants were subject to the bankruptcy laws.  Credi­tors could seize a debtor’s property, have the property sold, and if the proceeds from the sale were not enough, have the debtor imprisoned until his or her friends or relatives could pay the rest.  By the be­ginning of the eighteenth century, the law began to permit the release of debtors from prison and dis­charge the unpaid balance of their debts.  For at least another hundred years, however, the bank­ruptcy laws were creditors’ remedies, and debtors could still be imprisoned.  Today, of course, the Bankruptcy Code attempts to strike a balance between the interests of both debtors and creditors.

 

 

Chapter Outline

 

I.   Bankruptcy Proceedings

      Bankruptcy proceedings are held in federal bankruptcy courts under the authority of the federal dis­trict courts, to which rulings can be appealed. The Bankruptcy Code is in Title 11 of the U.S.C. and has eight chapters. Chapters 1, 3, and 5 include definitions and provisions governing case administration, creditors, debtors, and estates. Chapter 7 provides for liquidation. Chapter 9 governs the adjustment of municipal debts. Chapter 11 governs reorganizations. Chapters 12 and 13 provide for the adjustment of debts by parties with regular incomes (family farmers under Chapter 12).

 

II.  Liquidation Proceedings

      In a Chapter 7 liquidation (an ordinary or “straight” bankruptcy), a debtor states his or her debts and turns his or her assets over to a trustee, who sells nonexempt assets and distributes the proceeds to creditors.  With exceptions, the rest of the debts are discharged.

 

A.  Filing the Petition

 

1.  Voluntary Bankruptcy

    A debtor files a voluntary petition.  A debtor does not have to be insol­vent—anyone liable to a creditor can file.  A voluntary petition must contain:  (1) a schedule of secured and un­se­cured creditors and what is owed to each; (2) a statement of the debtor’s financial affairs; (3) a list of the debtor’s property; and (4) a statement of the debtor’s current income and ex­penses (to in­dicate a debtor’s ability to pay creditors from future income, permitting a court to dismiss the petition after a hearing and en­courage the filing of a Chapter 13 petition, when that would substantially improve the chances that creditors would be paid).

 

 

Case Synopsis—

 

Case 30.1: In re Lamanna

 

   Richard Lamanna lived with his parents and had no plans to move out.  His monthly expenses were $580.  His monthly income was $1,350.96, leaving a difference of $770.96.  During a four-week pe­riod, he charged $9,994.45 on credit cards.  Three months latter, when his total unsecured debt was $15,911.96, he filed a Chapter 7 petition in a federal bankruptcy court.  The court noted that Lamanna was capable of paying all of his debts under a Chapter 13 repayment plan and dismissed the case.  The U.S. Bankruptcy Appellate Panel for the First Circuit affirmed the dismissal, and Lamanna appealed, arguing in part that if he did not live with his parents, he would not have as much disposable income, and that thus he was being penalized for living with his parents.

 

   The U.S. Court of Appeals for the First Circuit affirmed, holding that granting Lamanna’s peti­tion would constitute substantial abuse.  Under a “totality of the circumstances” test, Lamanna “has sufficient disposable income to repay his debts under a Chapter 13 repayment plan in three to five years.  There is no evidence that Lamanna’s living situation was unstable or likely to change in the near future.  There is no evidence of other factors that cast doubt on the stability of Lamanna’s future income and expenses.”  Lamanna’s argument that he was penalized for living with his parents “boils down to the notion that Section 707 requires the bankruptcy court to impute a minimum cost of living to a debtor and then measure the debtor’s actual income against the higher of the imputed minimum and the debtor’s actual expenses.  Section 707 does not contain such an implicit requirement.”

 

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Notes and Questions

 

   Section 707(b) was added to the Bankruptcy Code as part of the Bankruptcy Amendments and Federal Judgeship Act of 1984.  It authorizes a bankruptcy court to dismiss a Chapter 7 petition of an individual debtor who owes primarily consumer debts if allowing the petition would be a “substantial abuse” of Chapter 7.  Why did the court in Lamanna’s case adopt a “test” for substantial abuse rather than simply applying Congress’s definition of the term?  Because Congress did not define “substantial

abuse” but left a flexible standard for courts to address each petition on its own merit, the court had to decide for itself.

 

   The primary impetus for the enactment of Section 707(b) was the credit industry’s unhappiness with the fact that consumer debtors who were able to repay their debts had increasingly been filing for bankruptcy relief since the enactment of the 1978 Bankruptcy Act.  Section 707(b) was intended to im­pose a restraint on consumer debtors’ access to Chapter 7 discharge “by interposing bankruptcy courts as gatekeepers who could examine the worthiness of debtor petitions and dismiss those petitions deemed abusive,” according to the court in Lamanna’s case.

 

   As the result in this case shows, if a debtor can pay his or her debts as the come due, the debtor’s petition for bankruptcy under Chapter 7 may be dismissed.  Does this mean that if a debtor cannot pay his or her debts as they come due, the debtor’s petition will not be dis­missed?  No.  An inability to pay debts as they come due will not shield a debtor from a dismissal of his or her petition under Section 707(b) of the Bankruptcy Code if bad faith is shown.  In other words, a court may take a petitioner’s bad faith into consideration in deciding whether to dismiss the petition.

 

 

2.  Involuntary Bankruptcy

    Most debtors can be forced into in­volun­tary bankruptcy by creditors.  If the debtor challenges the petition, he court will enter an order for relief if it finds:  (1) the debtor is generally not paying debts as they become due, or (2) a general receiver, assignee, or custodian took pos­session of or was appointed to take charge of substan­tially all of the debtor’s property within 120 days before the petition was filed.  If the petition is dismissed, creditors may be assessed costs and attorneys’ fees.  If a petition is filed in bad faith, a debtor may be awarded dam­ages for injury to reputation and punitive damages.

 

B.  Automatic Stay

    The automatic stay protects a debtor’s property from actions by the creditors.  Secured creditors are protected from losing the value of their security as a result of the automatic stay by the ade­quate protection doctrine, under which a court can require a debtor or trustee to make payments (or to provide additional collateral or replacement liens) to cover any decrease in value, or a court may grant other relief, such as a guaranty by a third party to cover losses.  (For example, an au­tomatic stay would pre­vent a creditor with a secured interest in a debtor’s trucks from repossess­ing the trucks, but a court could re­quire the debtor to make payments to cover any depreciation.)  A creditor’s willful violation of an automatic stay may entitle a party to recover compensatory and punitive damages, costs, and attorneys’ fees.

 

 

Additional Background—

 

Adequate Protection

 

   A secured creditor is pro­tected from losing his or her security as a result of the automatic stay by a concept known as adequate protection.  The following is the text of 11 U.S.C. Section 361, a section of the Bankruptcy Code providing for ade­quate protection under Chapters 7, 11, and 13 (for adequate pro­tection rules that apply in Chapter 12 cases, see the Additional Background accompanying the section on Chapter 12 below).

 

TITLE 11.  BANKRUPTCY

CHAPTER 3—CASE ADMINISTRATION

SUBCHAPTER IV—ADMINISTRATIVE POWERS

 

§ 361. Adequate protection

 

When adequate protection is required under section 362, 363, or 364 of this title of an interest of an en­tity in property, such adequate protection may be provided by—

 

(1) requiring the trustee to make a cash payment or periodic cash payments to such entity, to the ex­tent that the stay under section 362 of this title, use, sale, or lease under section 363 of this title, or

any grant of a lien under section 364 of this title results in a decrease in the value of such entity’s in­terest in such property;

 

(2) providing to such entity an additional or replacement lien to the extent that such stay, use, sale, lease, or grant results in a decrease in the value of such entity’s interest in such property;  or

 

(3) granting such other relief, other than entitling such entity to compensation allowable under section 503(b)(1) of this title as an administrative expense, as will result in the realization by such entity of the indubitable equivalent of such entity’s interest in such property.

 

(Pub.L. 95-598, Nov. 6, 1978, 92 Stat. 2569.)

 

(As amended Pub.L. 98-353, Title III, § 440, July 10, 1984, 98 Stat. 370.)

 

 

C.  Property of the Estate

    Commencement of a Chapter 7 proceeding creates an estate in property, which consists of all the debtor’s legal and equitable interests in property.

 

 

Case Synopsis—

 

Case 30.2: In re Andrews

 

   Tarmac Acquisition, Inc., bought AMAX Corp.  The AMAX owners, including John Andrews, signed agreements not to compete with Tarmac.  Andrews was to receive $1 million, payable in quar­terly installments over a five-year period.  Three years later, Andrews filed a bankruptcy petition.  He asked the court not to include, in the property of his estate, any future installments.  The court re­fused.  Andrews appealed.

 

   The U.S. Court of Appeals for the Fourth Circuit affirmed.  “Pre-petition assets, like the NCA [noncompetition agreement] payments, are those assets rooted in the debtor’s pre-petition activities, including any proceeds that may flow from those assets in the future.”  The payments “are plainly rooted in, and grow out of, Andrews’s pre-petition activities.”

 

 

D.  Creditors’ Meeting and Claims

    The debtor must also attend (unless excused by the court) and submit to examination under oath.  At the meeting, the trustee ensures that the debtor is advised of the potential consequences of bankruptcy and of his or her ability to file for bankruptcy under a different Chapter.  Normally, creditors must file proof of their claims within ninety days of the meeting.

 

    In a disputed or unliquidated claim, the court sets the value.  Any creditor’s claim is allowed au­tomatically unless contested by the trustee, the debtor, or another creditor.  Claims for breach of employment contracts or real estate leases for terms longer than one year are limited to one year’s rent or wages.  Filing a false claim is a crime.

 

E.  Exemptions

    A debtor can exempt certain property from bankruptcy, choosing between exemptions provided under state law and federal law.  (States may bar the use of federal exemptions.)  The Bankruptcy Code’s exemptions are set out in the text.

 

F.  The Trustee

    A trustee’s principal duty is to col­lect and re­duce to money the property of the debtor’s estate and to close up the estate as fast as is compatible with the par­ties’ best interests.

 

1.  Trustee’s Powers

    The text briefly sketches the trustee’s powers.  One way to outline those powers is to note that the Bankruptcy Code gives a trustee general and specific powers.  The general pow­ers inhere in the trustee’s position, which is equivalent in rights to that of certain other parties.  (A trustee has the same rights as a lien creditor who could have levied execution on the debtor’s property, for instance—that is, a trustee has priority over an unperfected secured party.  A trustee also has power equivalent to that of a bona fide purchaser of real property from the debtor.  A trustee has specific powers to set aside a transfer of the debtor’s property. These powers include any voidable rights and the power to avoid preferences, certain statutory liens, and fraudulent transfers.  (If a trustee does not act to en­force a right, the debtor can.  In either case, however, these powers must be exercised within two years of the order for re­lief.  The period runs even if a trustee has not been appointed.)  The trustee also can require per­sons holding a debtor’s property when a petition is filed to give the property to the trustee.

 

2.  Voidable Rights

    A trustee can use any ground—including fraud, duress, incapacity, and mutual mis­take—that a debtor can use to obtain return of the debtor’s property.

 

3.  Preferences

    A trustee can recover a debtor’s payment or transfer of property made to a creditor in pref­er­ence over others. Generally, payment for services rendered within ten to fifteen days before payment is not considered a preference.  If a creditor receives payment in the ordinary course of busi­ness (for last month’s telephone bill, for example), the payment cannot be re­covered.  A consumer-debtor can transfer any property to a creditor up to a value of $600 without it constituting a prefer­ence.

 

4.  Liens on Debtor’s Property

    A trustee can avoid the fixing of certain statutory liens on a debtor’s prop­erty.

 

5.  Fraudulent Transfers

    A trustee may avoid fraudulent transfers made within a year of the filing of the petition or made with intent to hinder, delay, or defraud a creditor.  Transfers made for less than rea­son­ably equivalent consideration are vulnerable if by making them the debtor became insol­vent, was left in busi­ness with a small amount of capital, or intended to incur debts that he or she could not pay.

 

G.  Distribution of Property

    If collateral is surrendered to a secured party, he or she can accept it in full satisfaction of the debt or foreclose on it and use the proceeds to pay off the debt.  If the collateral’s value exceeds the debt, the proceeds cover reasonable fees and costs incurred because of the debtor’s default.  If the collateral’s value is less than the debt, the secured creditor becomes an unse­cured creditor for the difference.

 

    The text sets out the order in which unsecured debts are paid.  Each class must be paid before the next class is entitled to any proceeds.  If proceeds are insufficient to pay all credi­tors in a class, payment is proportional, and classes lower in priority receive nothing.  Any amount re­maining after creditors are paid goes to the debtor.  If a debtor has no assets, creditors are told not to file a claim, and unsecured creditors—most, if not all, of whose debts are discharged—receive nothing.

 

H.  Discharge

    The text lists claims that are not dischargeable and circumstances in which a discharge will be denied.

 

 

Case Synopsis—

 

Case 30.3: In re Jercich

 

   In June 1981, James Petralia began work for George Jercich, Inc., a mortgage company wholly owned and operated by George Jercich. Petralia’s primary duty was to obtain investors to fund the loans. Jercich agreed to pay Petralia a salary plus monthly commissions for loans that were funded through his efforts. When Jercich failed to pay the commissions, Petralia quit and filed a suit in a California state court against Jercich. The court found that Jercich could pay Petralia, but chose to use the money for personal investments, and that this was willful, deliberate, and constituted “sub­stantial oppression.” The court ruled in Petralia’s favor. Jercich appealed to a state intermediate

 appellate court and filed for bankruptcy. The state court affirmed, but the bankruptcy court held the debt dischargeable. A bankruptcy appellate panel affirmed. Petralia appealed.

 

   The U.S. Court of Appeals for the Ninth Circuit reversed. “[W]here an intentional breach of con­tract is accompanied by tortious conduct which results in willful and malicious injury, the resulting debt is excepted from discharge.” Based on the state court’s findings, “Jercich’s nonpayment of wages .  .  . constituted tortious conduct” and “the injury to Petralia was willful.” Jercich’s willful failure to pay was found to constitute substantial oppression, which is “despicable conduct that subjects a person to cruel and unjust hardship in conscious disregard of that person’s rights. We hold that these .  .  . findings are sufficient to show that the injury inflicted by Jercich was malicious.”

 

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Notes and Questions

 

   Was it significant that the debt in this case consisted of unpaid wages? As the court, stated, “Public policy has long favored the full and prompt payment of wages due an employee. Wages are not ordi­nary debts. Because of the economic position of the average worker and, in particular, his family, it is essential to the public welfare that he receive his pay promptly. Thus, the prompt payment of wages serves society’s interest through a more stable job market, in which its most important policies are safeguarded.”

 

 

 

Additional Cases Addressing this Issue —

 

   Recent cases focusing on exceptions to discharge in bankruptcy proceedings include the following.

 

•  In re Roach, __ Bankr. __, 2003 WL 115191 (E.D.La. 2003) (a debtor, a recovering alcoholic whose earning potential as a nurse was somewhat limited by restrictions placed on her employment as re­sult of her history of alcoholism, did not show that her present inability, without undue hardship, to repay her student loan was likely to persist for a significant portion of loan repayment period, and was not be relieved of the debt).

 

•  In re Murphy, 282 F.3d 868 (5th Cir. 2002) (in holding that all of a debtor’s federally guaranteed student-loan debts were nondischargeable, including portion used for living expenses, the court rea­soned that the purpose, not the use, of a loan controls whether the loan is within the Bankruptcy Code’s educational-loan dischargeability exception, and in this case, the debtor’s student loans were within the exception based on their educational purpose).

 

•  In re Long, 271 Bankr. 322 (8th Cir. BAP 2002) (the court upheld a conclusion that the repayment of student-loan indebtedness would impose an undue hardship on the debtor, holding in part that it was proper to consider the debtor’s medical condition and prognosis in examining her present and future financial resources).

 

 

 

Case Synopsis—

 

Case 30.4: In re Ellison

 

   Stanley and Kay Ellison were officers, directors, and shareholders of Sovereign World Travel, Ltd., a travel agency in Charleston, West Virginia. Sovereign Travel entered into an agreement with Air­lines Reporting Corp. (ARC) to collect payments for airline tickets, deposit the proceeds in an account with Whitesville State Bank for ARC’s benefit, and report the sales to ARC. The Ellisons guaranteed Sovereign Travel’s payments. In 1994, Sovereign Travel and the Ellisons filed Chapter 7 petitions in a federal bankruptcy court. ARC filed a complaint with the court against the Ellisons, seeking damages based on their guaranties and a declaratory judgment that this debt was nondischargeable. The court ruled in ARC’s favor, awarding $574,678. The Ellisons appealed to a federal district court, which af­firmed. The Ellisons appealed.

 

   The U.S. Court of Appeals for the Fourth Circuit affirmed. The indebtedness to ARC based on the Ellisons’ personal guaranties was nondischargeable because it was caused solely by the Ellisons’ breach of their fiduciary duties. The Ellisons were “personally responsible for the conduct that gave rise to Sovereign Travel’s defalcation to ARC. They personally handled Sovereign Travel’s weekly sales reports and ARC’s trust account at the Whitesville State Bank. And they withheld money that was designated to be placed in trust for ARC, causing Sovereign Travel’s default. Thus, it was the Ellisons themselves who depleted ARC’s trust funds to the point that checks properly drawn on the trust account were returned for insufficient funds.”

 

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Notes and Questions

 

   Could the Ellisons have been held personally liable for the tortious acts of Sovereign Travel on the sole basis of their corporate positions? No, and the court acknowledged that a corporate officer “is in no way personally liable for corporate torts solely on account of his [or her] corporate position.” The court stated, however, that personal liability may lie where, as here, the Ellisons “breached their fiduciary duty to the corporation as officers and directors, and their tortious conduct made them jointly and sev­erally liable with the corporation vis-a-vis ARC, quite apart from their personal guarantees.”

 

 

 

Additional Cases Addressing this Issue —

 

   Recent cases concerning objections to discharge in bankruptcy proceedings include the following.

 

•  In re Spadoni, __ Bankr. __, 2003 WL 105366 (1st Cir. 2003) (a creditor justifiably relied on a debtor’s promises to pay overdue rent on property subleased from the creditor, as required under the Bankruptcy Code provision making nondischargeable any debt obtained by fraud).

 

•  In re Raisley, __ Bankr. __, 2003 WL 41551 (W.D.Pa. 2003) (a creditor did not justifiably rely on a debtor’s statement that the property to be sold was not affected by any judgments or outstanding in­struments of indebtedness, as required under the Bankruptcy Code provision making nondischarge­able any debt obtained by fraud, when the creditor, through its agent, conducted for itself a search for judgments).

 

 

1.  Revocation of Discharge

    A debtor may lose his or her discharge by revocation on petition by the trustee or a creditor.  The court may within a year revoke a discharge if a debtor acted fraudulently or dishon­estly dur­ing bankruptcy proceedings.

 

2.  Reaffirmation of Debt

    A reaffirmation agreement must be filed with the court before a discharge is granted.  A debtor can re­scind the agreement any time before discharge or within sixty days of filing the agreement, whichever is later.  (This pe­riod must be stated clearly and conspicuously in the agreement.)

 

III. Reorganizations

      Chapter 11 is used commonly by corporations, but any debtor (except a stockbroker or a commodities bro­ker) eligible for Chapter 7 relief is eligible for Chapter 11 relief.  Under Chapter 11, creditors and debtor plan for the debtor to pay some debts, be discharged of the rest, and continue in business.  The same principles cover Chapter 7 and Chapter 11 proceedings (a case may be voluntary or involuntary, the automatic stay and adequate protection rules apply, and so on). Also, after notice and a hearing, a court may dismiss a case under Section 1112 “for cause.”

 

A.  Workouts

    The text notes that workouts are sometimes used in place of bankruptcies.

B.  Debtor in Possession

    A debtor generally continues in business as a debtor in possession.  The court may appoint a trus­tee to operate the business if gross mismanagement is shown or if appointing a trustee is oth­er­wise in the estate’s best interest.

 

C.  Collective Bargaining Agreements

    A DIP may reject a collective bargaining agreement, after proposing nec­es­sary contract modifica­tions to the union and making a good faith attempt to reach agreement on the modifi­ca­tions, if the union fails to adopt them without good cause.

 

D.  Creditors’ Committees

    A committee of unsecured creditors is appointed to consult with the debtor (or the trustee) about administration of the case or formulation of the plan.  Additional committees may be ap­pointed to represent special-interest creditors.  In most cases, orders affecting the estate are not entered without the committees’ input.

 

E.  The Reorganization Plan

    The text sets out the purposes and details of a Chapter 11 plan.  Once developed, a plan is submit­ted to each class of creditors, who must accept it unless the class is not adversely affected by it.  Even if all classes accept a plan, the court may not confirm it if it is not “in the best interests of the credi­tors.”  If only one class accepts a plan, the court may still confirm it under the Code’s cram down provision. 

 

IV.  Additional Forms of Bankruptcy Relief

 

A.  Individuals’ Repayment Plan

    Individuals (not partnerships or corporations) with regular income who owe fixed unsecured debts of less than $250,000 or fixed secured debts of less than $750,000 may use Chapter 13.

 

1.  Filing the Petition

    Only a debtor can initiate a Chapter 13 case.  Certain Chapter 7 and Chapter 11 cases may be converted to Chapter 13 cases with a debtor’s consent.  The automatic stay applies in Chapter 13 cases to consumer debt but not business debt.

 

2.  Filing the Plan

    The text covers some of the details of Chapter 13 plans.  Only a debtor may file a plan.  The time for payment may not exceed three years unless the court approves an extension, in which case it may not exceed five years.

 

3.  Confirmation of the Plan

    A plan will be confirmed if:  (1) secured creditors have accepted it; (2) it provides that cred­i­tors retain their liens and the value of the property to be distributed to them is not less than the secured por­tion of their claims; or (3) the debtor surrenders property securing the claims to the creditors.

 

4.  Objection to the Plan

    Unsecured creditors cannot vote to confirm a plan, but they can object to it.  The court can ap­prove a plan over an objection of the trustee or an unsecured creditor.

 

 

Case Synopsis—

 

Case 30.5: In re Andersen

 

   Doreen Andersen had student loan obligations.  She filed a Chapter 13 plan that included the dis­charge of those obligations.  The lenders filed an untimely objection, which court denied, and the court confirmed the plan.  After Andersen fulfilled the plan, the court entered a discharge.  When the lend­ers attempted to collect the balance of the loans, Andersen filed a suit in a bankruptcy court.  The court held that the debts had not been discharged.  Andersen appealed.

 

   The bankruptcy appellate panel reversed and remanded. The lenders failed to object to Andersen’s plan in time. The plan was confirmed and the final order of discharge discharged the loans.

 

 

5.  Modification of the Plan

    A plan may be modified at the request of the debtor, the trustee, or an unsecured creditor.  If there is an objection, there must be a hearing.

 

6.  Discharge

    Most debts are dischargeable, including fraudulently incurred debt and claims resulting from mali­cious or willful injury.  A discharge can be revoked within one year if it was ob­tained by fraud.

 

B.  Family Farmers

    Chapter 12 is for a family farmer.  A Chapter 12 filing is similar to a Chapter 13 filing.

 

 

Additional Background—

 

Adequate Protection

 

   A secured creditor can peti­tion to lift the automatic stay for adequate protection of his or her in­ter­est if the value of the collateral is less than the amount of the secured debt.  The rules pertaining to adequate protection under Chapter 12 differ from those that apply to proceedings under other chap­ters.  The following is the text of 11 U.S.C. Section 1205, a section of the Code providing for adequate protection under Chapter 12.

 

TITLE 11.  BANKRUPTCY

CHAPTER 12—ADJUSTMENT OF DEBTS OF A FAMILY FARMER WITH REGULAR ANNUAL INCOME

SUBCHAPTER I—OFFICERS, ADMINISTRATION, AND THE ESTATE

 

§ 1205. Adequate protection

 

(a) Section 361 does not apply in a case under this chapter.

 

(b) In a case under this chapter, when adequate protection is required under section 362, 363, or 364 of this title of an interest of an entity in property, such adequate protection may be provided by—

 

(1) requiring the trustee to make a cash payment or periodic cash payments to such entity, to the ex­tent that the stay under section 362 of this title, use, sale, or lease under section 363 of this title, or any grant of a lien under section 364 of this title results in a decrease in the value of property securing a claim or of an entity’s ownership interest in property;

 

(2) providing to such entity an additional or replacement lien to the extent that such stay, use, sale, lease, or grant results in a decrease in the value of property securing a claim or of an entity’s owner­ship interest in property;

 

(3) paying to such entity for the use of farmland the reasonable rent customary in the community where the property is located, based upon the rental value, net income, and earning capacity of the property;  or

 

(4) granting such other relief, other than entitling such entity to compensation allowable under section 503(b)(1) of this title as an administrative expense, as will adequately protect the value of property se­curing a claim or of such entity’s ownership interest in property.

 

(Added Pub.L. 99-554, Title II, § 255, Oct. 27, 1986, 100 Stat. 3107.)

 

REPEAL OF SECTION AND SAVINGS PROVISIONS

 

< Pub.L. 99-554, Title III, § 302(f), Oct. 27, 1986, 100 Stat. 3124, repealed this section on Oct. 1, 1993, and all cases commenced or pending under chapter 12 of title 11, United States Code, and all matters and proceedings in or relating to such cases, shall be conducted and determined under such chapter as if such chapter had not been repealed, and substantive rights of parties in connection with such cases, matters, and proceedings shall continue to be governed under the laws applicable to such cases, mat­ters, and proceedings as if such chapter had not been repealed. >

 

 

 

Teaching Suggestions

 

1. Students might be reminded that the bankruptcy laws offer relief not only to the debtor who has ex­pended too much credit, but also to the creditor who has extended too much credit.

 

2. When discussing the differences and similarities between the Bankruptcy Code’s different chap­ters, ask students which chapter a creditor would probably prefer that an individual debtor use.  (Most creditors would probably prefer Chapter 13.)

 

3. It could be explained that federal exemptions tend to be more generous than most states’ exemp­tions and that that is why creditors have urged many states to disallow use of federal exemptions by debtors resid­ing within their borders.  As an additional assignment, students could be asked to re­search their state’s ex­emp­tions and compare them to the federal exemptions.  Hypotheticals could be worked through to compare the ex­emption schemes’ advantages to debtors and creditors.  Ask stu­dents what type of debtor and what type of creditor would find each scheme more favorable.

 

4. One way to outline the trustee’s powers for students is to note that the Bankruptcy Code gives a trustee general and specific powers. The general pow­ers inhere in the trustee’s position, which is equivalent in rights to that of certain other parties. A trustee has the same rights as a lien creditor who could have levied execution on the debtor’s property, for instance—that is, a trustee has priority over an unperfected secured party. A trustee also has power equivalent to that of a bona fide purchaser of real property from the debtor. A trustee has specific powers to set aside a transfer of the debtor’s property. These powers include any voidable rights and the power to avoid preferences, certain statu­tory liens, and fraudulent transfers.

 

5. One detail of the Bankruptcy Code that often interests students is the status of student loans.  Stu­dent loans that are not dischargeable under Chapter 7 include certain loans that have been due less than five years after the first installment payment came due.  The five-year period does not in­clude temporary suspensions of payments.  Ask students to imagine that Art borrows $5,000 in September 2001 to fin­ish graduate school.  Art graduates in June 2002.  The first in­stallment payment comes due in December 2002, but Art has not found a job and obtains a one-time six-month suspension of pay­ments.  In June 2009, Art files a petition to declare bankruptcy under Chapter 7.  If repaying the loan would constitute undue hardship, is Art’s loan dischargeable?  The limitation on dischargeability of student loans that have been due less than five years after the first installment came due would not af­fect the dischargeability of Art’s loan, because its first installment came due more than five years be­fore Art filed the bankruptcy petition.

 

Cyberlaw Link

 

   What role might the Internet play in the context of bankruptcy proceedings?

 

 

 

Discussion Questions

 

1.    Who can use Chapter 7?  Any debtor, defined as any “person,” including individuals, partnerships, and corpora­tions (but not railroads, insurance companies, banks, savings and loan associations, and credit unions, to which other chap­ters of the Code or other federal or state statutes apply), can use Chapter 7.  A debtor does not have to be in­solvent; anyone liable to a creditor can file.

 

2.    What powers does a trustee have?  A trustee has general and specific powers.  The gen­eral powers in­here in the trustee’s position, which is equivalent in rights to that of certain other parties (for ex­ample, a lien creditor who could have levied execution on the debtor’s property—that is, a trustee generally has priority over an unperfected secured party).  A trustee can require persons holding a debtor’s property when a petition is filed to give the property to the trustee.  A trustee has specific powers of avoidance. These powers in­clude: (1) any voidable rights (fraud, duress, incapacity, mutual mis­take) that a debtor can use to ob­tain return of the debtor’s property; (2) the power to avoid preferences (that is, payment or transfer of property to a creditor in preference over others, if the transfer was made within ninety days of the bankruptcy filing by an insolvent debtor—insolvency is presumed for the ninety days—for a preex­isting debt and gave the creditor more than he or she would have received in the bankruptcy proceeding); (3) the power to avoid certain statu­tory liens (liens that first become effective on a debtor’s insolvency and liens that are not perfected or enforce­able against a bona fide purchaser on the date of the petition); and (4) the power to avoid fraudulent transfers made within a year of the filing of the petition or made with intent to hin­der, delay, or defraud a creditor (transfers made for less than reasonably equivalent consideration are vulner­able if by making them the debtor became insolvent, was left in business with a small amount of capital, or in­tended to incur debts that he or she could not pay).

 

3.    How are secured debts handled in a bankruptcy proceeding?  Within thirty days of filing a peti­tion or before the first creditors’ meeting, whichever is first, a consumer-debtor must file with the clerk of court a statement of intent to retain or sur­render secured collateral.  (The trustee is to enforce the statement within forty-five days.)  If the collateral is surrendered, the secured party can accept it in full satisfaction of the debt or foreclose on it and use the pro­ceeds to pay off the debt.  If the value exceeds the debt, the proceeds cover rea­sonable fees and costs incurred because of the debtor’s default.  Any excess is used to satisfy unsecured credi­tors’ claims.  If the collateral’s value is less than the debt, the secured creditor becomes an unsecured creditor for the difference.

 

4.    What is the essential difference between bankruptcy under Chapter 7 and bankruptcy under Chapter 11?  Under Chapter 7, a debtor’s assets are liquidated; under Chapter 11, a debtor’s assets are ad­ministered in the hope of a continuation in business and a return to solvency.  Under Chapter 11, a debtor gen­erally contin­ues in business as a debtor in possession (although the court may appoint a trustee to operate the business if gross mismanagement is shown or if appointing a trustee is otherwise in the estate’s best interest).

 

5.    What consideration must a debtor give to a collective bargaining agreement in a Chapter 11 filing?  A debtor may reject a collective bargaining agreement, if that would successfully rehabilitate the debtor.  Gen­erally, a collective bargaining agreement can be rejected if the debtor proposes necessary contract modifi­ca­tions to the union and makes a good faith attempt to come to an agreement on the modifications, and the un­ion fails to adopt them without good cause.

 

6.    Who is eligible for relief under Chapter 13?  Individuals (not partnerships or corporations) with regu­lar income who owe fixed unsecured debts of less than $100,000 or fixed secured debts of less than $350,000 may use Chapter 13.  Can a Chapter 13 proceeding be initiated by involuntary petition?  No.  Only a debtor can initiate a Chapter 13 case, although certain Chapter 7 and Chapter 11 cases may be con­verted to Chapter 13 cases with a debtor’s consent.  Do the automatic stay rules apply in Chapter 13 cases?  The automatic stay rules applies in Chapter 13 cases to consumer debts but not business debts.  The stay is automatically vacated to allow recovery from a co-debtor, twenty days after a request that it be vacated, unless written objection is filed.

 

7.    Who is eligible for relief under Chapter 12?  Family farmers are eligible for relief under Chapter 12—a family farmer is one whose gross income is at least 50 percent farm-dependent and whose debts are at least 80 percent farm-related (total debt must not exceed $1,500,000).  A partnership or close corporation, at least 50 percent owned by a farm family, also qualifies.  A farmer who files under Chapter 11 or 13 can convert to Chapter 12.  A farmer who files under Chapter 12 can convert to Chapter 7.  How is the value of a secured creditor’s collateral protected under Chapter 12?  A secured creditor can petition to lift the automatic stay for adequate protection of his or her interest if the value of the collateral is less than the amount of the secured debt.  Typically, the collateral is farmland.  Chapter 12 provides for the payment of reasonable market rental payments to creditors to protect the value of the land and the operation of the farm as a going concern.

 

 

Activity and Research Assignments

 

1.    Ask students to imagine that they are filing for bankruptcy.  Have them make a list of their assets and a list of their debts, and determine which assets they could choose to exempt.  From a financial point of view, does declaring bankruptcy appear to be a favorable alternative for them at this time?  (The bankruptcy court in your district may be able to provide copies of the forms that the court uses in bankruptcy filings, and the stu­dents could be asked to fill them out.)

 

2.    If the bankruptcy court in your district is in nearby, tell students to visit the court to see for themselves persons and businesses involved in local filings.  If the court is not nearby, perhaps a local trustee or someone from the trustee’s office could visit the class and discuss bankruptcy procedures and current local rules in the community.

 

 

Explanations of Selected Footnotes in the Text

 

      Footnote 4: The definition of farmer that applies under Chapter 7 differs from the definition of family farmer that applies under Chapter 12.  In fact, the Bankruptcy Code distinguishes between farmer, family farmer, and family farmer with regular annual income, using the different definitions for different purposes.  As noted in the text, a farmer is an individual (or corporation or partnership under certain con­ditions) who received more than 80 percent of his gross income in the preceding taxable year from farming operations, and a family farmer is an individual (or an individual and spouse or a corporation or partnership, subject to cer­tain qualifications) who (or who and whose spouse) received more than 50 percent of his (or their) gross in­come in the preceding taxable year from farming operations, subject to certain debt and ownership restric­tions.  A family farmer with regular annual income is a family farmer whose annual income is suffi­ciently stable to enable him to make payments under a Chapter 12 plan.

 

      Footnote 14: Under 11 U.S.C. Section 1112(b), a court may, after no­tice and a hearing, dismiss a case under Chapter 11 “for cause.”  The statute lists various circumstances that may constitute “cause,” although the “list is not exhaustive.  The court will be able to consider other factors as they arise, and to use its equitable powers to reach an appropriate result in individual cases.”  [See House Report No. 95-595, 95th Cong., 1st Sess. 405 (1977) and Senate Report No. 95-989, 95th Cong., 2d Sess. 117 (1978).]  The following is the text of 11 U.S.C. Section 1112(b).

 

 

TITLE 11.  BANKRUPTCY

CHAPTER 11—REORGANIZATION

SUBCHAPTER I—OFFICERS AND ADMINISTRATION

 

§ 1112. Conversion or dismissal

 

*  *  *  *

 

(b) Except as provided in subsection (c) of this section, on request of a party in interest or the United States trustee, and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title or may dismiss a case under this chapter, whichever is in the best in­terest of creditors and the estate, for cause, including—

 

(1) continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilita­tion;

 

(2) inability to effectuate a plan;

 

(3) unreasonable delay by the debtor that is prejudicial to creditors;

 

(4) failure to propose a plan under section 1121 of this title within any time fixed by the court;

 

(5) denial of confirmation of every proposed plan and denial of a request made for additional time for fil­ing another plan or a modification of a plan;

 

(6) revocation of an order of confirmation under section 1144 of this title, and denial of confirmation of another plan or a modified plan under section 1129 of this title;

 

(7) inability to effectuate substantial consummation of a confirmed plan;

 

(8) material default by the debtor with respect to a confirmed plan;

 

(9) termination of a plan by reason of the occurrence of a condition specified in the plan;  or

 

(10) nonpayment of any fees or charges required under chapter 123 of title 28.

 

 

 

Answers to Essay Questions in

Study Guide to Accompany West’s Business Law, Ninth Edition

By Hollowell & Miller

 

1.    Compare Chapters 7, 11, 12, and 13, discussing, for each chapter, the purpose or function, who is eli­gible for relief , whether proceedings can be initiated voluntarily or involuntarily, proce­dures leading to dis­charge, and the advantages.  Purpose.  The purpose of Chapter 7 is liquidation, the purpose of Chapter 11 is reorganization, and the purpose of Chapters 12 and 13 is adjustment.  Who Is Eligible for Relief.  Under Chap­ter 7, any “person” (including partnerships and corporations) except railroads, insurance companies, banks, savings and loan institutions, and credit unions is eligible for relief.  Under Chapter 11, any debtor el­igible under Chapter 7 and railroads are eligible for relief.  Under Chapter 12, any family farmer whose gross in­come is at least 50 percent farm-dependent and whose debts are at least 80 percent farm-related or any part­nership or close corporation at least 50 percent owned by a farm family, when total debt does not exceed $1.5 million, is eligible for relief.  Under Chapter 13, any individual (not a partnership or corporation) with regu­lar income who owes fixed unsecured debt of less than $100,000 or secured debt of less than $350,000 is eligi­ble for relief.  Who Can Petition.  Proceedings may be initiated voluntarily by a debtor or involuntarily by credi­tors un­der Chapters 7 and 11, except that farmers and charitable institutions cannot be involuntarily peti­tioned.  Proceedings can only be initiated voluntarily under Chapters 12 and 13.  Procedures Leading to Discharge.  Under Chapter 7, nonexempt property is sold with proceeds distributed in a certain priority to classes of credi­tors; dischargeable debts are terminated.  Under Chapter 11, a plan for reorganization is sub­mitted, and if it is approved and followed, debts are discharged.  Under Chapters 12 and 13, a plan is submit­ted, and if it is ap­proved—it must be approved if the debtor turns over all disposable income for a three-year period—and fol­lowed, debts are discharged.  Advantages.  The advantages of Chapter 7 include the discharge of most debts and the debtor’s consequent opportunity for a fresh start.  The advantages of Chapter 11 include the debtor’s continuation in business under a plan that allows for reorganization and liquidation of debts.  The advantages of Chapters 12 and 13 include the debtor’s continuation in business and the discharge of most debts.

 

2.    How are secured creditors protected from losing the value of their security as a result of an automatic stay?  A secured creditor may peti­tion for relief from the automatic stay in certain circumstances.  Secured creditors are protected from losing the value of their security by the adequate protection rules.  Under these rules, a court can require a debtor or trustee to make payments, or provide additional collateral or replace­ment liens to cover a decrease in value, or a court may grant other relief, such as a guaranty by a third party to cover losses.  In a Chapter 12 case, a se­cured creditor can petition to lift the stay for adequate protection of his or her interest if the value of the collat­eral is less than the amount of the secured debt.  Typically, in a Chapter 12 case, the col­lateral is farmland.  Chapter 12 provides for the payment of reasonable market rental payments to creditors to protect the value of the land and the operation of the farm as a going concern.  Gen­erally, the amount of rea­sonable market rental value has been based on the gross rental value of the farm­land and its income potential, considering crop re­quirements, government payments, and so on.