Bankruptcy Spring 2016 Professor Brown
I. Introduction to Bankruptcy
Back to the 1700s, bankruptcy was a criminal act. Victim had to petition for debtor to be declared a bankrupt.
Bankrupt’s were moral, business failures and were viewed as bad people. You were placed into debtor’s prison. In some jurisdictions this could extend to your family.
Failed system because the debtors were forced to pay for their habitation while jailed. Also had to pay for food.
Bankruptcy Act of 1800 no longer had to have someone file you as bankrupt, more friendly creditors could file.
1920’s no longer legal to send someone to debtors prison for being bankrupt, could finally declare yourself bankrupt.
The “honest but unfortunate debtor”: Creditors realized they could very quickly become creditors themselves. Why? When creditors cant get money from debtors, they run into their own debt problems.
This created a dramatic shift in attitude (moral component), by the 19th century, people realized sometime bankruptcy just happens to people even if they’re careful.
Today, balances the interest of ALL the parties in interest (all parties who have something at stake).
Different Types of Bankruptcy (p.14)-
Chapter 7 (liquidation)- classic type, all of the debtors assets are marshaled by one party who represents the estate (trustee). All of the assets are then sold, converted to cash, and the creditors are paid. This gives different avenues for getting possession of debtor’s assets, different ways to liquidate and different ways to distribute assets among creditors.
Chapter 11/13 (payment plans)- reorganization, the debtor keeps all of his assets. It isn’t essential that they have to sell the assets. The debtor proposes a plan, where they pay back their debts over a period of time. Not selling off their assets, so either borrow money to give to creditors and pay back the bank (this is Chap 11, usually corporate). Versus Chapter 13 (individual), establish certain amount to come in from debtor every month, pay to trustee and allocates payments to creditors according to the plaintiff (repayment approach).
Advantages to Creditor- debtor is encouraged to work hard and get an income, so more likely to be paid more towards debts. Under Ch11, businesses can keep operating while paying their debts.
Important to protect creditors from each other, of those who try to gain an unfair advantage in the bankruptcy process. If follow an orderly fashion, then can increase the value of the debtor and they will be able to make bigger payments to the creditors (all the creditors will maximize the group and individual recovery).
Process in bankruptcy is designed to be transparent, people are held accountable.
Have access to great amount of information, have broad participation rights in a case on any issue that affects their interests. Significant controls in place on debtor, which ensure the creditors will be paid.
Creditors also have a voice in the proposed plan, and under CH11 can even vote on the proposed plan.
Advantages to Debtor- get to keep possessions (ie home), fresh start, orderly process of payment plan (business can just walk away from it or individual can also walk away after filing). Chapter 11 business emerges fresh with vibrant business.
Why are debtors given an advantage? Learn from their mistakes and not repeat, this will benefit society as a whole. Give some advantages so debtors are more honest in i.e. disclosing their assets (give something to look forward to).
In either situation, two objectives include: (1) Fresh Start and (2) Collection. Both of the above approaches have adv/dis to creditor and debtor.
Tragedy of the Commons problem (like bankruptcy)- eventually this common resource is completely depleted. Generally, to deal with this problem, set rules, structure so no one ever uses too much that its depleted. Or, need someone to police it. Similar to filing bankruptcy, filing because there isn’t enough of a persons resources to meet everyone’s demands. Often individual creditors may try to protect themselves and end up hurting the entire creditor group.
Steps in Bankruptcy:
Filing- can file themselves, or a group of creditors can file. These filings are subject to considerations of good faith, sanctions etc. Usually people are pretty good about filing.
An estate is created for all of the debtors assets, consists of all the property interest of the debtor at the commencement of the bankruptcy. Look at what happened at the moment of the filing, happens after come after as property of the estate.
Have to divulge assets before the filing, to help with recovery for the benefit of the estate.
Restrictions on property becoming under trustee (under Chapter 11), also restrictions on what the trustee can do with the property. Trustee’s job is to protect the VALUE of the debtor assets. Trustee can even be held liable if take advantage of the property.
Also restrictions on different creditors ability to sue the debtor (i.e. cant have too many suits at one time). Without this, the debtor would have no chance. How is litigation stopped? “Automatic Stay”, means an injunction becomes active against the continuation of various actions that would change that snapshot of the debtor at the time of filing.
Debtors and creditors have clear rights and procedures to follow during a bankruptcy proceeding. Have to do everything with honesty, reasonableness, etc.
Court approval is required for most actions involving assets of the estate.
The US Trustee is the supervisor of all of this, watches over the cases, specifically certain duties within a case. Also make calls on lawyer fees. In charge of maintaining the panel of trustees.
This is different than the Trustee, who is an individual appointed in a Chap 7 or Chap 13 case to administer the estate.
Some cases also involve an independent examiner, appointed for a specific issue. Job is to investigate/report back.
Step 1: Always, look to the language of the relevant section of the bankruptcy code.
Step 2: Look to relevant case law. Reference to non-bankruptcy law may also be important. Can usually find a case that is similar on some level.
-If no clear answer, come back to common law and policy. Often less about the law then the appearances.
II. The Beginning of a Case
-Bankruptcy code derived from state law, want to make sure the court is interpreting law that is still good.
-Power of the Court §105(a) Gap filler, or as recognizing the equitable power of the bankruptcy court to fill gaps in the statute.
(a) The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.
-Cannot use this power to rewrite the code, cant be used to expand the courts subject matter or jurisdiction.
-First three chapters of code apply to personal and business bankruptcies
A. The Bankruptcy Estate and The Automatic Stay
-Chapter 3 of the Bankruptcy Code
-Personal BR filed under Chapter 7 Liquidation (surrender assets and start over) or Chapter 13 Reorganization/Restructuring (keep most and enter into payment plan with creditors)
-Why do we have an automatic stay? Prevent the race to the courthouse, want to centralize the proceedings as much as possible and bring as much of the issues into that court as we can.
Step 1: Commencement of the Case
Debtor files a petition for relief under the bankruptcy code (§ 301), some limited instances creditors can file involuntary petition.
At the point in time the petition is filed, a new legal fiction is created- the Estate.
Estate- provides that an estate is created but tells us what comprises the estate. All legal property of the debtor at commencement of the case, wherever located and by whoever held. (very broad)
(a) “The commencement of a case under section 301, 302, or 303 of this title creates an estate. Such estate is comprise
hrift trusts, but this doesn’t apply here.
Control of the Case
Trustee has control over the estate
Debtor is not free to act as they wish with property of the estate
541 details what is property of the estate, trustee controls this property for the benefit of creditors.
The Automatic Stay- § 362(a) (* important for exam*)
à This is Automatic upon the filing of the petition! Prohibits any creditor from collecting from the debtor or the debtors estate.
Provides for a stay of three types of actions after commencement of the case: (1) actions against the debtor or the debtors property (subsections 1,2,5,6,8 ie exemptions, trustee returning some property because it doesn’t benefit the estate), (2) limits the actions against property of the estate (subsections 2,3,4,7 ie. Cant collect on judgment from debtor, need to wait until BR process is over).
Prohibits any creditors attempts to continue to collect from the debtor or the debtor’s property.
Benefits the debtor because don’t have to worry about losing assets to other creditors, creditors also benefit because debtors know what will be claimed by creditors.
362(a)(1)- issuance of process or judicial proceeding
(a)(2)-judgment obtained before the commencement of the case
(a)(3)- sweeping protections
(a)(4) lien against the property of the estate, cannot exercise state rights as lien holder.
(a)(5) cannot create, enforce a lien against property of the estate.
(a)(6) acts to recover prepetition claims against the debtor (very broad)
Subsection (b) contains some exceptions. Reflects potential for abuse and captures policy judgment and need for stay v. power for abuse.
(b)(2) Domestic obligations, cant use bankruptcy.
(b)(4) obligations ie environmental clean up
Subsection (c) no longer applies when case ends, when property is no longer under the estate, when the case is closed the automatic stay goes away. Also includes approaches for lifting the stay.
Subsection (d), avenues for certain creditors to be able to lift the automatic stay. Secured creditor ie and debtor has property and it is being left out unprotected and its value is at risk. Creditor may be entitled to seize property to protect interest.
(d)(1) can lift the stay for an abuse of the stay process.
(d)(2) applies in reorganization
Subsection (k) willfull violations of the automatic stay, two types of damages. (1) is actual damages where the other party has knowledge of the BR and acts anyways, even if not doing so maliciously, don’t have to know action is violation of the stay, just that there is a CR ongoing (learn of BR because when file, fill out sheet with any potential creditors on). (2) Punitive damages (need to establish maliciousness).
**In the 2nd circuit, 362(k) does NOT apply to corporate bankruptcy filers, only individual filers** (see LTD Steel, 920 F.2d 183)
Corporate filers aren’t out of luck, look to § 105(a) which recognizes the BR court has the inherent powers of the court so can sanction parties for misconduct with actual or punitive damages. But have to prove they had knowledge of BR and acted anyway and acted maliciously or in bad faith.