Bankruptcy
Frost
Fall 2012
I. Debt Collection Outside of Bankruptcy
A. The concept of leverage and collection outside of court
1. Leverage is an extremely important concept. It basically means using your legal position to gain a better bargaining position in negotiations.
2. For instance there is “hostage value” – debtors pay high-priority items like their house or their car first because the consequences of losing them are so great. Thus, the threat of collection is a more powerful tool than collection itself.
3. Perhaps the biggest source of leverage is the adverse impact collection proceedings have on a person’s credit ratings. Since that rating is important for access to future credit, the threat of damaging it is an extremely powerful tool.
a) The Fair Credit Reporting Act (FCRA), 15 USCA 1681 et. seq., provides limitations on how much leverage can be attained by placing limits on the procedures for debtors to challenge the accuracy of their credit report.
(1) However, the FCRA doesn’t provide nearly as much protection as it appears because it doesn’t cover in-house debt collection.
(2) Heintz – A lawyer is a “debt collector” for FCRA purposes (so be careful!)
B. State-law debt collection
1. Judgment collection
a) Execution (by a lien creditor) – being a judgment creditor alone gives no interest in the debtor’s property or income; you have to go get a writ of execution and have the sheriff levy (or execute) on a specific piece of the debtor’s property.
(1) Note that in most states, judicial sales are governed by antiquated statutes – returns on the sales are typically quite low. A low price alone won’t invalidate the sale, but it might increase judicial scrutiny for other problems.
(2) A lien can apply to after-acquired real property (Estate of Robbins) (min. rule), but you have to take steps to keep the judgment alive (Weaver).
b) Garnishment – going after an asset of the debtor held by a 3rd party. It creates a “temporal net” that “catches” money placed in an account.
(1) Collection typically requires a writ of garnishment, especially if it’s an intangible, like money in an account (be it bank or payroll).
(2) Courts are generally more lenient with a garnishee who defaults than they are with a defaulting debtor, especially if the garnishee is a natural person. (Webb).
(3) Garnishment of a bank account – the key is that banks have the right to setoff, i.e., to offset any amount owed to them by the debtor before they pay the garnishor (that is, the creditor).
(a) The setoff language must be in the bank’s agreement with the debtor (it’s boilerplate, so every bank has it).
(b) Setoff is in essence a security interest held by the bank; the bankruptcy code explicitly treats it as such.
(c) Problem 5.1: FF gets garnishment writ on WS’s bank account for $3k; he has a ($10) balance. On 2/5, he deposits $5k; on 2/7, SF gets $3.5k judgment and does same; on 2/9 both writs are served.
(i) Bank gets $10 setoff, leaving $4,990 balance. Who gets what depends on the state; either FF wins (if writ date relates back); otherwise, they split pro-rata.
(4) Wage Garnishment
(a) The basic problem with wage garnishment is that the debtor still has to provide food and shelter, etc. for himself – you obviously can’t take every dollar of his paycheck.
(b) 15 USCA § 1671, et seq. sets federal limits (lesser of 25% of disposable income or 30x minimum wage).
(i) This acts as a floor – state law can provide additional protections to the debtor. (Commonwealth Edison)
(ii) Texas doesn’t permit garnishment at all (except for child support).
c) Judgment liens by recordation – some states have a “short-cut” process, typically for real estate only, that permits a creditor to get a lien via a simple filing process.
d) Family debts (alimony, child support) – in many states, the debtor can be imprisoned for failure to pay, and property exemptions often don’t apply.
e) Voluntary liens – secured creditors get a voluntary lien on collateral that permits them to collect via self-help (i.e., repossession).
f) Collection by the federal government – When the federal government is a creditor, it follows the Federal Debt Collection Procedures Act, 28 USCA § 3001 et. seq.
g) Statutory liens/trust funds – state law often provides special rules for certain types of creditors, such as landlords and mechanics.
h) Pre-judgment remedies – there’s a basic tension between due process rights and insuring a remedy. In most states there is a bond requirement, and you have to allege the debtor is a flight risk (or will damage property, etc.). Not important for this course, but very important for real life.
2. State law priorities (covered in more detail in the course on secured credit)
a) General Rule: 1st in time wins (“the race of the diligent”)
b) Unsecured vs. Unsecured – 1st to levy wins; levy date may be deemed to be the date the sheriff is given the writ, depending on the state.
c) Unsecured vs. Secured – 1st to perfect wins. Unsecured perfects by levy; secured perfects by filing.
d) Judgment Lien Creditor/Secured Creditor vs. Buyers – Typically 1st to perfect, but buyers of inventory almost always win regardless of timing.
3. State law exemptions
a) Each state has its own set of exemptions, or property that cannot be reached by a creditor (ex: a homestead exemption prevents seizure of the homestead except for failing to pay the mortgage or taxes)
(1) For example, Texas has very generous exemptions, while Alabama does not.
(2) Most states impose dollar limits to prevent calling all assets as exempt.
b) Note there is a separate exemption regime for federal taxes that actually trumps the state exemptions; you should always pay the IRS!
C. Fraudulent conveyances
1. In order to prevent a debtor from frustrating collection attempts by giving away property , every state has a rule permitting the court to invalidate the improper transfer.
a) “A man must be just before he is generous.”
b) Ex.: a “badge of fraud” is the debtor selling ownership of an asset while retaining possession. Twyne’s Case
2. Most states (39) have adopted the Uniform Fraudulent Transfers Act (UFTA), which governs the invalidation of fraudulent transfers.
a) The UFTA defines “asset” as property of the debtor,” but it doesn’t include exempt property or property encumbered by a lien.
b) A “present” creditor is one whose claim arose before the transfer was made.
c) Transfers fraudulent to present and future creditors (UFTA § 4)
(1) Transfers made with actual fraud (i.e., intent to defraud) (UFTA § 4(a)(1))
(a) UFTA § 4(b) lists “badges of fraud” to consider in determining intent, including if the transferee was an insider, the debtor retaining possession, concealment of ei
value was exchanged (and spiritual fulfillment probably does not fit in UFTA § 3’s definition of “value).
D. Assignments for the Benefit of Creditors (ABC’s) and other remedies
1. A debtor can assign all his nonexempt property to a 3rd party and have his creditors go deal with him; it gets all the creditors off his back.
a) Property is in the custody of the court; trustee acts in much the same way as a bankruptcy TIB.
2. Composition – Creditors all agree to a partial payment in full satisfaction of the debt.
a) This is used in bankruptcy as well, but with important differences – such as the inability in bankruptcy for a creditor to “revive” the debt once the composition has been accepted.
3. Extension – Creditors give debtor more time to pay.
4. Receivership – Similar to how a guardian takes over the property of a minor or incompetent; it is commonly used when the debtor is exempt from bankruptcy protection (such as churches, non-profits, certain insurance companies)
a) There are two types of receivership: regulatory (ex.: SEC takes over a financial institution for breaking regulations) and financial (to protect creditors.)
5. Why use a state alternative to bankruptcy? Procedures can be faster and less expensive; some options are less public (like compositions); full bankruptcy protections aren’t always necessary.
II. Consumer Bankruptcy – Common Elements
A. Deciding what type of bankruptcy to file
1. The first thing a lawyer should do is to determine if there are any conflicts of interests he might have by representing one of the parties to a bankruptcy proceeding.
a) § 327(a) – an attorney must be “disinterested” – meaning no interest at all in the outcome of the case. This is a tough standard to meet.
2. Next, a lawyer should see if a non-bankruptcy proceeding would be better.
3. Finally, a lawyer should consider whether a liquidation (Ch. 7) or a payout (Ch. 13) would be better. Some individuals with large debts not qualifying for Ch. 13 may want to use Ch. 11.
4. Converting to other Chapters
a) You can convert your case from a Ch. 7 to another chapter once. § 706
b) You can convert a Ch. 13 to a Ch. 7 any time. § 1307.
c) You can convert a voluntary Ch. 11 only under certain conditions. § 1112.
5. Involuntary consumer bankruptcies
a) Creditors can force a debtor into Ch. 7 (or 11) if… (§ 303(b))
(1) 12 or more creditors, and 3 or more of those creditors have undisputed, non-contingent, unsecured claims totaling $10k in the aggregate over any lien on the debtor’s property.
(2) Less than 12 creditors, if one or more has an undisputed, non-contingent, unsecured claim totaling $10k in the aggregate over any lien on the debtor’s property.
