Bankruptcy Law Outline
Ruskin, Winter 2017
Chapter One: Background on State Law and Debt Collection
As a general matter, the Bankruptcy Code does not create creditors’ rights; instead, it limits some of those rights, eliminates others, and provides a mechanism to enforce those that remain.
Creditors come to bankruptcy with property rights in the debtor’s assets.
Creditor’s rights are normally based on state law
A creditor and debtor create a security interest (a lien) in the debtor’s personal property through a process called “attachment” which requires: (1) that value has been given (typically from the creditor to the debtor); (2) the debtor has rights in the collateral or the power to transfer right in the collateral to the creditor; and (3) the debtor has authenticated a security agreement that describes the collateral.
Upon attachment, the creditor (secured party) acquires rights in the collateral and has remedies against the collateral that a creditor without a lien does not have.
If you have a secured interest, there is no need to obtain a judgment.
(Ex.) If the debtor defaults in repaying the secured obligation, the secured party may take possession of the collateral and may sell the collateral in an effort to recover the amount owed.
For a security interest to have priority over the rights of others with an interest in the collateral – such as a buyer, another secured party, or a judicial lienholder – the secured party must generally “perfect” the security interest, a process that normally involves providing public notice of the security interest.
The process of perfection varies for different types of collateral
Common methods used to perfect a security interest in the debtor’s goods are: (i) by filing a financing statement; and (ii) if the collateral is a motor vehicle, by applying to the DMV that issued a certificate of title for the vehicle to have the security interest noted on the certificate.
Creditors that have a consensual or nonconsensual lien (secured creditors) in a debtor’s collateral fare better under bankruptcy, for the most part, than creditors with a lien (unsecured creditors).
Unsecured creditors have far fewer rights and options for collecting. Often the unsecured creditor’s only remedy in dealing with uncooperative debtors may be to bring a civil action to obtain a judgment against the debtor.
State Law Debt Collection (Creating a Judicial Lien)
*Judgment creditor can obtain an interest in the debtor’s property through the judicial process.
i. Default occurs
ii. Creditor sues in state court and becomes a judgment creditor
iii. Judgment Creditor can place a lien on assets: garnish wages or repossess property (execution).
Once debtor’s personal property is located
Obtain Writ of Execution: directs sheriff to seize (levy) and sell whatever assets of the debtor it specifies. Used against the debtor’s tangible personal and real property.
Obtain Writ of Garnishment: typically used to collect on intangible assets, particularly obligations owed to the debtor by a third party (such as wages or funds from a deposit account). Writ is served on the employer or back (the garnishee). Writ directs garnishee to pay the obligation either to the creditor or to the court, rather than to the debtor.
a. can only garnish up to 25% of gross earnings.
iv. State law exemptions can make it such that certain property cannot be levied or partly levied on.
Once personal property is levied on or real property becomes subject to a judgment lien, the property can be sold pursuant to a process prescribed by state statute (sometimes at auction) and the proceeds of the sale are used to satisfy the costs of execution and then applied to the judgment debt.
The Judgment Debtor
Some judgment debtors have the ability to exempt (to shield) some of their real and personal property from execution and garnishment, such as “life necessities” such as food up to a certain value or a homestead.
Reasons for exempting certain property:
Exemptions prevent the debtor from becoming impoverished (federal law restricts the amount of a debtor’s wages that may be garnished.
Some of the debtors exempt property may have not meaningful resale value (family photos, used clothes, etc.)
Some property is exempt for spiritual or humanitarian reasons (family bibles, inexpensive wedding rings, etc.)
Prejudgment Writ of Attachment: allow a creditor to go after the debtor’s assets even prior to judgment. Most states permit issuance of these or a prejudgment writ of garnishment in certain circumstances
– Under this process, a creditor may have the sheriff seize the debtor’s assets or may require an obligor to pay to the court the amount owed to the debtor before judgment is rendered against the debtor.
– Generally, only available if the creditor can demonstrate to the court that the debtor is trying to hide assets in anticipation of an adverse judgment.
– State statutes may require that the debtor be provided notice and an opportunity for a hearing prior to issuance of this kind of writ and may require that the creditor post a bond to protect the debtor from damages should judgment not be entered against the debtor.
Additional State Law Processes
Assignment for Benefit of Creditors: where debtor voluntarily turns over all of its property to an assignee. The assignee invites creditors to submit claims against the debtor and uses the assigned property to pay those claims as well as the cost of administration.
Unlike a bankruptcy proceeding, an assignment for benefit of creditors does not result in a discharge of the debtor’s obligations to the extent those obligations are not satisfied.
Receivership: an equitable device courts use to protect creditors with interests in the debtor’s property. Prior to the availability of the federal bankruptcy process, receiverships were often used to keep the debtor’s business operating. Allowed assets to be liquidated in an orderly fashion, rather than in a rushed sale. They allowed for the business to be operated while it reorganized or facilitated a sale of the business.
A reason to use this today is when dealing with real property, to protect the value of the property from depreciation that may result from the debtor’s misuse of the property.
Both are available as a matter of state law today, but have more limited utility given the wide availability of the bankruptcy process.
Chapter Two: Bankruptcy Basics
*Two principal policies underlying current bankruptcy law:
The fresh start (debtor should not be forever indentured by debts, should get to start life over)
Providing for a fair and orderly distribution to creditors
The inherent conflict between the twin goals of bankruptcy – appropriate relief for those in trouble and equitable treatment for their creditors – ensures that it always will be an area of contention.
The Counseling Solution
§109(h) – requires that the individual debtor receive credit counseling “during the 180-day period preceding the date of filing.”
Characters in Bankruptcy Code
i. Debtor – can be an individual, corporation, partnership, or municipality
1. Ch. 7 – cannot be a railroad, insurance company, or bank
2. Ch. 9 – an insolvent municipality, authorized ot be a debtor by state law
3. Ch. 11 – a railroad, or person eligible under Ch. 7
4. Ch. 13 – an individual with regular income, subject to debt limits
Chapter 7 (Liquidation)
Chapter 7 governs “liquidations”
Its purpose is to achieve a fair distribution to creditors of whatever nonexempt property the debtor has and to give the individual a fresh start by discharging the debtor’s obligations to pay the unpaid portion of most debts.
Used both by individuals and businesses.
Commences when the debtor files a petition for bankruptcy relief and pays the filing fee, or when creditors take the procedural initiative to file and involuntary petition (§303).
Filing the petition invokes the Automatic Stay (§362(a)) which is an injunction against virtually all creditor collection activity. The stay’s prohibition on collection efforts frequently provides an immediate benefit to the debtor by preventing, among other things, the commencement or continuation of lawsuits, mortgage foreclosures, garnishments, executions, and repossessions. Meanwhile the creditors are assured that all of the other creditors are similarly enjoined and that an orderly and reasonably fair process will b
ile for bankruptcy protection do so under Chapter 13; almost all the rest do so under Chapter 7.
Payments to creditors are funneled through the standing trustee, and typically the payment plan lasts for 3 years, but may extend to 5 years for cause or if the debtor’s monthly household income exceeds the median monthly income for the same size household in that state §1322(d).
Unless creditors will be paid in full, debtor must transfer all disposable income (besides reasonable and necessary living expenses) to the trustee.
At the end of the payment plan, the debtor receives a discharge of most unpaid debts
Chapter 13 remains attractive for debtors because they can keep their homes and other nonexempt assets.
From a creditor’s standpoint, payment may take a lot longer in Chapter 13 than in Chapter 7.
To be eligible for Chapter 13 relief, debtor must generally have unsecured debts totaling less than $383,175 and secured debts less than $1,149,525 (§109(e)). A debtor whose debts exceed either or both of these limits may be limited to relief under Chapter 11.
Chapter 11 (Reorganization)
Used most often by those engaged in business, whether doing so as an individual or through a partnership, LLC, or corporation.
Applies to corporations whose shares are publicly traded as well as to those whose stock is closely held.
It is also available to individuals without a business and may be desirable to those who have too much debt to be eligible for Chapter 13.
Reorganizations allow a floundering business the chance to stay afloat and thus remain a contributing part of the economy and a source of employment.
To make reorganization attractive to debtors, debtors in Chapter 11 are empowered to remain in control of their financial affairs as a “debtor in possession,” rather than have a trustee come in and take over.
Debtor has exclusive right to file a “plan of reorganization” – their blueprint for dealing with their financial affairs and for paying their creditors – for the first 120 days after the filing §1121(b).
Plan will typically organize creditors into groups – called “classes” – and detail how the creditors in each class will be paid.
The creditors are then entitled to vote on the plan. Unless a majority of the voting claimants in each class, and two-thirds of the amount of the voted claims in each class, approve the plan, the plan will generally not be confirmed.
There is a process in Chapter 11 whereby a debtor can use to confirm – or “cram down” – a plan despite the existence of one or more dissenting classes (§1129(b)).
One other notable requirement is that each claimant must either accept the plan or be paid, in present value terms, at least the amount the creditor would have recovered in Chapter 7 (§1129(a)(7)).
If the plan complies with the Code’s requirements, and if the court determines it is feasible, it is “confirmed” and put into effect. The remainder of the debtor’s obligations are discharged §1141.
The debtor is given a fresh start through the binding effect on all concerned of a confirmed plan of reorganization.
The debtor’s business is frequently losing money – sometimes hemorrhaging – during the bankruptcy process, and if the parties fail to reach prompt agreement on a plan of reorganization, they may find themselves with little left to divvy up. When this happens, the debtor may simply dismiss the case or, more likely, convert the case to a Chapter 7 liquidation.