Business Law Chapter 28

discharge

When discharge is granted, the debtor is relieved of responsibility to pay the discharged debts. In other words, the debtor is no longer legally liable to pay the discharged debts. Discharge is one of the primary reasons a debtor files for bankruptcy. The specifics of discharge under each type of bankruptcy are discussed in this chapter. Certain debts are not dischargeable in bankruptcy. Creditors who have nondischargeable claims against the debtor may participate in the distribution of the bankruptcy estate. The creditor may pursue the nondischarged balance against the debtor after bankruptcy. Debts that are not discharged in bankruptcy

meeting of the creditors (also called the first meeting of the creditors)

Within a reasonable time after the court grants an order for relief (not less than 10 days or more than 30 days) the court must call a meeting of the creditors (also called the first meeting of the creditors). The bankruptcy judge cannot attend the meeting. The debtor must appear and submit to questioning, under oath, by creditors. Creditors may ask questions regarding the debtor's financial affairs, disposition of property prior to bankruptcy, possible concealment of assets, and similar matters. The debtor may have an attorney present at this meeting.

Article I, Section 8, Clause 4 of the U.S. Constitution

, "The Congress shall have the power . . . to establish . . . uniform laws on the subject of bankruptcies throughout the United States." Bankruptcy law is exclusively federal law; there are no state bankruptcy laws. Congress enacted the original federal Bankruptcy Act in 1878.

If personal property of an individual debtor secures a claim or is subject to an unexpired lease (e.g., an automobile lease) and is not exempt property, the debtor must

1) surrender the personal property, (2) redeem the property by paying the secured lien in full, or (3) assume the unexpired lease.

The following debts are not dischargeable in bankruptcy:

1. Interest up to $23,675 in equity in property used as a residence and burial plots (called the "homestead exemption") Interest up to $3,775 in value in one motor vehicle Interest up to $600 per item in household goods and furnishings, wearing apparel, appliances, books, animals, crops, or musical instruments, up to an aggregate value of $12,625 for all items Interest in jewelry up to $1,600 Interest in any property the debtor chooses (including cash) up to $1,250, plus up to $12,625 of any unused portion of the homestead exemption Interest up to $2,375 in value in implements, tools, or professional books used in the debtor's trade Any unmatured life insurance policy owned by the debtor Professionally prescribed health aids Many government benefits, regardless of value, including Social Security benefits, welfare benefits, unemployment compensation, veteran's benefits, disability benefits, and public assistance benefits Certain rights to receive income, including domestic support payments (e.g., alimony, child support), certain pension benefits, profit sharing, and annuity payments Interests in wrongful death benefits and life insurance proceeds to the extent necessary to support the debtor or his or her dependents Personal injury awards up to $23,675 Retirement funds that are in a fund or an account that is exempt from taxation under the Internal Revenue Code, except that an exemption for individual retirement accounts (IRAs) shall not exceed $1,283,025 for an individual unless the interests of justice require this amount to be increased

petition

A bankruptcy case is commenced when a petition is filed with a bankruptcy court.

proof of claim

A creditor must file a proof of claim stating the amount of the claim against the debtor. The document for filing a proof of claim is provided by the court. The proof of claim must be timely filed, which generally means within 6 months of the first meeting of the creditors. A secured creditor whose claim exceeds the value of the collateral may submit a proof of claim and become an unsecured claimant as to the difference. An equity security holder (e.g., a shareholder of a corporation) must file a proof of interest.

reaffirmation agreement

A debtor and a creditor can enter into a reaffirmation agreement, whereby the debtor agrees to pay the creditor for a debt that is dischargeable in bankruptcy ( A reaffirmation agreement must be entered into before discharge is granted and must be filed with the court. Approval by the court is required if the debtor is not represented by an attorney. If the debtor is represented by an attorney, the attorney must certify that the debtor voluntarily entered into the reaffirmation agreement and understands the consequences of the agreement. Even if the debtor is represented by an attorney, court approval is required if the agreement will cause undue hardship on the debtor or his or her family.)

creditors' committee

After an order for relief is granted, the court appoints a creditors' committee composed of representatives of the class of unsecured claims. The court may also appoint a committee of secured creditors and a committee of equity holders. Generally, the parties holding the seven largest creditor claims or equity interests are appointed to their requisite committees. Committees may appear at bankruptcy court hearings, participate in the negotiation of a plan of reorganization, assert objections to proposed plans of reorganization, and the like.

schedules

An individual debtor must submit the following schedules on filing a voluntary petition: a list of secured and unsecured creditors, with addresses; a list of all property owned; a statement of the financial affairs of the debtor; a statement of the debtor's monthly income; current income and expenses; evidence of payments received from employers within 60 days prior to the filing of the petition; and a copy of the debtor's federal income tax return for the most recent year ending prior to the filing of the petition. (In addition, an individual debtor must file a certificate stating that he or she has received the required prepetition credit counseling. All forms must be sworn under oath and signed by the debtor)

Limitations on Who Can File for Chapter 13 Bankruptcy

Bankruptcy law establishes dollar limits on the secured and unsecured debt that a debtor may have in order to qualify to file for Chapter 13 bankruptcy. Only an individual with regular income alone or with a spouse who owes individually or with a spouse (1) noncontingent, liquidated, unsecured debts of not more than $394,725 and (2) secured debts of not more than $1,184,200 may file a petition for Chapter 13 bankruptcy. Individual debtors who exceed these dollar limits do not qualify for Chapter 13 bankruptcy. Sole proprietorships, because they are owned by individuals, may file for Chapter 13 bankruptcy.

attorney certification

Bankruptcy law requires an attorney certification whereby an attorney who represents a client in bankruptcy must certify the accuracy of the information contained in the bankruptcy petition and the schedules, under penalty of perjury. If any factual discrepancies are found, the attorney is subject to monetary fines and sanctions. If an attorney represents a debtor in bankruptcy, the attorney must conduct a thorough investigation of the debtor's financial position and schedules to determine the accuracy of the information contained in the petition and schedules.

postpetition counseling

Before an individual debtor receives a discharge in a Chapter 7 or Chapter 13 bankruptcy the debtor must receive postpetition counseling by attending a personal financial management course approved by the U.S. Trustee. This course is designed to provide the debtor with information on responsible use of credit and personal financial planning.

The following debts are not dischargeable in bankruptcy:

Claims for income or gross receipts taxes owed to federal, state, or local governments accrued within 3 years prior to the filing of the petition for bankruptcy Certain fines and penalties payable to federal, state, and local governmental units Claims based on the debtor's liability for causing willful or malicious injury to a person or property Claims arising from fraud, larceny, or embezzlement by the debtor while acting in a fiduciary capacity Domestic support obligations and alimony, maintenance, and child support payments resulting from a divorce decree or separation agreement Unscheduled claims Claims based on a consumer-debtor's purchase of luxury goods or services of more than $675 from a single creditor on or within 90 days of the order for relief Cash advances of more than $950 obtained by a consumer-debtor by use of a revolving line of credit or credit cards on or within 70 days of the order for relief. Judgments and consent decrees against the debtor for liability incurred because of the debtor's operation of a motor vehicle, a vessel, or an aircraft while legally intoxicated A debt that would result in a benefit to the debtor that outweighs the detrimental consequences to a spouse, former spouse, or child of the debtor An amount owed to a pension, profit-sharing, or stock bonus plan and loans owed to employee retirement plans

U.S. bankruptcy courts

Congress created a system of federal bankruptcy courts. ecessary because the number of bankruptcies would overwhelm the federal district courts. The bankruptcy courts are part of the federal court system, and one bankruptcy court is attached to each of the 94 U.S. district courts in the country. Bankruptcy judges, specialists who hear bankruptcy proceedings, are appointed for 14-year terms. The relevant district court has jurisdiction to hear appeals from bankruptcy courts.

nonexempt property

If a debtor qualifies for a Chapter 7 liquidation bankruptcy, the nonexempt property of the bankruptcy estate must be distributed to the debtor's secured and unsecured creditors pursuant to statutory priority established by the Bankruptcy Code. The claims of secured creditors to the debtor's nonexempt property have priority over the claims of unsecured creditors.

Debtor-in-Possession

In most Chapter 11 cases, the debtor is left in place to operate the business during the reorganization proceeding . The court may appoint a trustee to operate the debtor's business only on a showing of cause, such as fraud, dishonesty, or gross mismanagement of the affairs of the debtor by current management. The debtor-in-possession is empowered to operate the debtor's business during the bankruptcy proceeding. This power includes authority to enter into contracts, purchase supplies, incur debts, and so on. Credit extended by postpetition unsecured creditors in the ordinary course of business is given automatic priority as an administrative expense in bankruptcy.

Chapter 7—Liquidation (also called straight bankruptcy)

In this type of bankruptcy proceeding, the debtor is permitted to keep a substantial portion of his or her assets (exempt assets); the debtor's nonexempt property is sold for cash, and the cash is distributed to the creditors; and any of the debtor's unpaid debts are discharged. The debtor's future income, even if the debtor becomes rich, cannot be reached to pay the discharged debt. Thus, a debtor would be left to start life anew, without the burden of the prepetition debts. (Example Annabelle finds herself overburdened with debt, particularly credit card debt. Assume that Annabelle qualifies for Chapter 7 bankruptcy. When she files for Chapter 7 bankruptcy, her unsecured credit is $100,000. Annabelle has few assets, and most of those are exempt property (e.g., her clothes, some furniture). Her nonexempt property is $10,000, which will be sold to raise cash. The $10,000 in cash will be distributed to her debtors on a pro rata basis—that is, each creditor will receive 10 cents for every dollar of debt owed. The other $90,000 is discharged—that is, the creditors must absorb this loss. Annabelle is free from this debt forever. She is given a fresh start, and her future earnings are hers.)

prepetition counseling

Individuals filing for bankruptcy must receive prepetition counseling within 180 days prior to filing a petition for bankruptcy. This includes counseling on types of credit, the use of credit, and budget analysis. The counseling is to be provided by not-for-profit credit counseling agencies approved by the U.S. Trustee.

abusive homestead exemptions

It provides that a debtor may not exempt an amount greater than $160,375 if the property was acquired by the debtor within 40 months before the filing of the petition for bankruptcy.

Discharge of unsatisfied debts is denied if the debtor:

Made false representations about his or her financial position when obtaining an extension of credit. Transferred, concealed, removed, or destroyed property of the estate with the intent to hinder, delay, or defraud creditors within one year before the date of the filing of the petition. Falsified, destroyed, or concealed records of his or her financial condition. Failed to account for any assets. Failed to submit to questioning at the meeting of the creditors (unless excused). Failed to complete an instructional course concerning personal financial management (unless excused).

As to secured creditors, the following two situations can result:

Oversecured secured creditor. (If the value of the collateral securing the secured loan exceeds the secured interest, the secured creditor is an oversecured creditor. In this case, the property is usually sold, and the secured creditor is paid the amount of its secured interest (i.e., principal and accrued principal and interest) and reasonable fees and costs resulting from the debtor's default. The excess becomes available to satisfy the claims of the debtor's unsecured creditors). Undersecured secured creditor. ( If the value of the collateral securing the secured loan is less than the secured interest, the secured creditor is an undersecured creditor. In this case, the property is usually awarded to the secured creditor. The secured creditor then becomes an unsecured creditor as to the amount still owed to it, which consists of unpaid principal and interest and reasonable fees and costs of the debtor's default.)

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.2

Subsequently, credit card companies, commercial banks, and other businesses lobbied Congress to pass a new bankruptcy act that would reduce the ability of some debtors to relieve themselves of unwanted debt through bankruptcy. In response, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.2 The 2005 act substantially amended federal bankruptcy law, making it much more difficult for debtors to escape unwanted debt through bankruptcy.

Qualifications for Chapter 7 Bankruptcy

Test 1: Median Income Test. ( The first step in determining whether a debtor qualifies for Chapter 7 relief is to apply the median income test. A state's median income is defined as that income where half of the state's families of a specified size have incomes above that figure and half of the state's families of that size have incomes below that figure. The median income for a family of two will differ from the median income for a family of 3 and so on.) If a family has median family income equal to or below the state's median family income for the size of the debtor's family, the debtor qualifies for Chapter 7 bankruptcy. (The debtor may proceed with the Chapter 7 case and be granted discharge of unsecured debts. Thus, for debtors at or below the state median income, the 2005 act makes no changes in the ability to obtain Chapter 7 relief.) (Example Assume that a state's median income for a family of four is $75,000. If the median income of the debtor's family of four is $60,000, the debtor qualifies for Chapter 7 bankruptcy relief.) (If a family has median family income that is higher than the state's median family income for the size of the debtor's family, the debtor does not automatically qualify for a Chapter 7 bankruptcy. A second test, the means test, is applied to see if the debtor qualifies for Chapter 7 bankruptcy.) Test 2: Means Test. (The means test is a calculation that establishes a bright-line test to determine whether the debtor has sufficient disposable income to pay prepetition debts out of postpetition income. Disposable income is determined by taking the debtor's actual income and subtracting expenses for a typical family the same size as the debtor's family. Income is the actual income of the debtor. However, expenses are determined by using preestablished government tables and not the actual expenses of the family. A complicated formula is used to calculate the debtor's disposable income and thus determine whether the debtor qualifies for Chapter 7 bankruptcy.) If, because of the application of the means test, a debtor is determined to have a sufficient disposable income as determined by bankruptcy law, the debtor does not qualify for Chapter 7 bankruptcy. The petition for Chapter 7 bankruptcy will be denied by the bankruptcy court. Usually, these debtors will file for Chapter 13 bankruptcy (discussed later in this chapter). (If, however, using the means test calculation a debtor is determined to have an insufficient amount of disposable income as determined by bankruptcy law, the debtor qualifies for Chapter 7 bankruptcy. These debtors may be granted Chapter 7 discharge of debts. Thus, some of the debtors that have income above the state's median income for the debtor's size of family will qualify for Chapter 7, and some will not.)

Bankruptcy Reform Act of 1978.

The 1978 act made it easier for debtors to rid themselves of unsecured debt, primarily by filing for Chapter 7 liquidation bankruptcy.

. Small business bankruptcy

The Bankruptcy Code permits a "small business," defined as one with total debts of less than $2,566,050, to use a simplified, fast-track form of Chapter 11 reorganization bankruptcy. Small business bankruptcy provides an efficient and cost-saving method for small businesses to reorganize under Chapter 11.

State Exemptions

The Bankruptcy Code permits states to enact their own exemptions. States that do so may (1) give debtors the option of choosing between federal and state exemptions or (2) require debtors to follow state law. The exemptions available under state law are often more liberal than those provided by federal law.

(Case 28.2 U.S. SUPREME COURT CASE Bankruptcy Fraud) Husky International Electronics, Inc. v. Ritz

The U.S. Supreme Court held that the Bankruptcy Code exempted from discharge false misrepresentation schemes. The Supreme Court reversed the decision of the court of appeals and remanded the case for final disposition.

(Case 28.1 FEDERAL COURT CASE Bankruptcy Discharge) Speedsportz v. Lieben

The U.S. bankruptcy court held that Lieben had committed fraud and embezzlement and was liable to Speedsportz for $49,232. The bankruptcy court ruled that this amount owed to Speedsportz could not be discharged in Lieben's bankruptcy.

fraudulent transfers

The bankruptcy court may void certain fraudulent transfers of a debtor's property made by the debtor within 2 years prior to filing a petition for bankruptcy. To void a transfer or an obligation, the court must find that (1) the transfer was made or the obligation was incurred by the debtor with the actual intent to hinder, delay, or defraud a creditor or (2) the debtor received less than a reasonable equivalent in value. (Example Kathy owes her unsecured creditors $100,000. On February 9, Kathy knows that she is insolvent. Kathy owns a Mercedes-Benz automobile that is worth $55,000. On February 9, Kathy sells her Mercedes-Benz automobile to her friend, Wei, for $30,000. Wei is a bona fide purchaser who does not know of Kathy's financial situation. On July 1, Kathy files for Chapter 7 liquidation bankruptcy while still owing the $100,000 to her unsecured creditors. The court can void Kathy's sale of her automobile to Wei as a fraudulent transfer because it occurred within 2 years of the petition and Kathy received less than a reasonable equivalent in value. Because Wei was a bona fide purchaser, the court must repay Wei the purchase price of $30,000 to recover the automobile from her.)

Confirmation of a Chapter 13 Plan of Payment

The court can confirm a Chapter 13 plan of payment if the prior requirements are met and if (1) the plan was proposed in good faith, (2) the plan passes the feasibility test (e.g., the debtor must be able to make the proposed payments), (3) the plan is in the best interests of the creditors (i.e., the present value of the payments must equal or exceed the amount that the creditors would receive in a Chapter 7 liquidation proceeding), (4) the debtor has paid all domestic support obligations owed, and (5) the debtor has filed all applicable federal, state, and local tax returns. (The debtor must begin making the planned installment payments to the trustee in equal monthly installments. The trustee is responsible for remitting these payments to the creditors. The trustee is paid for administering the plan.)

Chapter 13 Discharge

The court grants an order discharging the debtor from all unpaid unsecured debts covered by the plan after all the payments required under the plan are completed (which could be up to 3 years or up to 5 years). This is called a Chapter 13 discharge. The debtor must certify that all domestic support payments have been paid before discharge is granted. Most unpaid taxes are not discharged. A debtor cannot be granted Chapter 13 discharge if the debtor has received discharge under Chapter 7, 11, or 12 within the prior 4-year period or Chapter 13 relief within the prior 2-year period of the order for relief in the current Chapter 13 case.

Chapter 11 Plan of Reorganization

The debtor has the exclusive right to file a Chapter 11 plan of reorganization with the bankruptcy court within the first 120 days after the date of the order for relief. This period may be extended up to 18 months. The debtor has the right to obtain creditor approval of the plan, but if the debtor fails to do so, any party of interest (e.g., a trustee, a creditor, an equity holder) may propose a plan. The plan of reorganization sets forth the proposed new financial structure of the debtor (. This includes the portion of the unsecured debts proposed to be paid by the debtor and the unsecured debt the debtor proposes to have discharged. The plan must specify the executory contracts and unexpired leases that the debtor proposes to reject that have not previously been rejected in the bankruptcy proceeding. The plan also designates how equity holders are to be treated, describes any new equity investments that are to be made in the debtor, and includes other relevant information.) (The debtor must supply the creditors and equity holders with a disclosure statement that contains adequate information about the proposed plan of reorganization so that they can make an informed judgment about the plan.)

statutory priority of unsecured claims

Unsecured claims are to be satisfied out of the bankruptcy estate in the order of their statutory priority, as established by the Bankruptcy Code.

homestead exemption

The federal Bankruptcy Code permits homeowners to claim a homestead exemption of $23,675 in their principal residence. If the debtor's equity in the property (i.e., the value above the amount of mortgages and liens) exceeds the exemption limits, the trustee may sell the property to realize the excess value for the bankruptcy estate. (Example Assume that a debtor owns a principal residence worth $500,000 that is subject to a $400,000 mortgage and the debtor therefore owns $100,000 of equity in the property. The debtor files a petition for Chapter 7 liquidation bankruptcy. The trustee may sell the home, pay off the mortgage, pay the debtor $23,675 (applying the federal exemption), and use the remaining proceeds of $76,325 for distribution to the debtor's creditors.)

Automatic Stay in Chapter 11

The filing of a Chapter 11 petition stays (suspends) actions by creditors to recover the debtor's property. This automatic stay suspends certain legal actions against the debtor or the debtor's property, including the ability of creditors to foreclose on assets given as collateral for their loans to the debtor. This automatic stay is extremely important to a business trying to reorganize under Chapter 11 because the debtor needs to keep its assets to stay in business. (Example Big Oil Company owns a manufacturing plant and has borrowed $50 million from a bank, using the plant as collateral for the loan. If Big Oil Company files for Chapter 11 bankruptcy, the automatic stay prevents the bank from foreclosing and taking the property. Once out of bankruptcy, Big Oil Company must pay the bank any unpaid arrearages and begin making the required loan payments again.)

automatic stay

The filing of a voluntary or an involuntary petition automatically stays—that is, suspends—certain legal actions by creditors against the debtor or the debtor's property applies to collection efforts of secured and unsecured creditors, is designed to prevent a scramble for the debtor's assets in a variety of court proceedings (Instituting or maintaining legal actions to collect prepetition debts Enforcing judgments obtained against the debtor Obtaining, perfecting, or enforcing liens against the property of the debtor Nonjudicial collection efforts, such as self-help activities (e.g., repossession of an automobile)) (Actions to recover domestic support obligations (e.g., alimony, child support), the dissolution of a marriage, and child custody cases are not stayed in bankruptcy. Criminal actions against the debtor are also not stayed.)

order for relief

The filing of either a voluntary petition or an unchallenged involuntary petition constitutes an order for relief. If the debtor challenges an involuntary petition, a trial is held to determine whether an order for relief should be granted. If an order is granted, the case is accepted for further bankruptcy proceedings. In the case of an involuntary petition, the debtor must file the same schedules filed by voluntary petition debtors.

fresh start.

The goal of bankruptcy laws is to balance the rights of debtors and creditors and provide methods for debtors to be relieved of some debt to obtain a fresh start

Property of a Chapter 13 Estate

The property of a Chapter 13 estate consists of all nonexempt property of the debtor at the commencement of the case and nonexempt property acquired after the commencement of the case but before the case is closed. In addition, the property of the estate includes earnings and future income earned by the debtor after the commencement of the case but before the case is closed. This ensures that prepetition creditors receive payments from the debtor's postpetition earnings and income. (The debtor remains in possession of all of the property of the estate during the completion of the plan except as otherwise provided by the plan. If the debtor is self-employed, the debtor may continue to operate the business. Alternatively, the court may order that a trustee operate the business, if necessary.)

Bankruptcy Code,

Title 11 of the U.S. Code. The Bankruptcy Code establishes procedures for filing for bankruptcy, resolving creditors' claims, and protecting debtors' rights.

Voluntary petition

a petition filed by the debtor. A voluntary petition can be filed by the debtor in Chapter 7 (liquidation), Chapter 11 (reorganization), Chapter 12 (family farmer or fisherman), and Chapter 13 (adjustment of debts) bankruptcy cases. The petition has to state that the debtor has debts.

Chapter 13—Adjustment of Debts of an Individual with Regular Income

a rehabilitation form of bankruptcy for individuals The debtor has several advantages under Chapter 13. These include avoiding the stigma of Chapter 7 liquidation, retaining more property than is exempt under Chapter 7, and incurring fewer expenses than in a Chapter 7 proceeding. The creditors have advantages, too: They may recover a greater percentage of the debts owed them than they would recover under a Chapter 7 bankruptcy. are usually filed by individual debtors who do not qualify for Chapter 7 liquidation bankruptcy and by homeowners who want to protect nonexempt equity in their residence. Chapter 13 enables debtors to catch up on secured credit loans, such as home mortgages, and avoid repossession and foreclosure.

Executory Contracts and Unexpired Leases in Chapter 11

contracts or leases that have not been fully performed. (A major benefit of Chapter 11 bankruptcy is that the debtor is given the opportunity to accept or reject certain executory contracts and unexpired leases.) (A contract to purchase goods or supply goods at a later date is an executory contract. A 20-year office lease that has 8 years left until it is completed is an unexpired lease. Other executory contracts and unexpired leases may include consulting contracts, contracts to purchase or provide services, equipment leases, warehouse leases, automobile and equipment leases, leases for office and commercial space, and the like) (Under the Bankruptcy Code, a debtor-in-possession (or trustee) in a Chapter 11 proceeding is given authority to assume or reject executory contracts. In general, the debtor rejects unfavorable executory contracts and assumes favorable executory contracts. The debtor is not liable for damages caused by the rejection of executory contracts and unexpired leases in bankruptcy.) (Examples Big Oil Company enters into a contract to sell oil to another company, and the contract has 2 years remaining when the oil company files for Chapter 11 bankruptcy. This is an executory contract. Big Oil Company has leased an office building for 20 years from a landlord to use as its headquarters, and it has 15 years left on the lease when it declares bankruptcy. This is an unexpired lease. In the Chapter 11 reorganization proceeding, Big Oil Company can reject (get out of) either the executory contract or the unexpired lease without any liability; it can keep either one if doing so is in its best interests.)

bankruptcy estate

created on the commencement of a bankruptcy case. It includes all the debtor's legal and equitable interests in real, personal, tangible, and intangible property, wherever located, that exist when the petition is filed, and all interests of the debtor and the debtor's spouse in community property. Certain exempt property (as discussed later in this section) is not part of the bankruptcy estate. (Gifts, inheritances, life insurance proceeds, and property from divorce settlements that the debtor is entitled to receive within 180 days after the petition is filed are part of the bankruptcy estate. Earnings from property of the estate—such as rents, dividends, and interest payments—are property of the estate.) (Earnings from services performed by an individual debtor are not part of the bankruptcy estate in a Chapter 7 liquidation bankruptcy. However, the 2005 act provides that a certain amount of postpetition earnings from services performed by the debtor that are earned for up to 5 years after the order for relief may be required to be paid as part of the completion of Chapter 12 (family farmer or family fisherman), Chapter 11 (reorganization), and Chapter 13 (adjustment of debts) cases.)

Consumer debt

debts incurred by an individual for personal, family, or household purposes. The petition must be filed in good faith. The petition must state that the debtor desires to obtain an extension or a composition of debts, or both.

U.S. Trustee

federal government official who has responsibility for handling and supervising many of the administrative tasks associated with a bankruptcy case.3 A U.S. Trustee is empowered to perform many of the tasks that the bankruptcy judge previously performed.

Confirmation of a Chapter 11 Plan of Reorganization

here must be confirmation of a Chapter 11 plan of reorganization by the bankruptcy court for the debtor to be reorganized under Chapter 11. The bankruptcy court confirms a plan of reorganization under the acceptance method if (1) the plan is in the best interests of the creditors because the creditors would receive at least what they would receive in a Chapter 7 liquidation bankruptcy, (2) the plan is feasible (i.e., the new, reorganized company is likely to succeed), and (3) each class of creditors accepts the plan (i.e., at least one-half the number of creditors who represent at least two-thirds of the dollar amount of the debt vote to accept the plan).

Involuntary petition.

is a petition that is filed by a creditor or creditors and places the debtor into bankruptcy. An involuntary petition can be filed in Chapter 7 (liquidation) and Chapter 11 (reorganization) cases; an involuntary petition cannot be filed in Chapter 12 (family farmer or fisherman) or Chapter 13 (adjustment of debts) cases.

Chapter 7 discharge

it is granted quite soon after the petition is filed. The individual debtor is not responsible for paying prepetition debts out of postpetition income, as would be required in other forms of bankruptcy. (In a Chapter 7 bankruptcy, the property of the estate is sold, and the proceeds are distributed to satisfy allowed claims. The remaining unpaid debts that the debtor incurred prior to the date of the order for relief are discharged.) (Example Suppose that at the time that Eric is granted Chapter 7 relief, he still owes $50,000 of unsecured debt that there is no money in the bankruptcy estate to pay. This debt is composed of credit card debt, an unsecured loan from a friend, and unsecured credit from a department store. This $50,000 of unsecured credit is discharged. This means that Eric is relieved of this debt and is not legally liable for its repayment. The unsecured creditors must write off this debt.)

bankruptcy trustee

must be appointed in Chapter 7 (liquidation), Chapter 12 (family farmer or family fisherman), and Chapter 13 (adjustment of debts) bankruptcy cases. A trustee may be appointed in a Chapter 11 (reorganization) case on a showing of fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management. Trustees, who are often lawyers, accountants, or business professionals, are entitled to receive reasonable compensation for their services and reimbursement for expenses. Once appointed, a trustee becomes the legal representative of the debtor's estate and has the power to sell and buy property, invest money, and the like.

Chapter 13 plan of payment

must be filed not later than 90 days after the order for relief. The debtor must file information about his or her finances, including a budget of estimated income and expenses during the period of the plan. The Chapter 13 plan may be either up to 3 years or up to 5 years, depending on a complicated calculation specified in the Bankruptcy Code. The plan must be submitted to secured and unsecured creditors for acceptance. The plan is confirmed as to a secured creditor or an unsecured creditor if that creditor accepts the plan. If a secured creditor does not accept the plan, the court may still confirm the plan if the secured creditor will be paid in full, including arrearages, during the plan. If an unsecured creditor objects to the plan, the court may still confirm the plan if the debtor agrees to commit all disposable income during the plan period to pay the unsecured creditors. However, during the plan period, unsecured creditors might not receive full payment of the debt owed to them.

individual with regular income

one whose income is sufficiently stable and regular to enable the individual to make payments under a Chapter 13 plan. (Regular income may be from any source, including wages, salary, commissions, and from investments, Social Security income, pension income, or public assistance. The debts of the individual debtor must be primarily consumer debt.)

. Undue hardship

onstrued strictly and is difficult for a debtor to prove unless the debtor can show severe physical or mental disability or inability to pay for basic necessities, such as food or shelter, for his or her family. Co-signers (e.g., parents who guarantee their child's student loan) must also meet the heightened undue hardship test to discharge their obligation.

Chapter 11 is available to

partnerships, corporations, limited liability companies, and other business entities. Most of the Chapter 11 proceedings are filed by corporations and other businesses that want to reorganize their capital structure by receiving discharge of a portion of their debts and obtaining relief from burdensome contracts and to emerge from bankruptcy as going concerns. Chapter 11 is also filed by wealthy individual debtors who do not qualify for Chapter 7 or Chapter 13 bankruptcy.

Filing a Chapter 13 Petition

proceeding can be initiated only through the voluntary filing of a petition by an individual debtor with regular income. A creditor cannot file an involuntary petition to institute a Chapter 13 case

Exempt property

property of the debtor that he or she can keep and that does not become part of the bankruptcy estate. The creditors cannot claim the property. property of the debtor that he or she can keep and that does not become part of the bankruptcy estate. The creditors cannot claim the property.

Chapter 11—Reorganization of the Bankruptcy Cod

provides a method for reorganizing a debtor's financial affairs under the supervision of the bankruptcy court.9 The goal of Chapter 11 is to reorganize the debtor with a new capital structure so that the debtor emerges from bankruptcy as a viable concern. This option, which is referred to as reorganization bankruptcy, is often in the best interests of debtors and creditors.

extension

provides for a longer period of time for the debtor to pay the debts. (Example A debtor who is obligated to pay a debt within one year petitions the bankruptcy court to extend the time in which to pay the debt to 3 years.)

composition

provides for the reduction of a debtor's debts. (Example A debtor who owes an unsecured creditor $10,000 petitions the court to reduce the unsecured debt owed the creditor to $7,000.)

Labor Union and Retiree Benefits Contracts

require the payment of agreed-on wages and other benefits to union member-employees for some agreed-on period in the future. Debtors also often have contracts to pay union and nonunion retired employees and their dependents' medical, surgical, hospitalization, dental, and death benefits (retiree benefits). In a Chapter 11 case, union members and union retirees are represented by the responsible labor union. The court appoints a committee to represent nonunion retirees. (The debtor and the representatives of the union members and retirees can voluntarily agree to modification of the union collective bargaining agreement and retiree benefits. If such an agreement is not reached, the debtor must confer in good faith with the union and retirees' representative, but if a settlement cannot be reached, the debtor can petition the bankruptcy court to reject the union agreement or to modify retiree benefits. The court can reject a union contract or modify retirees' benefits if the court finds that the "balance of equities" favors rejection or modification and the rejection or modification is necessary to the debtor's reorganization.)

Discharge of Debts

the debtor usually proposes to reduce its unsecured debt so that it can come out of bankruptcy with fewer debts to pay than when it filed for bankruptcy. The bankruptcy court permits the debtor to discharge the amount of unsecured credit that would make its plan of reorganization feasible. Unsecured credit is discharged on a pro rata basis. (Example Big Oil Company has $100 million in secured debts (e.g., real estate mortgages, personal property secured transactions) and $100 million in unsecured credit when it files for Chapter 11 bankruptcy. In its plan of reorganization, Big Oil Company proposes to eliminate 60 percent—$60 million—of its unsecured credit. If the court approves, then Big Oil will emerge from bankruptcy owing only $40 million of prepetition unsecured debt. The other $60 million is discharged, and the creditors can never recover these debts in the future.)

Chapter 12—Adjustment of Debts of a Family Farmer or Fisherman with Regular Income

the federal Bankruptcy Code contains special provisions for the reorganization bankruptcy of family farmers and family fishermen. Under Chapter 12, only the debtor may file a voluntary petition for bankruptcy. To qualify, a family farmer cannot have debt that exceeds $4,153,150, and a family fisherman cannot have debt that exceeds $1,924,550. The debtor files a plan of reorganization. The plan may modify secured and unsecured credit and assume or reject executory contracts and unexpired leases. The plan period is usually 3 years, although a court may increase the period to up to 5 years, based on showing of cause. To confirm a plan of reorganization, the bankruptcy court must find the plan to be feasible. During the plan period, the debtor makes the debt payments required by the plan. When the family farmer or family fisherman has completed making the payments required by the plan, the bankruptcy court grants the debtor discharge of all the debts provided for by the plan.

If a class of creditors does not accept the plan,

the plan can be confirmed by the court by using the Bankruptcy Code's cram-down provision. In order for the court to confirm a plan over the objection of a class of creditors, at least one class of creditors must have voted to accept the plan. (Example BigDotCom Corporation has financial difficulties and has filed for Chapter 11 reorganization. At the time of filing for Chapter 11, the corporation has $100 million of secured credit, $100 million of unsecured credit, and common stockholders whose equity securities are now worthless. The corporation files a plan of reorganization whereby the corporation (1) keeps the secured assets for the business, pays the secured creditors any arrearages owed, and has the secured creditors retain their secured interests in the secured assets; (2) reduces unsecured debt by $45 million and discharges $55 million of unsecured debt; (3) eliminates the interests of the equity holders; (4) rejects specified executory contracts and unexpired leases; (5) eliminates several unprofitable product lines; (6) provides for the payment of required unpaid taxes; and (7) accepts the investment of $30 million in capital from an investment bank that wants to invest in the corporation. If this plan is approved by the court, $55 million of the corporation's unsecured debt is discharged. The corporation emerges from Chapter 11 as a reorganized going concern.)