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Chapter 26

BankruptcyINTRODUCTION

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 credi tors. Thus, the law attempts to protect the rights of debtor and creditor, with an emphasis on requiring debtors to pay as many of their debts as they can.

Because many debtors end up in bankruptcy because they can no longer afford to make the payments on their homes, this chapter begins with an introduction to mortgages and the foreclosure process. The chapter also looks at laws that assist debtors by providing exemptions that protect certain property from creditors.

CHAPTER OUTLINE

I. MortgagesAn individual who buys real property typically borrows the funds from a financial institution to pay for it. A mortgage is a written instrument that gives the creditor an interest in, or a line on, the property as security for the payment. A mortgage loan is a contract.

ADDITIONAL BACKGROUND—

The Sale of Real Estate

Transfers of ownership interests in real property are frequently accomplished by means of a sale. The sale of real estate is similar to the sale of goods, because it involves a transfer of ownership, often with specific warranties. In the sale of real estate, however, certain formalities such as the execution of a deed are observed that are not required in the sale of goods.

Several steps are involved in any sale of real property. The first step is the formation of the land sales contract. A title search (to verify that the seller has good title to the property and that no other claims to the property exist) follows, along with, usually, negotiations to obtain financing for the purchase. The final step is the closing.

Brokers. Buyers and sellers of real property frequently enlist the services of a real estate agent, or broker. Real estate agents are information brokers. They provide buyers and sellers of real estate with infor-mation and specialize in matching the wants of buyers with the property being offered for sale by sellers. The

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broker is usually retained by the seller and acts as the seller’s agent in the sale of the property. As compensation for their services, brokers usually receive a commission (which can vary between 1 to 10 percent of the purchase price) from the seller when the sale is concluded. A broker can also simultaneously act as an agent of the buyer, in which case a dual agency exists. Generally, a broker may not act as an agent for more than one party without the consent of all parties involved. (There exist some buyer-only brokers.) Most states require real estate brokers to be licensed, and, in some states, brokers may be required to meet continuing-education or other requirements. A seller engages the services of a broker through a written listing agreement. In an open listing, the seller contracts for the services of more than one broker, and the first broker to produce a buyer receives the commission. In an exclusive listing, the seller contracts with just one broker, who receives the exclusive right to find a buyer and receive the commission from the seller. Under an exclusive listing agreement, the broker is entitled to a commission even if another broker sells the property.

Sales Contract. Generally, when someone decides to purchase real estate, he or she makes a written offer to purchase the property and puts up earnest money to show that an earnest, or serious, offer is being made. (If the offeror decides to withdraw the offer, the earnest money, or deposit binder money, will of ten be forfeited to the seller.) The offer states in some detail the exact offering price for the property and lists any other conditions that may be appropriate. The offer may be conditioned on the offeror’s ability to obtain fi -nancing, for example. Within a specified time period, the seller of the property either accepts or rejects the of-fer. If the offer is accepted, then a contract of sale is drawn up. The signing of the sales contract is usually accompanied by a deposit, which may be 10 percent of the purchase price paid to the seller. The buyer can then add to the existing earnest money to bring it up to the desired amount.

Deposits toward the purchase price normally are held in a special account, called an escrow account, until all of the conditions of sale have been met and the closing takes place, at which time the money is trans-ferred to the seller. The escrow agent, which may be a title company, bank, or special escrow company, acts as a neutral party in the sales transaction and facilitates the sale by allowing the buyer and seller to close the transaction without having to exchange documents and funds. An escrow agent is an agent of all of the par-ties involved in the sales transaction. When a conflict between the parties results in conflicting duties on the part of the agent, normally the agent will have a court resolve the conflict.

Sometimes, an arrangement is made in which a potential buyer is given the right to purchase property in the future, within a specified period of time and for a specific price. This is called an option contract. To be enforceable, the contract must be in writing, and consideration must be given to the seller. Essentially, payment to the seller compensates the seller for taking the property off the market until the end of the time specified in the option contract. Potential buyers may also obtain a right of first refusal. Frequently, those who lease property with the intention of possibly buying it in the future will have such a clause added to the lease contract. This right means that the lessee, or tenant, has first priority if the seller decides to sell the property. In other words, if the seller receives an offer from a third party, the seller cannot accept the offer until the tenant indicates that he or she does not intend to purchase the property.

Title Examination. After the sales contract has been negotiated, the buyer or buyer’s attorney (or the broker, escrow agent, title insurance company, or lending institution from which the purchase price is being borrowed) will begin the title examination, which entails examining at the county recording office the history of all past transfers and sales of the property in question. The title examiner will generally obtain an abstract from a private abstract company. This document lists all the records relating to a particular parcel of land. After reading the abstract, the examiner will give an opinion as to the validity of the title. Title examinations are not foolproof, and buyers of real property generally purchase title insurance to protect their interests in the event that some defect in the title was not discovered during the examination. A title insurance policy insures


CHAPTER 26: BANKRUPTCY 3

against loss resulting from any defects in the title and guarantees that, if any defects do arise, the title company issuing the policy will defend the owner’s interests and pay all legal expenses involved.

Financing. Unless a buyer pays cash for the property, the buyer must obtain financing for the purchase with a mortgage loan. A mortgage loan is a loan made by a banking institution or trust company for which the property is given as security. In some states, the mortgagor (the borrower) holds title to the property; in others, the mortgagee (the lender) holds title until the loan is completely repaid. In several states, a trustee—a third party—holds title on behalf of the lender. The trustee then deeds the property back to the bor rower when the loan is repaid. If the payments are not made, the trustee can deed the property to the lender or dispose of it by auction, depending on state law.

There are numerous ways of financing the purchase of real property, some of which are quite creative. Frequently, financing is obtained through a conventional long-term mortgage loan in which the payment schedule extends over a period of twenty-five to thirty years. Traditionally, the interest rate for long-term loans was fixed—that is, the interest rate did not change over the period of the loan. Today, long-term loans often have variable rates of interest. In a variable-rate loan, the interest rate is pegged to a specified standard, such as the prime rate—the rate of interest offered by lending institutions to their most creditworthy customers—and adjusted at specified intervals, such as six months or a year. In some situations, the seller may be willing to finance the purchase for a buyer. That is, the buyer will pay, say, 10 percent of the price as a down payment and make periodic (usually monthly) payments to the seller until the balance of the purchase price is paid. In other situations, a wraparound mortgage may be used.

Several terms used in mortgage transactions merit special mention and clarification. Obtaining a mortgage normally involves paying a fee to the lender in the form of points. A point is a charge of 1 percent on the amount of a loan. Therefore, if the lender’s fee is two points and the amount of the loan is $80,000, the fee amounts to $1,600. This charge may be assessed against the buyer, the seller, or both.

If the mortgage terms allow for prepayment privileges, then the borrower can prepay the mortgage before the maturity date without penalty. Prepayment privileges may be especially important if market interest rates fall below the interest rate of the mortgage loan—in which case the loan could be refinanced to the advantage of the borrower.

An amortization schedule shows what portions of each monthly payment on a loan-term loan, such as a mortgage loan, go to the interest and to the principal on the loan, respectively. In the first several years of the loan, the borrower pays primarily interest on the mortgage, so the amount owing on the principal of the loan declines very slowly. By the end of the payment schedule, however, the payments are mostly on the prin-cipal. An amortization schedule is usually given to the borrower by the lending institution; if not, the borrower can request one.

Closing. The final step in the sale of real estate is the closing—also called settlement or closing escrow. The escrow agent coordinates the closing with the recording of deeds, the obtaining of ti tle insurance, and other concurrent closing activities. Several costs must be paid, in cash, at the time of clos ing. These costs comprise fees for services, including those performed by the lender, escrow agent, and title company, and they can range from several hundred to several thousand dollars, depending on the amount of the mortgage loan and other conditions of sale. Lending institutions are required by law to notify—within a specified time period—each applicant for a mortgage loan of the specific costs that must be paid at the closing.

Warranty of Habitability. The common law rule of caveat emptor (“let the buyer beware”) held that the



seller of a home made no warranties with respect to its soundness or fitness unless such a warranty was specifically included in the deed or contract of sale. Although caveat emptor is still the rule of law in a minority of states, there is currently a strong trend against it and in favor of an implied warranty of habitability. Under this new approach, the courts hold that the seller of a new house warrants that it will be fit for human habitation regardless of whether any such warranty is included in the deed or contract of sale. This warranty is similar to the UCC’s implied warranty of merchantability for sales of personal property. In recent years, some states, such as Virginia, have passed legislation creating such warranties for newly constructed resi-dences. Under an implied warranty of habitability, the seller warrants that the house is in reasonable working order and is of reasonably sound construction. To recover damages for breach of the implied warranty of habitability, the purchaser is only required to prove that the home he or she purchased was somehow defec-tive and to prove the damages caused by the defect. Under the warranty of habitability theory, the seller of a new home may be in effect a guarantor of the home’s fitness.

Seller’s Duty to Disclose. Traditionally, under the rule of caveat emptor, a seller had no duty to disclose to the buyer defects in the property, even if the seller knew about the defects and the buyer had no rea -sonable way to discover them. Currently, in many jurisdictions, courts have placed on sellers a duty to dis -close any known defect such as a rotted roof that materially affects the value of the property and that the buyer could not reasonably discover. Under these circumstances, nondisclosure is similar to representing that the defect does not exist, and the buyer may have grounds for a successful lawsuit based on fraud or misrepresentation.

A. FIXED-RATE V. ADJUSTABLE-RATE MORTGAGES

1. Fixed-Rate MortgagesA fixed-rate mortgage is a standard mortgage with a fixed rate of interest. Payments are the same for its duration. The interest rate may be based on the borrower’s credit history, credit score, income, and debts.

2. Adjustable-Rate Mortgages (ARMs)The interest rate on an adjustable-rate mortgage changes periodically. The rate may begin relatively low and fixed. After a certain time, and at certain intervals, the rate adjusts. The adjustment consists of a specified number of points added to an index rate. Most ARMs limit the amount that the rate can increase over the duration of the loan.

B. MORTGAGE PROVISIONSTerms may include—

• Loan terms—the amount, the interest rate, the period of repayment, and others.• A prepayment penalty clause.• Provisions for the maintenance of the property.• A statement obligating the borrower to maintain homeowners’ insurance.• A list of the borrower’s non-loan financial obligations—property taxes and so on.• A provision for the borrower’s payment of regular and ordinary expenses associated with the

property—taxes, insurance, and other assessments—through the lender.• Creditor protection, such as—

Mortgage insurance—If the debtor defaults, the insurer reimburses the creditor for part of the loan.



Recording the mortgage—Recording a mortgage in the appropriate county office perfects the creditor’s interest in the property. On the debtor’s default, a creditor who has not perfected his or her interest may have the priority of an unsecured creditor.


Recording the MortgageRecording statutes are in force in every jurisdiction. Their purpose is to provide prospective buyers with a

way to check whether there has been an earlier transaction. Hence, recording a deed gives constructive notice to the world that a certain person is now the owner of a particular parcel of real estate.

There are three basic types of recording statutes—

• Race statutes provide that the first purchaser to record a deed has superior rights to the property, regardless of whether he or she knew that someone else had already bought it but had failed to record the deed.

• Pure notice statutes provide that, regardless of who files first, a person who knows that someone else has already bought the property cannot claim priority.

• Race-notice statutes provide that a purchaser who does not know that someone else has already bought the property and who records his or her deed first can claim priority.

Irrespective of the particular type of recording statute adopted by a state, recording a deed involves a fee. The grantee typically pays this fee, because he or she is the one who will be protected by recording the deed.

C. MORTGAGE FORECLOSUREIf a borrower defaults, or fails to pay a loan, the lender can foreclose on the mortgaged property. The foreclosure process allows a lender to repossess and auction the property. A foreclosure can be expensive and remains on a borrower’s credit report for seven years.

1. Ways to Avoid Foreclosure

• Forbearance—The postponement of part or all of the payments of a loan in danger of foreclosure. This may be based on a borrower’s securing a new job, selling the property, or some other factor.

• Workout—A voluntary attempt to cure a default. A workout agreement sets out the parties’ rights and responsibilities—for example, a lender may agree to delay foreclosure in exchange for a borrower’s financial information.

• Short sale—A sale of the property for less than the balance due on a mortgage loan. A borrower—who typically must show some hardship—sells the property with the lender’s consent.

2. Foreclosure ProcedureA lender must strictly comply with the terms of the state statute governing foreclosures.



CASE SYNOPSIS—

Case 26.1: McLean v. JP Morgan Chase Bank N.A.

JP Morgan Chase Bank, N.A., filed a foreclosure action in a Florida state court against Robert McLean. The mortgage attached to the complaint identified a different mortgagee and lender, however. Later, Chase provided an assignment of McLean’s mortgage that was dated three days after the filing of the suit and a note with an undated indorsement. From a judgment in Chase’s favor, McLean appealed.

A state intermediate appellate court reversed. A party seeking foreclosure must have standing to foreclose when it files its complaint. In this case, the mortgage was assigned after Chase filed its complaint, and the indorsement on the note was undated. To succeed, on remand Chase would have to prove that it owned the note at the time of the complaint or file a new complaint.

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Notes and Questions

What might the lender have done to avoid an unfavorable result in this case? The lender should have been more careful with the paperwork and its dates. The mortgage and its assignment should have been more easily traceable and should have been verified before the complaint was filed. The indorsement on the note should have been dated. Separate records proving the dates of the assignment and indorsement might also have been kept. Otherwise, how would the lender know that it was filing a complaint against the right defendant?

ADDITIONAL CASES ADDRESSING THIS ISSUE —

Mortgage ForeclosureRecent cases focusing on notice, service, and other requirements in foreclosure proceedings

include the following.

• Kersey v. PHH Mortgage Corp., 682 F.Supp.2d 588 (E.D.Va. 2010) (when a mortgagee was obligated to have, or reasonably attempt to have, a face-to-face meeting with the mortgagor before it could commence foreclosure, the mortgagee’s failure to comply gave rise to a cognizable breach of contract claim).

• ABN AMRO Mortgage Group, Inc., v. McGahan, __ Ill.2d __, __ N.E.2d __, 2010 WL 2222126 (2010) (a mortgagee must name a personal representative for a deceased mortgagor in a foreclosure proceeding for the court to acquire jurisdiction—there must be personal service because the mortgagor is a necessary party to the action).

• First National Bank of Chicago v. Silver, 73 A.D.3d 162, 899 N.Y.S.2d 256 (2 Dept. 2010) (a summary judgment in a foreclosure action in the mortgagee’s favor must be reversed and the complaint dismissed when the mortgagee did not deliver statutory-specific notice to the homeowner, together with the summons and complaint, as required by state law).



• Rabinowitz v. Deutsche Bank, __ Misc.2d __, __ N.Y.S.2d __, 2010 WL 2106217 (Sup. 2010) (a mortgagee gave adequate notice of a foreclosure sale when notice of a first auction was published for four successive weeks and—after the successful bidder refused to sign a memorandum of sale and decided not to buy the property—the mortgagee published notice of a postponement of sale and scheduled a second auction).

D. REDEMPTION RIGHTS

• In all states, a borrower can exercise a right of redemption to buy the property after default by paying the amount of the debt, plus interest and costs, before the foreclosure sale.

• In some sates, a borrower can exercise a statutory right of redemption to buy the property even after a judicial foreclosure and sale of the property at auction to a third party. This right may exist for up to a year after the sale.

II. Laws Assisting DebtorsA. EXEMPTED REAL PROPERTY

Each state allows a homestead exemption, which permits a debtor to retain all or part of the family home free from the claims of unsecured creditors or trustees in bankruptcy. The purpose of the exemption is to ensure that a debtor will retain some form of shelter. A few states allow the homestead exemption only if the judgment debtor has a family.

B. EXEMPTED PERSONAL PROPERTYPersonal property that is most often exempt (up to at least a specified dollar amount) includes—

• Household furniture.• Clothing and certain personal possessions.• A vehicle (or vehicles) for transportation.• Certain animals.• Equipment the debtor uses in a business or trade.

III. The Bankruptcy CodeThe U.S. Constitution gave Congress the power to establish “uniform laws on the subject of bankruptcies throughout the United States.” Federal bankruptcy laws (as amended most recently in the 2005 Bankruptcy Reform Act) are called the Bankruptcy Code or the Code.


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.


Bankruptcy Abuse and Consumer Protection Act (BACPA) of 2005The most significant changes to bankruptcy law in nearly thirty years occurred in 2005, with the

enactment of the Bankruptcy Abuse and Consumer Protection Act (BACPA) of 2005.

For individual debtors, key changes from previous law included—

• Subject to a means test, many debtors must file for bankruptcy under the Bankruptcy Code’s Chapter 13 instead of the more commonly used Chapter 7, which often provided an almost complete discharge of all debts. Under Chapter 13, as amended by BACPA, a debtor must comply with a repayment plan for up to five years, according to a strict budget.

• Debtors’ attorneys may be liable for inaccurate, incomplete, or other erroneous information in documents filed with the court.

• Creditors can review a debtor’s federal tax filings, to compare them against court-filed documents and to challenge discrepancies.

• Creditors who have not been properly notified of a bankruptcy filing may be able to foreclose on a debtor’s property and garnish his or her wages.

• Debtors must seek credit counseling.

• Fewer debts can be discharged under Chapter 13. Notable limits include fraudulently obtained credit-card debt, fraudulently-unpaid tax debt, fraudulently-incurred fiduciary debt, and debts related to criminal fines and victim restitution, and civil liability for willful and malicious injury or death.

• Under Chapter 13, the entire amount of a secured claim, such as a car loan, must be repaid (instead of, for example, reducing the amount to o current value).

• Spousal and child support debts have top priority (except for a trustee’s expenses). The automatic stay can be lifted to collect child support debts.

• The amount of a homestead exemption was limited in a variety of ways, which were focused primarily on attempts to defraud creditors or avoid crime-related or tort-based liability.

• Protection was extended on retirement and college-savings plans (see an ADDITIONAL BACKGROUND elsewhere in this chapter).

For small-business debtors, key changes from previous law included—

• Small-business debtors are those with $2 million or less in debt on the date they file for bankruptcy.



• The deadline for filing a plan of reorganization under Chapter 11 is 300 days within the filing of the initial petition. The time within which a small-business debtor has the exclusive right within which to file a plan was extended to 180 days.

• For small-business debtors, the grounds on which a court can convert a Chapter 11 case to a Chapter 7 case were specified and expanded.

• A U.S. Trustee can inspect the premises and the books of a small-business debtor.

• Small-business debtors must include copies of balance sheets, income statements, cash-flow statements, federal tax returns, and other documents with their bankruptcy petitions. Such debtors must also file periodic financial reports with information on profitability and cash receipts. Forms that debtors must submit to creditors before their approval of a Chapter 11 plan or reorganization were simplified.

The U.S. Small Business Administration is expected to monitor the impact of BACPA on small businesses and inform Congress of any needed changes.

A. GOALS OF BANKRUPTCY LAWBankruptcy law has two main goals—

• To protect a debtor by giving him or her a fresh start without creditors’ claims.• To ensure equitable treatment of creditors competing for a debtor’s assets.

B. BANKRUPTCY COURTSBankruptcy proceedings are held in federal bankruptcy courts under the authority of the federal district courts, to which rulings can be appealed.

C. TYPES OF BANKRUPTCY RELIEFThe 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).

D. SPECIAL TREATMENT OF CONSUMER DEBTORSA clerk of court must provide consumer-debtors (those whose debts arise primarily from purchases of goods for personal or household use) with certain information.

IV. Chapter 7—LiquidationIn 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. VOLUNTARY BANKRUPTCYWithin 180 days of receiving credit counseling from an approved nonprofit agency, a debtor can file a voluntary petition. The debtor’s attorney must verify the information in the petition. A debtor does not have to be insolvent—anyone liable to a creditor can file. A husband and wife can file jointly.


Voluntary Bankruptcy InformationIn the case from which the following is excerpted, In re Riddle, 344 Bankr.702 (S.D. Fla. 2006), the court

held that the information provided by the debtors was complete and, thus their case was not subject to automatic dismissal under the BAPCPA.

SUA SPONTE ORDER DETERMINING DEBTORS' COMPLIANCE WITH FILING REQUIREMENTS OF SECTION 521(a)(1)

A. JAY CRISTOL, Chief Judge.

Pursuant to 11 U.S.C. § 521(i), if an individual debtor in a voluntary case under Chapter 7 or 13 fails to file all of the information required under 11 U.S.C. § 521(a)(1) within 45 days after the date of the filing of the petition, the case shall be “automatically dismissed” effective on the 46th day after the date of the filing of the petition.

The Court has reviewed the docket and the papers filed by debtors in this case and believes the information required by 11 U.S.C. § 521(a)(1), and provided by the debtors, is complete. Moreover, no party in interest has filed a request for an order of dismissal pursuant to 11 U.S.C. § 521(i)(2). Notwithstanding, the Court feels compelled to comment on the unusual and confusing language in this statutory provision.

I do not like dismissal automatic,It seems to me to be traumatic.I do not like it in this case,I do not like it any place.As a judge I am most keento understand, What does it mean?How can any person knowwhat the docket does not show?What is the clue on the 46th day?Is the case still here, or gone away?And if a debtor did not dowhat the Code had told him toand no concerned party knew it,Still the Code says the debtor blew it.Well that is what it seems to say:the debtor's case is then “ Oy vay! ”This kind of law is symptomaticof something very problematic.For if the Trustee does not knowthen which way should the trustee go?Should the trustee's view prismatic



continue to search the debtor's atticand collect debtors' assets in his fistfor distribution in a case that standsdismissed?After a dismissal automaticwould this not be a bit erratic?The poor trustee cannot knowthe docket does not dismissal show.What's a poor trustee to do—except perhaps to say, “Boo hoo!”And if the case goes on as normaland debtor gets a discharge formal,what if a year later some fanaticclaims the case was dismissed automatic?Was there a case, or wasn't there one?How do you undo what's been done?Debtor's property is gone as if by a thief,and Debtor is stripped but gets no relief.I do not like dismissal automatic.On this point I am emphatic!I do not wish to be dramatic,but I can not endure this static.Dismissal automatic is not understood.Something more in 521 is neededfor dismissal automatic to be heeded.For all concerned this is not good.Before this problem gets too oldit would be good if we were told:What does automatic dismissal mean?And by what means can it been seen?Are we only left to guess?Oh please Congress, fix this mess!Until it's fixed what should I do?How can I explain this mess to you?If the Code required an old fashioned order,that would create a legal border,with complying debtors' cases defendedand 521 violators' cases ended,from the unknown status of dismissal automatic,to the certainty of a status charismatic.The dismissal automatic problem would be gone,and debtors, trustees and courts could move on.As to this case, how should I proceed?Review of the record is warranted, indeed.A very careful record review,tells this Court what it should do.Was this case dismissed automatic?It definitely was NOT and that's emphatic.



Based upon the Court's review, the Court has determined that the debtors have complied with the information requirements of 11 U.S.C. § 521(a)(1).

Accordingly, it is ORDERED:

1. This case is not subject to automatic dismissal under 11 U.S.C. § 521(i)(1) or (2).

2. If any party in interest has any reason to contest the Court's finding that the debtors have filed all information required by 11 U.S.C. § 521(a)(1), that party shall file a motion for reconsideration not later than 20 days from the date of the entry of this order, and serve such motion on the trustee, the United States Trustee, debtors and debtors' counsel, if any. The motion should specifically identify the information and document(s) required by 11 U.S.C. § 521(a)(1) that the debtors have failed to file.

3. Nothing in this Order shall excuse the debtors' duty to cooperate with the United States Trustee and the trustee assigned to this case, and shall not prevent the United States Trustee or case trustee from requesting by any authorized means, including, but not limited to motion, that the debtors supply further information.

1. Chapter 7 SchedulesA voluntary petition must contain—

• A schedule of secured and unsecured creditors and what is owed to each.• A statement of the debtor’s financial affairs.• A list of the debtor’s property.• A statement of the debtor’s current income and expenses.• A certificate of credit counseling.• Proof of payments received from employers within 60 days.• A statement of monthly income;.• A copy of the debtor’s most recent federal income tax return.

A photo i.d. and copies of other tax returns must be submitted if the U.S. trustee requires. The schedules and other documents must be filed within forty-five days of the petition (except for the tax return, which can be filed up to seven days before the first creditors’ meeting.

2. Tax Returns during BankruptcyA tax return must be filed each year while a case is pending, with a copy provided to the court.

3. Substantial Abuse and the Means TestA grant of relief cannot be “substantial abuse” of Chapter 7.

a. The Basic FormulaIf a debtor’s family income is more than the median family income in the state in which the petition is filed, the petition may be dismissed on a presumption of abuse.

b. Applying the Means Test to Future Disposable IncomeDisposable income is calculated by subtracting living expenses and interest payments on secured debt. Living expenses are amounts allowed under formulas used by the Internal Revenue Service.



c. Can the Debtor Afford to Pay Unsecured Debts?To answer this question, a court may consider a debtor’s bad faith or other evidence of abuse.

4. Additional Grounds for DismissalA petition may be dismissed for a conviction of a violent or drug-related crime, or a failure to file the necessary documents or to pay post-petition domestic support.

5. Order for ReliefThe filling of the petition constitutes an order for relief (a discharge of debts). Creditors must be notified within twenty days.

B. INVOLUNTARY BANKRUPTCYCreditors can force debtors (not farmers or charitable institutions) into involuntary bankruptcy.

1. Requirements

• If the debtor has twelve or more creditors, three or more of these creditors having unsecured claims totaling at least $15,325 must join in the petition.

• If a debtor has fewer than twelve creditors, one or more creditors having a claim totaling $15,325 or more may file.

2. When the Debtor Challenges the PetitionIf the debtor challenges the petition, the court will enter an order for relief if the debtor is not pay ing debts as they become due or a receiver has taken possession of the debtor’s property.

C. AUTOMATIC STAYThe automatic stay protects a debtor’s property from creditors’ actions. A creditor’s willful violation of the stay may entitle a party to recover compensatory and punitive damages, costs, and attorneys’ fees.

1. Exceptions to the Automatic StayExceptions to the automatic stay include domestic support obligations and related proceedings, securities-regulation investigations, tax liens, prior evictions, and wage withholding for retirement-account loan repayments.

2. Requests for Relief from the Automatic StayA stay on a debt will automatically expire sixty days after a creditor’s request for relief from the stay.

3. Secured PropertyA stay on a secured debt may be lifted forty-five days after the first creditors’ meeting unless the debtor reaffirms the debt.

4. Bad FaithAn automatic stay does not take effect unless the court determines that it was filed in good faith.




Adequate Protection under Chapters 7, 11, and 13A 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. BANKRUPTCYCHAPTER 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 ex tent 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.)

D. ESTATE IN BANKRUPTCYCommencement of a Chapter 7 proceeding creates an estate in property, which consists of all the debtor’s legal and equitable interests in property before the filing of the petition. It also includes certain after-acquired property, such as gifts and inheritances.

E. THE BANKRUPTCY TRUSTEEA 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. Review for Substantial Abuse

• Within ten days of the first creditors’ meeting, the trustee must review the debtor’s fil ing and determine whether it is abuse under the means test, and if so, notify all creditors.



• Within forty days of the meeting, the trustee must file a motion to dismiss the petition, convert it to a Chapter 13 case, or state why not. The trustee must provide notice of a debtor’s petition to a domestic support creditor (e.g., an ex-spouse).

2. Trustee’s Powers

• Right to possession—The trustee has a right to possession of the debtor’s property and can require persons holding a debtor’s property when a petition is filed to give the property to the trustee.

• Strong-arm power—The trustee’s position is equivalent in rights to that of certain other parties. A trustee has strong-arm power—the same right as a lien creditor who could have levied execution on the debtor’s property.

• Powers of avoidance—A trustee also has specific avoidance 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.

3. Voidable RightsA 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.

4. PreferencesA trustee can recover a debtor’s payment or transfer of property made to a creditor within ninety days before the petition in preference to others.

a. Preferences to InsidersA transfer to an insider (a person or organization close to the debtor) made within a year of the bankruptcy petition can be avoided.

b. Transfer That Do Not Constitute PreferencesGenerally, payment for services rendered within ten to fifteen days before payment is not considered a preference. A consumer-debtor can transfer any property to a creditor up to a certain amount without it constituting a preference.

5. Fraudulent TransfersA trustee may avoid fraudulent transfers made within two years 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.

F. EXEMPTIONSA debtor can exempt certain property from bankruptcy. The Bankruptcy Code’s exemptions include, among others-

• Up to a certain amount (specific amounts are stated in the text) in equity in the debtor’s residence and burial plot.

• Interest in a motor vehicle up to a certain amount.



• Interest, up to a certain amount for any particular item or a certain amount for all items together, in household goods and furnishings, wearing apparel, appliances, books, animals, crops, or musical instruments.

• Interest in jewelry, up to a certain amount.• Interest in other property, up to a certain amount., plus a certain unused portion of the homestead

exemption.• Interest in any tools of the debtor’s trade, up to a certain amount.• The right to receive Social Security and certain welfare benefits, alimony and support payments,

certain retirement funds and pensions, and certain education savings accounts.


Exemption for Retirement and College SavingsAccording to a decision of the United States Supreme Court, individual retirement accounts (IRAs) could

not be seized during bankruptcy.a The Court explained that the IRAs were protected under 11 U.S.C. Section 522(d)(10)(E), which exempted “payment under a stock plan, pension, profit sharing, annuity, or similar plan or contract on account of . . . age.” The Court reasoned that a right to payment from an IRA “is casually connected to . . . age” and IRAs “provide income that substitutes for wages earned as salary or hourly compensation.” Left open were questions concerning the amount of the assets that were exempt and whether Roth IRAs—a specific type of IRA—were also covered.

The Bankruptcy Abuse and Consumer Protection Act (BACPA) of 2005 preempted this decision to provide protection for retirement and college-savings accounts. Under BACPA, most of the assets in IRAs are excluded from bankruptcy proceedings, just as employer-sponsored savings and pension plans known as 401(k)s were previously excluded. Education-focused accounts known as Coverdell accounts and 529 plans are also now partially outside the reach of creditors in a bankruptcy.

BACPA protected an unlimited amount of funds rolled over into IRAs from employer-sponsored retirement plans, as well as up to $1 million in new contributions. BACPA also protected Roth IRAs.

College-saving 529 plans allow certain levels of deposits per year (or five years’ of deposits as an initial balance) with latter tax-free withdrawals to pay for education. Prepaid 529 plans lock in the certain costs of college at current prices. A certain amount can be deposited in a Coverdell account each year, with withdrawals tax-free to pay for education. Not exempt under BACPA, however, are contributions to college-savings accounts within a year of the bankruptcy filing, and only $5,000 of contributions within the previous two years can be excluded from the debtor’s estate.

One of the purposes behind these exemptions was to encourage individuals to save more for re tirement and education.

a. Rousey v. Jacoway, __ U.S. __, 125 S.Ct. 1561, __ L.Ed.2d __ (2005).

1. State ExemptionsStates may bar the use of federal exemptions. In other states, debtors may choose between exemptions provided under state law and federal law.



2. Limitations on the Homestead ExemptionTo claim a state’s homestead exemption, the debtor must have lived in the state for two years be-fore filing the petition. Certain other residency and dollar limits may apply. Home equity may not be protected if a debt arose from a crime or tort indicating substantial abuse.

G. CREDITORS’ MEETING AND CLAIMS

• The U.S. trustee calls the creditors’ meeting within twenty and forty days of the petition. The debtor must 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.

H. DISTRIBUTION OF PROPERTY

1. Distribution to Secured CreditorsIf collateral is surrendered, a secured party can accept it in full satisfaction of the debt or sell it, apply the proceeds to the debt, and become an unsecured creditor for the difference.

2. Distribution to Unsecured CreditorsThere is an order in which unsecured debts are paid. Each class must be paid before the next class. If proceeds are insufficient to pay all creditors in a class, payment is proportional, and classes lower in priority receive nothing. Any amount remaining goes to the debtor. The order of priority is—

• Claims for domestic-support obligations.• Administrative expenses.• In an involuntary bankruptcy, expenses incurred in the ordinary course of business.• Unpaid wages, salaries, and commissions earned within ninety days of the filing.• Unsecured claims for contributions to employee benefit plans.• Consumer deposits.• Certain government taxes and penalties.• Claims for death or injury resulting from the unlawful operation of a motor vehicle.• Claims of general creditors.

I. DISCHARGEThe effect of a discharge is to void any judgment on a discharged debt and enjoin any action to collect a discharged debt (but not against a co-debtor).

1. Exceptions to DischargeThe most important claims not dischargeable under Chapter 7 include, among others—



• Claims for back taxes accruing within two years prior to bankruptcy.• Certain government fines and penalties.• Claims by creditors who were not notified of the bankruptcy.• Domestic support obligations.• Claims that arose from a debtor’s driving while intoxicated.• Claims against property or money obtained by the debtor by false representations.• Claims based on misuse of funds by the debtor.• Certain student loans, unless payment causes undue hardship.

ADDITIONAL CASES ADDRESSING THIS ISSUE—

Exceptions to Discharge for Student Loans

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).

2. Objections to DischargeThe following circumstances (relating to the debtor’s conduct and not to the debt) will cause a discharge to be denied—

The debtor’s concealment or destruction of property with the intent to hinder, de lay, or defraud a creditor.

The debtor’s fraudulent concealment or destruction of records, or failure to keep adequate records, of his or her financial condition.

The granting of a discharge to the debtor within eight years of the filing of the petition. The debtor’s failure to attend a required consumer-education course. Proceedings in which the debtor could be found guilty of a felony.

When a discharge is denied, the assets may still distributed to creditors. After the bankruptcy proceeding, the debtor remains liable for the unpaid portions of all claims.



CASE SYNOPSIS—

Case 26.2: In re Cummings

Clarence and Pamela Cummings filed a petition for a Chapter 7 bankruptcy in a federal bankruptcy court. After the Cummings filed two amended versions of the required schedules, the trustee asked for additional time to investigate. The court granted the request. The Cummings then filed a third amended schedule in which for the first time they disclosed the existence of First Beacon Management Co., LLC, “the new corporate anchor of their post-petition fresh start.” The trustee claimed that the Cummings’ failure to disclose their interest in First Beacon as debtor property was a “false oath relating to a material fact made knowingly and fraudulently” in violation of the Bankruptcy Code. The court agreed and denied a discharge. The debtors appealed.

The Bankruptcy Appellate Panel and the U.S. Court of Appeals for the Ninth Circuit affirmed. “The sequence of debtors' filings substantiates the presence of fraud.”

..................................................................................................................................................

Notes and Questions

What might the debtors have done to avoid an unfavorable result in this case? The debtors should have been more careful with their paperwork. They should have fully disclosed their interest in First Beacon in their first schedules, or they should satisfactorily explained why it was not mentioned at that time (or in the amendments)—because it had not yet been in existence, for example, or its omission had not been intentional—and assert that they had acted in good faith.

In any event, it is not likely that the debtors could have successfully avoided disclosing the existence of First Beacon, nor is it likely that they could have avoided the inclusion of its assets in the estate in bankruptcy.

A discharged debt is not treated as taxable income. If it were, how would a debtor’s situation be different? If a discharged debt were treated as taxable income, a debtor would be required to pay income tax on the amount of the discharged debt. Considering the lack of finances that most discharged debtors face, this would in effect trade one nondischargeable debt for another. There might then be no point in many cases for debtors to file for discharges in bankruptcy.

J. REAFFIRMATION OF DEBT

1. ProceduresA reaffirmation agreement must be filed with the court before a discharge is granted. Court approval may be required, and a reaffirmation will be denied if it would create undue hardship on the debtor.

2. Required DisclosuresCreditors must disclose to the debtor the amount of the debt reaffirmed, the date payments begin, and the right to rescind.



V. Chapter 11—Reorganization• Corporations commonly use Chapter 11, but any debtor (except a stockbroker or a commodities broker)

eligible for Chapter 7 is eligible for Chapter 11.

• The same principles cover Chapter 7 and Chapter 11 proceedings (a case may be voluntary or involuntary, the automatic stay rules apply, and so on).

• Under Chapter 11, creditors and debtor plan for the debtor to pay some debts, be discharged of the rest, and continue in business.

A. WORKOUTSWorkouts are sometimes used in place of bankruptcies.

B. REASONS FOR DISMISSALAfter notice and a hearing, a court may dismiss a case “for cause” to better serve creditors’ interests.

C. DEBTOR IN POSSESSIONA 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.

D. CREDITORS’ COMMITTEESA 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 PLANThe plan must—

• Designate classes of claims and interests.• Specify the treatment to be afforded the classes (the same per each creditor in a class).• Provide adequate means for execution.• Provide for payment of tax claims over a five-year period.

1. Filing the PlanA debtor may file a plan within the first 120 days (to eighteen months) after the date of the order for relief. If the debtor does not meet the deadline, any party may propose a plan.

2. Acceptance and Confirmation of the 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.

• For an individual, confirmation requires payment of domestic-support obligations. For a small business, confirmation must occur within forty-five days. 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.



3. DischargeA plan is binding on confirmation. Claims are not discharged if they would be denied in a liquidation proceeding. An individual debtor is not discharged until a plan’s completion.

ENHANCING YOUR LECTURE—

WHAT CAN YOU DO TO PREPARE

FOR A CHAPTER 11 REORGANIZATION? Chapter 11 of the Bankruptcy Code expresses the broad public policy of encouraging commerce. To this

end, Chapter 11 allows a financially troubled business firm to petition for reorganization in bankruptcy while it is still solvent so that the firm’s business can continue. Small businesses, however, do not fare very well under Chapter 11. Although some corporations that enter Chapter 11 emerge as functioning entities, very few smaller companies survive the process. The reason is that Chapter 11 proceedings are prolonged and extremely costly, and whether a firm survives is largely a matter of size. The greater the firm’s assets, the greater the likelihood it will emerge from Chapter 11 intact.

PLAN AHEAD

If you ever are a small-business owner contemplating Chapter 11 reorganization, you can improve your chances of being among the survivors by planning ahead. To ensure the greatest possibil ity of success, you should take action before, not after, entering bankruptcy proceedings. Your first step, of course, should be to do everything possible to avoid having to resort to Chapter 11. Discuss your financial troubles openly and cooperatively with creditors to see if you can agree on a workout or some other arrangement.

If you appear to have no choice but to file for Chapter 11 protection, try to interest a lender in loaning you funds to see you through the bankruptcy. If your business is a small corporation, you might try to negotiate a favorable deal with a major investor. For example, you could offer to transfer ownership of stock to the investor in return for a loan to pay the costs of the bankruptcy proceedings and an option to repurchase the stock when the firm becomes profitable again.

CONSULT WITH CREDITORS

Most important, you should form a Chapter 11 plan prior to entering bankruptcy proceedings. Consult with creditors in advance to see what kind of a plan would be acceptable to them, and pre pare your plan accordingly. Having an acceptable plan prepared before you file will expedite the proceedings and thus save substantially on costs.

CHECKLIST FOR THE SMALL-BUSINESS OWNER

1. Try to negotiate workouts with creditors to avoid costly Chapter 11 proceedings.

2. If your business is a small corporation, see if a major investor will loan you funds to help you pay bankruptcy costs in return for stock ownership.

3. Consult with creditors in advance, and have an acceptable Chapter 11 plan prepared before filing to expedite bankruptcy proceedings and save on costs.



VI. Bankruptcy Relief under Chapter 12 and Chapter 13A. FAMILY FARMERS AND FISHERMEN—CHAPTER 12

Chapter 12 is for a family farmer or fisherman, as defined in the Code.

• Family farmer—one whose gross income is at least 50 percent farm dependent and whose debts—which cannot exceed $4,031,575—are at least 50 percent farm-related. This includes partnerships and close corporations that are at least 50 percent owned by a farm family.

• Family fisherman—one whose gross income is at least 50 percent dependent on commercial fishing and whose debts—which cannot exceed $1,868,200—are at least 80 percent related to commercial fishing. This includes partnerships and close corporations that are at least 50 percent owned by a fisherman’s family.

1. Filing the PetitionA Chapter 12 filing is similar to a Chapter 13 filing. The debtor must file a plan not later than ninety days after the order for relief. The filing of the petition acts as an automatic stay against creditors’ and co-obligors’ actions against the estate.

2. Content and Confirmation of the PlanThe content of a plan under Chapter 12 is basically the same as that of a Chapter 13 repayment plan. The plan can be modified by the debtor but generally must be confirmed or denied within forty-five days of the filing of the plan.


Adequate Protection 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. 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. BANKRUPTCYCHAPTER 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. >

B. INDIVIDUALS’ REPAYMENT PLANS—CHAPTER 13Individuals (not partnerships or corporations) with regular income who owe fixed unsecured debts or fixed secured debts of less than certain statutorily specified amounts may use Chapter 13.

1. Filing the PetitionOnly a debtor can initiate a Chapter 13 case. Certain Chapter 7 and Chapter 11 cases may be converted to Chapter 13 cases. The automatic stay applies in Chapter 13 cases to consumer debt but not business debt or domestic-support obligations.

2. Good Faith RequirementA debtor must act in good faith at the time of the filing of the plan and the filing of the petition.

CASE SYNOPSIS—

Case 26.3: In re Welsh

David and Sharon Welsh filed a Chapter 13 petition. The bankruptcy trustee objected to the Welshes' proposed plan on the ground that it was not proposed in good faith because of the “minuscule” payments to unsecured claims while they were living in a $400,000 home, making payments on various luxury and unnecessary items, and failing to commit 100 percent of their disposable income—from which their Social Security income was excluded—to the plan (which would pay off about $14,700 of $180,500 of the debt).



From a judgment in the Welshes’ favor, the trustee appealed.

The U.S. Court of Appeals for the Ninth Circuit affirmed. “Under the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), the calculation of ‘disposable income’ incorporates the definition of ‘current monthly income,’ and the definition of ‘current monthly income’ excludes Social Security income.”

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Notes and Questions

Should a debtor be required to attempt to negotiate a repayment plan with a creditor to show good faith? Why or why not? No. A debtor's effort to negotiate a repayment plan certainly demonstrates good faith, but courts have rejected a rule that a debtor’s failure to make such an attempt shows a lack of good faith. It is possible that, for example, a debtor might not know about alternative repayment options. A better picture emerges from a debtor’s living conditions, assets and liabilities, ability or inability to work, and attempts to find work.

What Bankruptcy Code requirements were at the center of this case? There were two Bankruptcy Code requirements at the center of this case—good faith and the calculation of “disposable income” under Chapter 13.

The Code imposes the requirement of good faith on a debtor at both the time of the filing of the petition and the time of the filing of the plan. Good faith is not defined, but if the circumstances on the whole indicate bad faith, a court can dismiss a debtor’s bankruptcy petition.

Debtors with above-median income are required to calculate their “disposable income” by subtracting specific expenses from “current monthly income.” Expressly excluded from “current monthly income” are Social Security benefits. In other words, a debtor who receives Social Security income does not have to account for that income when calculating “disposable income.” The debtor then subtracts living expenses based on the Internal Revenue Service's “Collection Financial Standards,” a detailed series of averages for living expenses that the Service uses to calculate necessary expenditures for delinquent taxpayers. The debtor also subtracts his averaged payments to secured creditors due during the following sixty months. These calculations were added to the Code in the Bankruptcy Abuse Prevention and Consumer Protection Act, which Congress enacted in 2005.

On what ground did the trustee contend that the debtors had not proposed their Chapter 13 plan in good faith? The trustee argued that, in determining whether the Welshes proposed their Chapter 13 plan in good faith, the bankruptcy court should have considered Welsh's Social Security income. According to the trustee, the Welshes' failure to dedicate this income to the payment of unsecured creditors compels the conclusion that the plan was not proposed in good faith.

How did the court rule with respect to the trustee’s argument? The court concluded that the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), which expressly excludes Social Security benefits from the calculation of “current monthly income” and “disposable income,” “forecloses a court's consideration of a debtor's Social Security income * * * as part of the inquiry into good faith.”

The court reasoned that to conclude otherwise “would be to allow the bankruptcy court to substitute its judgment of how much and what kind of income should be dedicated to the payment of unsecured creditors for the judgment of Congress. Such an approach would not only flout the express language of Congress, but



also one of Congress's purposes in enacting the BAPCPA, namely to reduce the amount of discretion that bankruptcy courts previously had over the calculation of an above-median debtor's income and expenses.

SPECIAL EXHIBIT—

The Bankruptcy ProcessThe following illustration outlines the basic steps in the bankruptcy process for a non-business debtor.


BANKRUPTCY PETITION—MEANS TEST• Certain expenses are exempted to determine whether a debtor

can pay 25 percent of unsecured debt.• Income is compared to debtor’s state’s median to determine

whether a Chapter 7 filing is permissible.

CHAPTER 7With exceptions, assets are liquidated to pay creditors.

CHAPTER 13Under a court-approved five-year plan, a debtor lives on a

strict budget.

CREDIT-COUNSELINGDebtor must meet with a counselor within six months

before filing for bankruptcy.

CREDITOR-APPROVEDDEBT-MANAGEMENT

PLAN

PAYMENTS NOT MADE

PAYMENTS MADE

Filing is converted to

Chapter 7 proceeding.

Case is dismissed.

Hardship discharge is

granted.

Plan is revised.

MONEY MANAGEMENT CLASS• Debtor attends this class at the debtor’s expense.

• Debts are discharged as permitted under the applicable Chapter.

OR

OR

OR

OR


3. The Repayment PlanOnly a debtor may file a plan. This plan may provide for the payment of all obligations in full or for payment of an amount less than 100 percent. The plan must provide for—

• Turnover of the debtor’s future earnings or income to the trustee to execute the plan.• Full payment of all claims entitled to priority. Payments must be completed within three to five

years, depending on the debtor’s family income.• The same treatment of each claim within a particular class of claims.

a. The Length of the PlanSubject to the means test for family median income, the time for payment may not exceed three years unless the court extends it to five years.

b. Confirmation of the PlanA plan will be confirmed in a hearing twenty to forty-five days after the creditors’ meeting if—

• Secured creditors accept it.• It provides that creditors retain their liens.• The debtor surrenders property securing the claims to the creditors.• Creditors with purchase-money security interests in (a) motor vehicles bought within 910

days of a petition retain their liens until they are paid in full and (b) other personal property bought within one year are covered by the plan.

c. DischargeMost debts are dischargeable, except—

• Claims allowed by the plan.• Certain taxes and payments on retirement accounts.• Claims for domestic-support obligations.

TEACHING SUGGESTIONS

1. It is important that students tie together the material on debtors and creditors. You might ask them (or explain to them) what the law attempts to do in this area and why—that the legal system attempts to pro vide a framework for the orderly collection of debts and that without that framework few could afford to provide credit.

2. To distinguish for students among the various creditors’ remedies discussed in this chapter, use a timeline representing litigation on a debt and place each remedy at the point on the line when it might be used.

3. It may help students to understand how this material fits into the general scheme of creditors’ rights and remedies by briefly defining and classifying liens, and noting the priority of a lien creditor. For example: A lien is a claim against a debtor’s property that must be satisfied before the property (or its proceeds) is available to satisfy other creditors’ claims. Consensual liens—those based on the parties’ agreement—in-



clude perfected security interests, in the case of personal property, and mortgages, in the case of real estate. A lien may also arise under a statute or the common law or through a judicial proceeding. Statutory liens in-clude mechanic’s liens. Liens created at common law include artisan’s liens and innkeeper’s liens. Judicial liens include those that represent a creditor’s efforts to collect on a debt before a judgment (for example, through prejudgment attachment) or after it (for example, through a writ of execution). A lien creditor has priority only to the extent of the value of his or her collateral. Generally, a lien creditor has priority over an unperfected security interest but not over a perfected security interest. Mechanic’s liens and artisan’s liens, however, have priority over perfected security interests unless a statute provides otherwise.

4. Sometimes, students confuse prejudgment attachment with the concept of attachment in the context of a secured transaction. For that reason, it can be important to explain the difference. Prejudgment attachment occurs at the time of or immediately after commencement of a suit but before entry of a final judgment. Attachment in the context of a secured transaction occurs when all of the requirements for an enforceable security interest are satisfied and before the interest is perfected.

5. It could be explained that there are four types of statutory foreclosure: (1) strict foreclosure, allowed in a few states in which, after a period following default, the mortgagee acquires absolute title to the property; (2) entry, or writ of entry, allowed in a few states in which, on default, the mortgagee obtains a writ entitling him or her to possession, and after a period, the mortgagee receives absolute title; (3) power of sale, permitted in most states, according to which a sale can follow guidelines stated in the mortgage agreement instead of statutory guidelines; and (4) foreclosure sale, the usual method. The last type of foreclosure is discussed in the text.

6. 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.

7. 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.)

8. 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 resid ing within their borders. As an additional assignment, students could be asked to research their state’s exemp-tions 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.

9. 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 2007 to fin ish graduate school. Art graduates in June 2008. The first installment payment comes due in December, but Art has not found a job and obtains a one-time six-month suspension of payments. In June 2015, 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.



10. From a creditor’s point of view, there are several steps to take to assure the payment of a debt before a petition in bankruptcy is filed. These include the following.

• Obtain personal and corporate guaranties in credit agreements.• Obtain collateral for credit.• Perfect a security interest according to UCC Article 9.

Once a petition has been filed, to try to recoup payment, a creditor might do the following.

• Stop the delivery of goods in transit (see UCC Article 2).• File a proof of claim.• Ask the court to lift the automatic stay.• Object to plans and statements that are not proposed in good faith.

11. Obtain copies of a mortgage contract and ask students to discuss whether the apportionment of rights and duties between borrower and lender is fair and appropriate. Ask them for suggestions as to how these contracts could be improved and whether the borrower or lender should be better protected. The same activity could be repeated with a real estate sales contract.

12. It could be explained that there are four types of statutory foreclosure—

• Strict foreclosure is allowed in a few states in which, after a period following default, the mortgagee acquires absolute title to the property.

• Entry, or writ of entry, is allowed in a few states in which, on default, the mortgagee obtains a writ entitling him or her to possession, and after a period, the mortgagee receives absolute title.

• Power of sale is permitted in most states, according to which a sale can follow guidelines stated in the mortgage agreement instead of statutory guidelines.

• Foreclosure sale (discussed more fully in the text) is the most common method.

Cyberlaw Link

How might the availability of personal financial information on the Internet affect the debt and credit arrangements outlined in this chapter? What role might the Internet play in the context of bankruptcy proceedings?

If a mortgage can be negotiated and agreed to online, rather than by taking papers to a creditor’s or third party’s office, what effect might this have in disputes over compliance with the terms of the agreement?

DISCUSSION QUESTIONS

1. What is the usual method of mortgage foreclosure? The usual method of foreclosure is a judicial sale at which the mortgaged real estate is sold. If the sale proceeds cover the mortgage debt and foreclosure costs, the debtor receives any surplus. If the proceeds do not cover the debt and costs, the mortgagee can seek to recover the



difference through a deficiency judgment, which is obtained in a separate action. A deficiency judgment enti tles the creditor to recover this difference from a sale of a debtor’s other nonexempt property. Before a foreclosure sale, a mortgagor can redeem the property by paying the debt, plus any interest and costs. (This right is known as the equity of redemption. In some states, a mortgagor may redeem property within a certain time—called a statutory period of redemption—after the sale.)

2. How might a notice of default and foreclosure actually benefit a debtor? A debtor benefits most from having a debt forgiven and paying a debt is the most common method to accomplish this end. If a notice of default and foreclosure prompts an otherwise tardy debtor into paying down a debt, the debtor benefits by preventing damage to his or her credit ratings. Other debtors also benefit because creditors are encouraged to make more credit available, and can afford to do so at a cheaper price because the number of defaults is reduced.

3. Should the federal government regulate the advertising of real property and mortgages on the Internet to protect consumers from potential fraud? If so, what kind of regulations would be appropriate, and how might they be enforced? Yes, because the possibility that real estate buyers and sellers might otherwise be deceived by misleading or false advertising is too great and the consequences too severe. Appropriate regulations might resemble those that already exist to regulate real estate and mortgages and other advertising at the federal level. No, although some applicable federal regulation of marketing already exists, because the states should more appropriately regulate the advertising of real property and mortgages and other aspects of such transactions that occur within their borders.

4. Who can use Chapter 7? Any debtor, which is 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.

5. 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 prior ity 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). A trustee cannot avoid a transfer that was a bona fide payment of a domestic support debt, however.

6. 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, or the automatic stay is terminated.) 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 credi-



tors’ claims. If the collateral’s value is less than the debt, the secured creditor becomes an unsecured creditor for the difference.

7. 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).

8. Who is eligible for relief under Chapter 13? Individuals (not partnerships or corporations) with regular income who owe fixed unsecured debts of less than a certain statutorily prescribed amount or fixed secured debts of less than a certain statutorily prescribed amount may use Chapter 13.

9. 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.

10. Who is eligible for relief under Chapter 12? Any family farmer, with gross income at least 50 percent farm dependent and debts at least 50 percent farm related, or family fisherman, with gross income at least 50 percent dependent on commercial fishing operations and debts at least 80 percent related to a commercial fishing, or any partnership or closely held corporation at least 50 percent owned by a family farmer or fisherman, when total debt does not exceed a specified amount ($3.237 million for farmers and $1.5 million for fishers), can file for relief under Chapter 12.

ACTIVITY AND RESEARCH ASSIGNMENTS

1. Ask each student to draft a mortgage document providing for a certain type of loan.

2. Have students research local cases concerning the mortgages, foreclosures, and laws discussed in this chapter. In some communities, there is an abundance of such cases. Local newspapers and local courthouses are potential sources. Specific topics or specific cases could be assigned to students individually, in small groups, or to the class as a whole. Once they have looked at some of the cases, ask students under what common fact situations the legal issues tend to arise. What might the parties in these cases have done to avoid foreclosure or further

3. Have students find and read their state’s exemption statutes to determine what property is exempt from creditors’ actions. Ask them to identify the amount of the homestead exemption and whether it has any restrictions, and what kind and amount of personal property is exempt.

4. 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.)

5. If the bankruptcy court in your district is 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 10: Stefanie Kuehn, an art teacher, obtained a master’s degree at Cardinal Stritch University in Wisconsin. But when Kuehn asked for a transcript—which was required to receive an increase in salary from her school district—the university refused because she owed more than $6,000 in tuition. Kuehn offered to pay the nominal transcript fee but not the tuition. She then filed a petition in a federal bankruptcy court, listing the university as her only creditor, and while the case was pending, again asked for a transcript. The university again refused unless she paid the tuition. Kuehn complained to the court, which ordered the university to provide a transcript. A federal district court affirmed the order. The university appealed. In In re Kuehn, the U.S. Court of Appeals for the Seventh Circuit affirmed. Kuehn had a right to a copy of her transcript, and the university’s refusal to honor that right until she paid her tuition was an act to collect a debt in violation of the automatic stay. Property interests are created and defined by the law. Nothing in the Bankruptcy Code or other federal law creates or affects property rights in grades or the right to a transcript. No Wisconsin statute applies either, but under the state’s common law, property rights may arise from custom. In Wisconsin, universities have consistently provided certified transcripts at or around cost. This indicates that providing a transcript is an implied part of the “educational contract,” covered by the tuition and other fees. Because a transcript is part of the package of goods and services that a college offers in exchange for tuition, a student has a property right to a certified copy. In this case, Kuehn was willing to pay the cost. The university’s only reason for refusing to provide the transcript was to induce Kuehn to pay her unpaid tuition. But the automatic stay prohibits a creditor from acting to collect a claim against a debtor that arose before the filing of a bankruptcy petition.

Suppose that instead of offering to pay for a transcript, Kuehn had tried to obtain one on credit. Would the university’s refusal to provide one on that basis have led to the same result? Why or why not? If Kuehn had tried to buy a transcript on credit—in other words, to borrow more than she already owed—the university could refuse without violating the automatic stay. The automatic stay applies only when a creditor acts to collect a debt. A creditor can consider a debtor’s creditworthiness in deciding whether to extend more credit.

What actions might a college take to collect unpaid tuition that would not violate the Bankruptcy Code? The court reasoned that “the University is unable to collect Kuehn’s tuition only because it was careless. When Kuehn failed to pay her mounting bills the University could have refused to let her enroll in new classes. It could have refused to let her take exams. It could have refused to award a degree. Or the University could have required Kuehn to borrow from a third party to pay for her education. Student loans are not dischargeable unless a debtor can show undue hardship, and it is unlikely that Kuehn could have shown undue hardship. She was gainfully employed, and her debt to the University was substantially less than the extra income the master’s degree afforded. Presumably the University will protect itself in one or more of these ways in the future.”

Does the longstanding existence of a custom—in this case, the nominal amount of the fee charged by a college for a transcript—mean that it cannot change? No, and increasing the fee would not undercut a student’s property right to a transcript. The court in this case offered as an analogy the fact that “airlines used to carry checked baggage without a fee. But nobody . . / would conclude that United Airlines is depriving passengers of their property when it now charges for checked bags. The cost of checking baggage is determined by contractual rights that can be altered by the parties.” Thus, in the case of a university, the school “could announce to future students that transcript fees would reflect the value of the education.”

To avoid conflicts such as the one in this case, could a college charge a student a high fee for a transcript—for example, one that would equal the amount of any unpaid tuition? A provider of goods and



services is normally free to charge whatever the market will bear, and there is no law that limits the price of transcripts. Universities have consistently provided transcripts at or around cost, however. Along the line of reasoning in this case, it could be argued that providing a transcript is an implied part of the educational contract, covered by the fee for the course hours, for which a student has already paid. A college could not charge extra if the fee for instruction covers transcripts.

Footnote 13: Keldric Mosley incurred student loans while attending Georgia’s Alcorn State University. Medical problems from injuries received during training with the U.S. Army Reserve Officers' Training Corps led him to quit school. He left Alcorn to live with his mother in Atlanta. He worked briefly for several employers, but was unable to keep a job. By 2004, his monthly income consisted primarily of $210 in disability benefits from the Veterans' Administration. Homeless, under medication, and in debt for $45,000 to Educational Credit Management Corp., Mosley obtained a discharge under Chapter 7 of his student loans on the basis of undue hardship. Educational Credit appealed. In In re Mosley, the U.S. Court of Appeals for the Eleventh Circuit affirmed the lower court’s discharge of the student loans. Mosley’s medical problems, lack of skills, and “dire living conditions” made it unlikely that he would be able to hold a job and repay the loans. Furthermore, the debtor “has made good faith efforts to repay his student loans and would suffer undue hardship if they were excepted from discharge.” The court measured good faith “by the debtor's efforts to obtain employment, maximize income, and minimize expenses; his default should result, not from his choices, but from factors beyond his reasonable control.”

Is a debtor's failure to make a payment on a loan or present inability to make payments sufficient to show good faith? No. The court emphasized that “a debtor's failure to make a payment, standing alone, does not establish a lack of good faith.” The court also explained that “undue hardship does not exist simply because the debtor presently is unable to repay his or her student loans; the inability to pay must be likely to continue for a significant time such that there is a certainty of hopelessness that the debtor will be able to repay the loans within the repayment period.”

A discharged debt is not treated as taxable income. If it were, how would a debtor’s situation be different? If a discharged debt were treated as taxable income, a debtor would be required to pay income tax on the amount of the discharged debt. Considering the lack of finances that most discharged debtors face, this would in effect be to trade one nondischargeable debt for another. There might then be no point in many cases for debtors to file for discharges in bankruptcy.

Should a debtor be required to attempt to negotiate a repayment plan with a creditor to demonstrate good faith? Why or why not? Educational Credit argued in part that the good faith requirement obligated Mosley to attempt to negotiate a repayment plan under the “Income Contingent Repayment Program.” The court disagreed. “While a debtor's effort to negotiate a repayment plan certainly demonstrates good faith, courts have rejected a per se rule that a debtor cannot show good faith where he or she has not enrolled in the Income Contingent Repayment Program. . . . In this instance, it is questionable whether Mosley even knew about alternative repayment options, and, in light of his dire living conditions and persistent inability to obtain steady work, the bankruptcy court had sufficient evidence from which to conclude that these options would not have provided Mosley a realistic solution to his inability to pay.” The court also cited Mosley’s attempts to find work.

If this debtor were to relocate to a country with a lower cost of living than the United States, should his change in circumstances be a ground for revoking the discharge? Explain your answer. No, this would not constitute a ground for a revocation of the debtor’s discharge. A discharge may be revoked within a year if it is discovered that the debtor acted fraudulently or dishonestly during the bankruptcy proceeding, but this question does not indicate either circumstance.


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