Commercial Law (Mgmt 348)

Professor Charles H. Smith

Bankruptcy Law (Chapter 30)

Spring 2011

Introduction to Bankruptcy Law

• Bankruptcy filing is designed to provide debtor with relief from creditors and opportunity to get “fresh start.”

• Traditionally, bankruptcy filing viewed with suspicion since debtor often pays pennies on the dollar or may avoid debts entirely; or, as last resort.

• Now viewed as legitimate business strategy, especially reorganization under Chapter 11.

Introduction to Bankruptcy Law cont.

• Types of bankruptcy relief– Chapter 7 – liquidations.– Chapter 9 – municipalities (e.g., Orange County in

1994).– Chapter 11 – reorganizations.– Chapter 12 – family farmers and fishermen.– Chapter 13 – all other individuals.– We will cover Chapters 7 and 11 only.

Automatic Stay

• Upon any bankruptcy filing, automatic stay goes into effect (slang – “auto stay”).

• Prevents most creditors from taking any action – outside of bankruptcy court – to obtain relief against debtor, including– Formal collection efforts as such filing or

continued prosecution of lawsuit vs. debtor or enforcing judgment already obtained vs. debtor.

– Informal collection efforts such as contacting debtor by phone, etc.

Automatic Stay cont.

• Some creditors can obtain relief from the auto stay and therefore pursue collection efforts.

• Auto stay will terminate 60 days after request for relief unless court orders or parties agree otherwise; other limits apply if debtor has had previous bankruptcy filings dismissed.

• Adequate protection doctrine protects secured creditors from loss of security due to bankruptcy filing, so court may order debtor’s payment(s) to creditor.

• Auto stay does not apply to domestic support obligations or family law proceedings, eviction actions based on pre-filing judgment, or investigations by securities regulatory agency.

Liquidations – Chapter 7

• Debtor turns all assets over to trustee appointed by bankruptcy court.

• Trustee then sells assets and distributes proceeds to creditors.

• Debtor’s debts are then discharged (no further obligation).

• Many Chapter 7 filings are voluntary though some are involuntary (see following slides).

Liquidations – Chapter 7 cont.

• Voluntary filing by debtor– Debtor must receive credit counseling from approved non-

profit agency within 180 days before filing.– Debtor must file schedules (see list on page 613); filing may

be dismissed otherwise.– “Substantial abuse” presumed if debtor’s family income

greater than median family income in state of filing; presumption can be rebutted “by demonstrating special circumstances that justify additional expenses or adjustments of currently monthly income for which there is no reasonable alternative” (e.g., medical bills).

– Order for relief – court’s grant of assistance to debtor – will be entered once filing found to be proper.

Liquidations – Chapter 7 cont.

• Involuntary filing by debtor’s creditors– 12 or more creditors – 3 or more creditors having unsecured

claims of at least $13,475 must join filing.– Fewer than 12 creditors – one or more creditors having claim

of $13,475 may file.– Order for relief will be entered if either

• Debtor generally not paying debts as they become due, or• General receiver, assignee or custodian took possession

of, or was appointed to take charge of, substantially all of debtor’s property within 120 days before filing.

– If order for relief entered, then debtor must file schedules and provide information just like voluntary filing.

Liquidations – Chapter 7 cont.

• Bankruptcy “estate” is comprised of property held by the debtor’s at the time of filing plus certain property to which debtor becomes entitled within 180 days after filing.

• Withholdings for debtor’s employee benefit plan contributions excluded from estate.

• Proof of claim must be filed by creditor to create entitlement receive portion of estate.

• Exemptions – see list on pages 617-18, though state may preclude debtor from using exemptions provided by federal law; instead, exemptions provided by state law only.

Liquidations – Chapter 7 cont.

• Trustee is responsible for– Collecting debtor’s assets, sell the assets for cash, and

then distribute the cash to creditors.– Reviewing bankruptcy filing for substantial abuse.– Avoiding fraudulent transfers made or obligations

undertaken by debtor; fraudulent transfer/obligation is one made within 2 years of filing or made with actual intent to hinder, delay or defraud creditor; transfer for less than reasonably equivalent consideration may also be avoided if, by making it, debtor became insolvent or intended to incur debts he/she could not pay.

Liquidations – Chapter 7 cont.

• See Exhibit 30-1 (page 620) regarding collection and distribution of assets in typical voluntary bankruptcy.

• Once debtor’s assets liquidated and distribution to creditors made, debtor’s debts are discharged – i.e., debtor has no further obligation as to these debts (this includes judgments entered before filing).

• Some debts not dischargeable, such as debts based on debtor’s fraudulent or otherwise intentional conduct; some student loans are not dischargeable unless having to repay them would be “undue hardship.”

Reorganizations – Chapter 11

• Now viewed as legitimate business strategy for struggling business that wants to continue.

• Filing principles same for Chapters 7 and 11.• Focus on whether Chapter 11 filing is in creditors’

best interests.• Usually, debtor stays in possession though court

may appoint receiver to operate/supervise the debtor.

Reorganizations – Chapter 11

• Debtor must file reorganization plan that is fair and equitable – see list on page 625.

• Creditors’ committee often formed which is comprised of unsecured creditors – consults with trustee or debtor about case administration or formulation of reorganization plan.

Case Studies

• Hebbring v. U.S. Trustee, 463 F.3d 902 (9th Cir. 2006) (pages 614-15) – “substantial abuse.”

• In re Mosley, 494 F.3d 1320 (11th Cir. 2007) (pages 621-23) – “undue hardship.”

• Case Problem 30-4 (page 632) – automatic stay.• Case Problem 30-6 (page 632) – “additional

circumstances.”