Chapter 19: Creditors’ Rights and Bankruptcy

Chapter 1: Legal EthicsCHAPTER 19: CREDITORS’

RIGHTSAND BANKRUPTCY

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Learning Objectives1. What is a prejudgment attachment?

What is a writ of execution? How does a creditor use these remedies?

2. What is garnishment? When might a creditor undertake a garnishment proceeding?

3. In a bankruptcy proceeding, what constitutes the debtor’s estate in property? What property is exempt from the estate under federal bankruptcy law?

Learning Objectives4. What is the difference between an

exception to discharge and an objection to discharge?

5. In a chapter 11 reorganization, what is the role of the debtor in possession?

Introduction• Liens.• Garnishment.• Creditors’ Composition Agreements.• Suretyship.• Guaranty.

Laws Assisting Creditors• Liens.– Encumbrance on property to satisfy a debt or

protect a claim for the payment of debt.

Laws Assisting Creditors• Liens.–Mechanic’s Liens: security for labor,

materials, or service on real estate. CASE 19.1 BHP LAND SERVICES, INC. V. SEYMOUR (2011). What should Jean do next: settle with BHP, go through foreclosure, or appeal the case?

Laws Assisting Creditors Liens.–Artisan’s Lien. labor and materials on

personal property.–Judicial Liens: arises out of a court

decision. • Writ of Attachment: court orders sheriff to seize

non-exempt property. Writ of Execution: court order to seize and sell debtor’s non-exempt real and personal property to satisfy debt.

Laws Assisting Creditors Garnishment: permits a creditor to

collect a debt by seizing property of the debtor held by a third party (garnishee).–Typically the garnishee is the debtor’s

employer.–Garnishment Proceedings governed by

state law.

Laws Assisting Creditors Garnishment (cont’d). –Laws Limiting the Amount of Wages

Subject to Garnishment.• Both federal and state laws limit the

amount that can be taken out of a debtor’s take home pay.

Laws Assisting Creditors Creditors’ Composition Agreement.–Creditors take less than owed on a

liquidated debt.–Binding on those who agree because

consideration given by each depending on one another.

Laws Assisting Creditors Suretyship: promise by a third person

to be primarily liable for the debtor’s obligation to the creditor.–Express contract between surety and the

creditor.–Creditor can demand payment from

surety at any time after debt is due.

Laws Assisting Creditors Suretyship: (cont’d). –Creditor need not exhaust all legal

remedies against the debtor before holding the surety responsible.

Ex. 19-1 Suretyship and Guaranty Parties

Laws Assisting Creditors• Guaranty: third person making the guaranty is

secondarily liable.– Guarantor is liable only after the principal debtor

defaults.– Statute of Frauds requires guaranty to be in

writing, unless main purpose exception applies.

Laws Assisting Creditors• Suretyship and Guaranty.– Actions Releasing Surety and Guarantor: same as

those that will discharge the guarantor.– Defenses: Surety can use any of the principal

debtor’s defenses EXCEPT incapacity, bankruptcy, or statute of limitations.

Laws Assisting Creditors• Suretyship and Guaranty.– Defenses.• Surety can use his own defenses, EXCEPT fraud

between debtor and surety that is unknown by creditor.• Material contract modification between debtor and

creditor will release a gratuitous surety and a compensated surety to the extent he suffers a loss.

Laws Assisting Creditors• Suretyship and Guaranty.– Rights of the Surety and Guarantor.• Right of Subrogation.• Right of Reimbursement.• Right of Contribution.–Sureties in equal amounts.–Sureties in equal amounts, one or more co-

sureties missing or insolvent.

Protection for Debtors Exempted Real Property.–Homestead: state laws permit entirely

or up to a certain dollar amount. Exempted Personal Property.–Household furniture up to certain limit.–Clothing and personal possessions.–Vehicle for transportation.

Protection for Debtors Exempted Personal Property (cont’d).–Certain classified animals.–Equipment debtor uses in a trade or

business, up to certain dollar amount.

Bankruptcy Law Bankruptcy Courts. Types of Bankruptcy Relief. Special Requirements for Consumer

Debtors.

Bankruptcy Law Chapter 7 – liquidation. Chapter 11 – reorganizations. Chapter 12 - adjustment of debts of

family farmers and fishermen with regular incomes.

Chapter 13 - adjustment of debts of individuals with regular incomes.

Chapter 7-Liquidation Chapter 7: referred to as ordinary or

straight bankruptcy. –Debtor turns all assets over to the

bankruptcy trustee.–Trustee sells nonexempt property and

distributes the proceeds to the creditors. Remaining debts are discharged.

Chapter 7-Liquidation• Available for any person, individual,

corporation, partnership.• Railroads, insurance companies, banks,

savings and loan and investment companies licensed by the SBA, and credit unions cannot be debtors.

Chapter 7-Liquidation• Straight bankruptcy is commenced by the

filing of a voluntary or involuntary petition in bankruptcy with the bankruptcy court.– If a debtor files the petition, it is voluntary. – If creditors file a petition, it is involuntary.

Chapter 7-Liquidation Voluntary Bankruptcy.–Prior to filing, debtor(s) must receive

credit counseling within 180 days of filing, and submit certificate.–Debtor must confirm accuracy of

contents; attorney must file affidavit informing debtor about other chapters.

Chapter 7-Liquidation Voluntary Bankruptcy.–Chapter 7 Schedules.

1. A list of both secured and unsecured creditors, their addresses, and the amount of debt owed to each.

2. A statement of the financial affairs of the debtor.

Chapter 7-Liquidation Voluntary Bankruptcy.–Chapter 7 Schedules.• A list of both secured and unsecured creditors,

their addresses, and the amount of debt owed to each.• A statement of the financial affairs of the

debtor.• A list of all property owned by the debtor,

including property claimed by the debtor to be exempt.

Chapter 7-Liquidation Voluntary Bankruptcy.–Chapter 7 Schedules.• A listing of current income and expenses• A list of all property owned by the debtor,

including property claimed by the debtor to be exempt.• A certificate of credit counseling (as discussed

previously).

Chapter 7-Liquidation Voluntary Bankruptcy.–Chapter 7 Schedules.• A statement of the amount of monthly

income, itemized to show how the amount is calculated.• A copy of the debtor’s federal income tax

return for the most recent year ending immediately before the filing of the petition.

• Voluntary Bankruptcy.– Tax Returns During Bankruptcy.– Substantial Abuse—Means Test: to determine

whether debtor’s petition will be dismissed under Chapter 7. • Basic Formula: debtor’s average monthly income is

compared to median income in area where he lives. If below median income, no presumption of abuse.

Chapter 7-Liquidation

• Voluntary Bankruptcy.– Substantial Abuse—Means Test (cont’d)• Applying the Means Test to Future Disposable Income: if

debtor’s income is above the median income, then further calculations are necessary, including calculations of disposable income.

• Voluntary Bankruptcy.– Additional Grounds for Dismissal.• Conviction of violent crime or drug-trafficking.• Debtor fails to pay post-petition domestic-support

obligations.– Order for Relief.• If filing is proper, filing itself is an order for relief

• Involuntary Bankruptcy.– Creditors force debtor into bankruptcy. • If there are 12 or more creditors, need three or more

with unsecured claims totaling at least $14,425 to join in petition. If less than 3 creditors, one or more creditors with $14,425 debt may file.

• Involuntary Bankruptcy.– Debtor can challenge involuntary bankruptcy but

court will enter an order for relief if:• Debtor is not paying debts as they come due, OR• The debtor was in receivership for the 120 days before

filing the petition.

• Automatic Stay.– The moment a petition is properly filed, an

automatic stay is granted protecting debtor from all creditors.• Creditors cannot commence or continue most legal

actions.• Damages for knowing violation of stay.

• Automatic Stay.– Adequate Protection Doctrine: protects secured

creditors from losing their security interest due to the automatic stay.

• Automatic Stay.– Exceptions to the Automatic Stay.• Domestic Support Obligations.• Proceedings against Debtor related to divorce,

support, custody, and maintenance.• Investigations by securities regulatory agency.

– Limitations on the Automatic Stay.• Secured party can petition bankruptcy court for

relief from automatic stay.

• Bankruptcy Estate.– Debtor’s Estate includes:• All Debtor’s legal and equitable interests in property

presently held, including community property;• Property transferred in a “voidable” transaction; and • Property which Debtor becomes entitled within 180 days

after filing.

• Bankruptcy Estate.– Debtor’s Estate includes:• Proceeds and profits from the property of the estate.• After-acquired property such as inheritances, property

settlements, and life insurance death proceeds.

• Bankruptcy Estate.– Debtor’s Estate includes:• Proceeds and profits from the property of the estate.• After-acquired property such as inheritances, property

settlements, and life insurance death proceeds.

• Bankruptcy Trustee.– Appointed by Court: duties include collecting assets

and paying creditors in order of priority.• Duties for Means Testing: to determine whether there is

substantial abuse. Must file statement within 10 days after 1st meeting with creditors.

• Bankruptcy Trustee.– Trustee’s Powers: has right to ‘strong arm’

creditors return debtor’s property to trustee. • Has “Avoidance Powers” to set aside certain transfers:–Voidable Rights. –Preferences. –Fraudulent Transfers.

• Bankruptcy Trustee.– Trustee’s Powers.• Voidable Rights: Trustee can stand in shoes of

debtor and assert any lack of capacity or lack of assent.

• Bankruptcy Trustee.– Trustee’s Powers.• Preferences. –Debtor is not permitted to transfer property or

make a payment that favors—or gives a preference to—one creditor over another. –For a Trustee to recover payment, debtor must

be insolvent and transferred property for preexisting debt within previous 90 days.

• Bankruptcy Trustee.– Trustee’s Powers.• Preferences. –Preferences to Insiders: avoidance power of Trustee

extends to transfers made within ONE YEAR before filing.–Transfers That Do NOT Constitute Preferences:

payments for services within 15 days, payments made in ordinary course of business, and generally debts that are not preexisting.

• Bankruptcy Trustee.– Trustee’s Powers.• Fraudulent Transfers. Trustee may avoid fraudulent

transfers if made: (1) within two years of filing of petition, or (2) with actual intent to hinder, delay or defraud a creditor.

Chapter 7 - Exemptions(See Pages 376-377)

1. Up to $21,625 in equity in the debtor’s residence and burial plot (the homestead exemption).

2. Interest in a motor vehicle up to $3,450.

3. Interest, up to $550 for a particular item, in household goods and personal effects (up to $11,525).

4. Interest in jewelry up to $1,450. 5. Interest in any other property up to

$1,150, plus any unused part of the $21,625 homestead exemption up to $10,825.

6. Interest in any tools up to $2,175.7. A life insurance contract owned by the

debtor.

8. Certain interests in accrued dividends and interest not to exceed $11,525.

9. Professionally prescribed health aids. 10.Social Security and other benefits. 11.The right to receive certain personal-

injury and other awards up to $21,625.

Chapter 7-Liquidation Homestead Exemption.–Places limits on the amounts of home

equity debtors can shield from creditors.–Debtor must have lived in state two

years prior to filing.–Maximum equity: $146,450, if within

previous 3.5 years of filing.

• Creditors’ Meeting and Claims.– Trustee calls meeting of creditors, to examine

debtor under oath.– Creditors’ Claims: to receive a portion of debtor’s

estate, each creditor must file a proof of claim. Necessary if there is any dispute.

• Distribution of Property.– Debtor must file a statement of intention

regarding secured collateral. • Distribution to Secured Creditors.• Distribution to Unsecured Creditors: paid in the order

of their priority. If any amount is left over, it is returned to debtor.

Ex. 19-2 Distribution of Property

Chapter 7-Liquidation• Discharge.– Exceptions to Discharge: discharge of a debt

may be denied.– Objections to Discharge: court may deny claims

based on debtor’s conduct.– Effect of Discharge: voids, or sets aside any

judgment and prohibits any collector action.

Chapter 7-Liquidation• Discharge and Reaffirmation.– Revocation of Discharge.– Reaffirmation of Debt: debtor agrees to pay a

debt in bankruptcy by executing a reaffirmation agreement.• Reaffirmation Procedures: before discharge.• Reaffirmation Disclosures.

Chapter 11-Reorganizations Chapter 11—Corporations. Debtor

and Creditors formulate a plan under which the Debtor pays a portion of its debts and is discharged of the rest.–Same debtors as are eligible under

Chapter 7.

Chapter 11-Reorganizations “Fast Track” Chapter 11 for small

business debtors whose liabilities do not exceed $2 million and who do not own or manage real estate.

Workouts: focus is on the Best Interests of the Creditors.

Chapter 11-Reorganizations Debtor in Possession (DIP): business

operates under court supervision.–DIP has same powers as trustee.–But court may appoint trustee (receiver)

with ‘strong arm’ powers. Creditors Committees.

Chapter 11-Reorganizations Reorganization Plan.–Plan must be fair and equitable to all

parties. • Filing the Plan: within 120 days after date

relief order.• Acceptance and Confirmation of the Plan.

–Discharge.

Bankruptcy Relief under Chapter 13 and Chapter 12 Chapter 12: Family Farmer and

(Fisherman, 2005) Plans.–“Family Farmer” (Or Fisherman): 50% of

gross income comes from farming (or fishing) and whose debts are 80% farm (commercial fishing) related.–Procedure for filing.–Content of plan.–Court confirmation.

Bankruptcy Relief under Chapter 13 and Chapter 12 Chapter 13: Individuals’ Repayment

Plans. Not for partnerships, corporations.–For individuals with regular income who

owe fixed unsecured debts of <$360,475 or fixed secured debts of <1,081,400.

Bankruptcy Relief under Chapter 13 and Chapter 12 Chapter 13 (continued).–Filing the Plan: within 120 days after

order of relief.–Acceptance and Confirmation of the

Plan: court may refuse to accept or accept with “cram down.”

Bankruptcy Relief under Chapter 13 and Chapter 12 Chapter 13 (continued).–The Repayment Plan must:• Turn over to trustee the future earnings of

debtor as necessary for execution of plan.• Full payment through deferred cash payments of

all claims entitled to priority, including taxes.• CASE 19.2 RANSOM V. FIA CARD

SERVICES, N.A. (2011). Why was Ransom’s plan denied?

Bankruptcy Relief under Chapter 13 and Chapter 12 Chapter 13 (continued).–Discharge: after debtor has completed

all payments, court grants discharge.–CASE 19.3 UNITED STUDENT AID

FUNDS, INC. V. ESPINOSA (2010). Why wasn’t Espinosa’s plan ‘void’?

Chapter 19: Creditors’ Rights and Bankruptcy

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