Bankruptcy BASICS · basic explanation of the different cha- p ters under which a bankruptcy case may be filed and to answer some of the most commonly asked questions about the bankruptcy

BankruptcyBASICS

(Applicable to Cases Filed BEFORE October 17, 2005)

Leonidas Ralph Mecham, Director

Administrative Officeof the United States Courts

Leonidas Ralph Mecham, Director

Administrative Office

of the United States Courts

BASICSBankruptcy

Public Information Series

Bankruptcy Judges Division

Administrative Officeof the United States Courts

BASICSBankruptcy

A P R I L 2004Revised Second Edition

While the information presented in this pamphlet is accurate as of the date of pub-

lication, it should not be cited or relied upon as legal authority. It should not be used

as a substitute for reference to the United States Bankruptcy Code (title 11, United

States Code) and the Federal Rules of Bankruptcy Procedure, both of which may be

reviewed at local law libraries, or to local rules of practice adopted by each

bankruptcy court. Finally, this pamphlet should not substitute for the advice of

competent legal counsel. For additional copies, please contact the Bankruptcy

Judges Division, Administrative Office of the United States Courts, (202) 502-1900.

Introduction 1

The Discharge in Bankruptcy 5

Chapter 7. Liquidation Under the Bankruptcy Code 11

Chapter 13. Individual Debt Adjustment 18

Chapter 11. Reorganization Under the Bankruptcy Code 24

Chapter 12. Family Farmer Bankruptcy 38

Chapter 9. Municipality Bankruptcy 44

SIPA. Securities Investor Protection Act 53

Bankruptcy Terminology 61

CONTENTSTable of

INTRODUCTION • 1

THE PAMPHLETThe Bankruptcy Judges Division’s PublicInformation Series pamphlet providesbasic information to debtors, creditors,court personnel, the media, and the gen-eral public on different aspects of thefederal bankruptcy laws. The series isalso designed to provide individuals whomay be considering bankruptcy with abasic explanation of the different chap-ters under which a bankruptcy case maybe filed and to answer some of the mostcommonly asked questions about thebankruptcy process.

This pamphlet provides generalinformation only. While every efforthas been made to ensure that the infor-mation contained in it is accurate as ofthe date of publication, it is not a fulland authoritative statement of the lawon any particular topic. The informa-tion presented in the pamphlet shouldnot be cited or relied upon as legalauthority and should not be used as asubstitute for reference to the UnitedStates Bankruptcy Code (title 11,United States Code) and the FederalRules of Bankruptcy Procedure.

Most importantly, the pamphletshould not substitute for the advice of

competent legal counsel or a financialexpert. Neither the Bankruptcy JudgesDivision nor the Administrative Officeof the United States Courts can pro-vide legal or financial advice. Suchadvice may be obtained from a com-petent attorney, accountant, or finan-cial adviser.

THE PROCESSArticle I, Section 8, of the United StatesConstitution authorizes Congress toenact “uniform Laws on the subject ofBankruptcies.” Under this grant ofauthority, Congress enacted the “Bank-ruptcy Code” in 1978. The Code,which is codified as title 11 of theUnited States Code, has been amendedseveral times since its enactment. It isthe uniform federal law that governs allbankruptcy cases.

The procedural aspects of the bank-ruptcy process are governed by theFederal Rules of Bankruptcy Procedure(often called the “Bankruptcy Rules”)and local rules of bankruptcy. TheBankruptcy Rules contain a set of officialforms for use in bankruptcy cases. TheBankruptcy Code and Bankruptcy Rules(and local rules) set forth the formal legal

A Public Information Series ofthe Bankruptcy Judges Division

BASICSBankruptcy

2 • INTRODUCTION

procedures for dealing with the debtproblems of individuals and businesses.

There is a bankruptcy court for eachjudicial district in the country. Eachstate has one or more districts. Thereare 90 bankruptcy districts across thecountry. The bankruptcy courts gener-ally have their own clerk’s offices.

The court official with decision-mak-ing power over federal bankruptcycases is the United States bankruptcyjudge, a judicial officer of the UnitedStates district court. The bankruptcyjudge may decide any matter connectedwith a bankruptcy case, such as eligi-bility to file or whether a debtor shouldreceive a discharge of debts. Much ofthe bankruptcy process is administra-tive, however, and is conducted awayfrom the courthouse. In cases underchapter 7, 12, or 13, and sometimes inchapter 11 cases, this administrative

process is carried out by a trustee whois appointed to oversee the case.

A debtor’s involvement with thebankruptcy judge is usually very limited.A typical chapter 7 debtor will notappear in court and will not see thebankruptcy judge unless an objection israised in the case. A chapter 13 debtormay only have to appear before thebankruptcy judge at a plan confirmationhearing. Usually, the only formal pro-ceeding at which a debtor must appear isthe meeting of creditors, which is usual-ly held at the offices of the United Statestrustee. This meeting is informally calleda “341 meeting” because section 341 ofthe Bankruptcy Code requires that thedebtor attend this meeting so that credi-tors can question the debtor about debtsand property.

A fundamental goal of the federalbankruptcy laws enacted by Congressis to give debtors a financial “freshstart” from burdensome debts. TheSupreme Court made this point aboutthe purpose of the bankruptcy law in a1934 decision:

[I]t gives to the honest butunfortunate debtor…a new op-portunity in life and a clear fieldfor future effort, unhampered bythe pressure and discouragementof preexisting debt.

Local Loan v. Hunt, 292 U.S. 234, 244(1934). This goal is accomplishedthrough the bankruptcy discharge,which releases debtors from personalliability from specific debts and pro-hibits creditors from ever taking anyaction against the debtor to collectthose debts. This pamphlet describesthe Discharge in Bankruptcy in a ques-tion and answer format, discussing the

The court official

with decision-making

power over federal

bankruptcy cases

is the United States

bankruptcy judge,

a judicial officer of

the United States

district court.

INTRODUCTION • 3

timing of the discharge, the scope of thedischarge (what debts are dischargedand what debts are not discharged),objections to discharge, and revocationof the discharge. It also describes whata debtor can do if a creditor attempts tocollect a discharged debt after thebankruptcy case is concluded.

There are five basic types of bank-ruptcy cases provided for under theBankruptcy Code, each of which is dis-cussed in this pamphlet. The cases aretraditionally given the names of thechapters that describe them.

Chapter 7, entitled Liquidation, con-templates an orderly, court-supervisedprocedure by which a trustee collectsthe assets of the debtor’s estate, reducesthem to cash, and makes distributionsto creditors, subject to the debtor’sright to retain certain exempt propertyand the rights of secured creditors.Because there is usually little or nononexempt property in most chapter 7cases, there may not be an actual liqui-dation of the debtor’s assets. Thesecases are called “no-asset cases.” Acreditor holding an unsecured claimwill get a distribution from the bank-ruptcy estate only if the case is an assetcase and the creditor files a proof ofclaim with the bankruptcy court. Inmost chapter 7 cases, the debtorreceives a discharge that releases thedebtor from personal liability for cer-tain dischargeable debts. The debtornormally receives a discharge just a fewmonths after the petition is filed.

Chapter 13, entitled Adjustment ofDebts of an Individual With RegularIncome, is designed for an individualdebtor who has a regular source ofincome. Chapter 13 is often preferableto chapter 7 because it enables thedebtor to keep a valuable asset, such as

a house. It is also favored because itallows the debtor to propose a “plan”to repay creditors over time—usuallythree to five years. At a confirmationhearing, the court either approves ordisapproves the plan, depending onwhether the plan meets the BankruptcyCode’s requirements for confirmation.Chapter 13 is very different from chap-ter 7, since the chapter 13 debtor usu-ally remains in possession of the prop-erty of the estate and makes paymentsto creditors, through the trustee, basedon the debtor’s anticipated income overthe life of the plan. Unlike chapter 7,the debtor does not receive an immedi-ate discharge of debts. The debtor mustcomplete the payments required underthe plan before the discharge isreceived. The debtor is protected fromlawsuits, garnishments, and other cred-itor action while the plan is in effect.The discharge is also considerablybroader (i.e., more debts are eliminat-ed) under chapter 13 than the dischargeunder chapter 7.

Chapter 11, entitled Reorganization,ordinarily is used by commercial enter-prises that desire to continue operatinga business and repay creditors concur-rently through a court-approved plan ofreorganization. The chapter 11 debtorhas the exclusive right to file a plan ofreorganization for the first 120 daysafter the order for relief and must pro-vide creditors with a disclosure state-ment containing information adequateto enable creditors to evaluate the plan.The court ultimately approves (con-firms) or disapproves the plan of re-organization. Under the confirmedplan, the debtor can reduce its debts byrepaying a portion of its obligations anddischarging others. The debtor can alsoterminate burdensome contracts and

4 • INTRODUCTION

leases, recover assets, and rescale itsoperations in order to return to prof-itability. Under chapter 11, the debtornormally goes through a period of con-solidation and emerges with a reduceddebt load and a reorganized business.

Chapter 12, entitled Adjustment ofDebts of a Family Farmer with RegularAnnual Income, provides debt relief tofamily farmers with regular annualincome. The process under chapter 12is very similar to that of chapter 13under which the debtor proposes a planto repay debts over a period of time—no more than three years unless thecourt approves a longer period, notexceeding five years. There is also atrustee in every chapter 12 case whoseduties are very similar to those of achapter 13 trustee. The chapter 12trustee’s disbursement of payments tocreditors under a confirmed plan paral-lels the procedure under chapter 13.Chapter 12 allows a family farmer tocontinue to operate the farm while theplan is being carried out.

Chapter 9, entitled Adjustment ofDebts of a Municipality, providesessentially for reorganization, muchlike a reorganization under chapter 11.Only a “municipality” may file underchapter 9, which includes cities andtowns, as well as villages, counties, tax-ing districts, municipal utilities, andschool districts.

This pamphlet also contains a descrip-tion of liquidation proceedings underthe Securities Investor Protection Act.Although the Bankruptcy Code providesfor a stockbroker liquidation proceed-ing, it is far more likely that a failingbrokerage firm will find itself involvedin a SIPA proceeding. The purpose ofSIPA is to return to investors securitiesand cash left with failed brokerages.

Since being established by Congress in1970, the Securities Investor ProtectionCorporation has protected investorswho deposit stocks and bonds with bro-kerage firms by ensuring that every cus-tomer’s property is protected, up to$500,000 per customer.

The bankruptcy process is complexand relies on legal concepts like the“automatic stay,” “discharge,” “exemp-tions,” and “substantial abuse.” There-fore, the final chapter of this booklet is aglossary of Bankruptcy Terminologywhich explains, in layman’s terms, mostof the legal concepts that apply in casesfiled under the Bankruptcy Code.

The bankruptcy discharge variesdepending on the type of case a debtorfiles: chapter 7, 11, 12, or 13. ThisPublic Information Series pamphletattempts to answer some basic ques-tions about the discharge available toindividual debtors under all four chap-ters including:

1. What is a discharge in bankruptcy?

2. When does the discharge occur?

3. How does the debtor get a dis-charge?

4. Are all the debtor’s debts dischargedor only some?

5. Does the debtor have a right to a dis-charge or can creditors object to thedischarge?

6. Can the debtor receive a second dis-charge in a later chapter 7 case?

7. Can the discharge be revoked?

8. May the debtor pay a dischargeddebt after the bankruptcy case has beenconcluded?

9. What can the debtor do if a creditorattempts to collect a discharged debtafter the case is concluded?

10. May an employer terminate adebtor’s employment solely because theperson was a debtor or failed to repaya discharged debt?

From an individual

debtor’s standpoint, one

of the primary goals of

filing a bankruptcy case

is to obtain relief from

burdensome debt. Relief

is attained through the

bankruptcy discharge, the

purpose of which is to

provide a “fresh start”

to the honest debtor.

DISCHARGEThe Discharge in Bankruptcy

6 • THE DISCHARGE IN BANKRUPTCY

WHAT IS A DISCHARGEIN BANKRUPTCY?Under the federal bankruptcy statute, adischarge is a release of the debtorfrom personal liability for certain spec-ified types of debts. In other words, thedebtor is no longer required by law topay any debts that are discharged. Thedischarge operates as a permanentorder directed to the creditors of thedebtor that they refrain from takingany form of collection action on dis-charged debts, including legal actionand communications with the debtor,such as telephone calls, letters, andpersonal contacts.

Although a debtor is relieved of per-sonal liability for all debts that are dis-charged, a valid lien (i.e., a charge uponspecific property to secure payment of adebt) that has not been avoided (i.e.,made unenforceable) in the bankruptcycase will remain after the bankruptcycase. Therefore, a secured creditor mayenforce the lien to recover the propertysecured by the lien.

WHEN DOES THEDISCHARGE OCCUR?The timing of the discharge varies,depending on the chapter under whichthe case is filed. In a chapter 7 (liquida-tion) case, for example, the court usu-ally grants the discharge promptly onexpiration of the time fixed for filing acomplaint objecting to discharge andthe time fixed for filing a motion to dis-miss the case for substantial abuse (60days following the first date set for the341 meeting). Typically, this occursabout four months after the date thedebtor files the petition with the clerkof the bankruptcy court. In chapter 11(reorganization) cases, the dischargeoccurs upon confirmation of a chapter

11 plan. In cases under chapter 12(adjustment of debts of a familyfarmer) and 13 (adjustment of debts ofan individual with regular income), thecourt grants the discharge as soon aspracticable after the debtor completesall payments under the plan. Since achapter 12 or chapter 13 plan may pro-vide for payments to be made overthree to five years, the discharge typi-cally occurs about four years after thedate of filing.

HOW DOES THE DEBTORGET A DISCHARGE? Unless there is litigation involvingobjections to the discharge, the debtorwill automatically receive a discharge.The Federal Rules of BankruptcyProcedure provide for the clerk of thebankruptcy court to mail a copy of theorder of discharge to all creditors, theUnited States trustee, the trustee in thecase, and the trustee’s attorney, if any.The debtor and the debtor’s attorneyalso receive copies of the dischargeorder. The notice, which is simply acopy of the final order of discharge, isnot specific as to those debts deter-mined by the court to be non-dis-chargeable, i.e., not covered by thedischarge. The notice informs credi-tors generally that the debts owed tothem have been discharged and thatthey should not attempt any furthercollection. They are cautioned in thenotice that continuing collectionefforts could subject them to punish-ment for contempt. Any inadvertentfailure on the part of the clerk to sendthe debtor or any creditor a copy ofthe discharge order promptly withinthe time required by the rules does notaffect the validity of the order grant-ing the discharge.

THE DISCHARGE IN BANKRUPTCY • 7

Under the federal

bankruptcy statute,

a discharge is a

release of the debtor

from personal liability

for certain specified

types of debts. In

other words, the

debtor is no longer

required by law to

pay any debts that

are discharged.

ARE ALL OF THE DEBTOR’SDEBTS DISCHARGED ORONLY SOME?Not all debts are discharged. The debtsdischarged vary under each chapter ofthe Bankruptcy Code. Section 523(a) ofthe Code specifically excepts various cat-egories of debts from the dischargegranted to individual debtors. Therefore,the debtor must still repay those debtsafter bankruptcy. Congress has deter-mined that these types of debts are notdischargeable for public policy reasons(based either on the nature of the debt orthe fact that the debts were incurred dueto improper behavior of the debtor, suchas the debtor’s drunken driving).

There are 18 categories of debt except-ed from discharge under chapters 7, 11,and 12. A more limited list of exceptionsapplies to cases under chapter 13.

Generally speaking, the exceptions todischarge apply automatically if the lan-guage prescribed by section 523(a)applies. The most common types ofnon-dischargeable debts are certaintypes of tax claims, debts not set forthby the debtor on the lists and schedulesthe debtor must file with the court,debts for spousal or child support oralimony, debts for willful and maliciousinjuries to person or property, debts togovernmental units for fines and penal-ties, debts for most government fundedor guaranteed educational loans or ben-efit overpayments, debts for personalinjury caused by the debtor’s operationof a motor vehicle while intoxicated,and debts for certain condominium orcooperative housing fees.

The types of debts described in sec-tions 523(a)(2), (4), (6), and (15) (oblig-ations affected by fraud or maliciousnessor certain debts incurred in connectionwith property settlements arising out of

a separation agreement or divorcedecree) are not automatically exceptedfrom discharge. Creditors must ask thecourt to determine that these debts areexcepted from discharge. In the absenceof an affirmative request by the creditorand subsequent granting of the requestby the court, the types of debts set out insections 523(a)(2), (4), (6), and (15) willbe discharged.

A broader discharge of debts is avail-able to a debtor in a chapter 13 case thanin a chapter 7 case. As a general rule, thechapter 13 debtor is discharged from alldebts provided for by the plan exceptcertain long-term obligations (such as ahome mortgage), debts for alimony orchild support, debts for most govern-


ment funded or guaranteed educationalloans or benefit overpayments, debtsarising from death or personal injurycaused by driving while intoxicated orunder the influence of drugs, and debtsfor restitution or a criminal fine includedin a sentence on the debtor’s convictionof a crime. Although a chapter 13 debtor

generally receives a discharge only aftercompleting all payments required by thecourt-approved (i.e., “confirmed”) re-payment plan, there are some limited cir-cumstances under which the debtor mayrequest the court to grant a “hardshipdischarge” even though the debtor hasfailed to complete plan payments. Such a

discharge is available only to a debtorwhose failure to complete plan pay-ments is due to circumstances beyond thedebtor’s control.

The scope of a chapter 13 “hardshipdischarge” is similar to that in a chap-ter 7 case with regard to the types ofdebts that are excepted from the dis-charge. A hardship discharge also isavailable in chapter 12 if the failure tocomplete plan payments is due to “cir-cumstances for which the debtorshould not justly be held accountable.”

DOES THE DEBTOR HAVE THE RIGHT TO ADISCHARGE OR CAN CREDITORS OBJECT TOTHE DISCHARGE?In chapter 7 cases, the debtor does nothave an absolute right to a discharge.An objection to the debtor’s dischargemay be filed by a creditor, by the trusteein the case, or by the United Statestrustee. Creditors receive a notice short-ly after the case is filed that sets forthmuch important information, includingthe deadline for objecting to the dis-charge. A creditor who desires to objectto the debtor’s discharge must do so byfiling a complaint in the bankruptcycourt before the deadline set out in thenotice. Filing of a complaint starts alawsuit referred to in bankruptcy as an“adversary proceeding.” A chapter 7discharge may be denied for any of thereasons described in section 727(a) ofthe Bankruptcy Code, including thetransfer or concealment of propertywith intent to hinder, delay, or defraudcreditors; destruction or concealment ofbooks or records; perjury and otherfraudulent acts; failure to account forthe loss of assets; violation of a courtorder; or an earlier discharge in a chap-

A governmental unit

or private employer

may not discriminate

against a person

solely because the

person was a debtor,

was insolvent before

or during the case,

or has not paid

a debt that was

discharged in

the case.

THE DISCHARGE IN BANKRUPTCY • 9

ter 7 or 11 case commenced within sixyears before the date the petition wasfiled. If the issue of the debtor’s right toa discharge goes to trial, the objectingparty has the burden of proving all thefacts essential to the objection.

In chapter 12 and chapter 13 cases,the debtor is entitled to a dischargeupon completion of all payments underthe plan. The Bankruptcy Code doesnot provide grounds for objecting to thedischarge of a chapter 12 or chapter 13debtor. Creditors can object to confir-mation of the repayment plan, but can-not object to the discharge if the debtorhas completed making plan payments.

CAN A DEBTOR RECEIVE ASECOND DISCHARGE IN ALATER CHAPTER 7 CASE?A discharge will be denied in a laterchapter 7 case if the debtor has beengranted a discharge under chapter 7 orchapter 11 in a case filed within six yearsbefore the second petition is filed. Thedebtor will also be denied a chapter 7discharge if he or she previously wasgranted a discharge in a chapter 12 orchapter 13 case filed within six yearsbefore the date of the filing of the secondcase unless (1) all the “allowed unse-cured” claims in the earlier case werepaid in full, or (2) payments under theplan in the earlier case totaled at least 70percent of the allowed unsecured claimsand the debtor’s plan was proposed ingood faith and the payments representedthe debtor’s best effort.

CAN THE DISCHARGEBE REVOKED?A discharge can be revoked under certaincircumstances. For instance, a trustee,creditor, or the United States trustee mayrequest that the court revoke the debtor’s

discharge in a chapter 7 case based onallegations that the debtor obtained thedischarge fraudulently; the debtor failedto disclose the fact that he or sheacquired or became entitled to acquireproperty that would constitute propertyof the bankruptcy estate; or the debtorcommitted one of several acts of impro-priety described in section 727(a)(6) ofthe Bankruptcy Code. Typically, arequest to revoke the debtor’s dischargemust be filed within one year after thegranting of the discharge or, in somecases, before the date that the case isclosed. It is up to the court to determinewhether such allegations are true and, ifso, to revoke the discharge.

In a chapter 13 case, if confirmationof a plan or the discharge is obtainedthrough fraud, the court can revoke theorder of confirmation or discharge.

MAY THE DEBTOR PAY ADISCHARGED DEBT AFTERTHE BANKRUPTCY CASEHAS BEEN CONCLUDED?A debtor who has received a dischargemay voluntarily repay any dischargeddebt. A debtor may repay a dischargeddebt even though it can no longer belegally enforced. Sometimes a debtoragrees to repay a debt because it isowed to a family member or because itrepresents an obligation to an individ-ual for whom the debtor’s reputation isimportant, such as a family doctor.

WHAT CAN THE DEBTORDO IF A CREDITORATTEMPTS TO COLLECT ADISCHARGED DEBT AFTERTHE CASE IS CONCLUDED?If a creditor attempts collection effortson a discharged debt, the debtor canfile a motion with the court, reporting


the action and asking that the case bereopened to address the matter. Thebankruptcy court will often do so toensure that the discharge is not violat-ed. The discharge constitutes a perma-nent statutory injunction prohibitingcreditors from taking any action,including the filing of a lawsuit,designed to collect a discharged debt. Acreditor can be sanctioned by the courtfor violating the discharge injunction.The normal sanction for violating thedischarge injunction is civil contempt,which is often punishable by a fine.

CAN AN EMPLOYER TERMINATE A DEBTOR’SEMPLOYMENT SOLELYBECAUSE THE PERSONWAS A DEBTOR OR FAILED TO REPAY A DISCHARGED DEBT?The law provides express prohibitionsagainst discriminatory treatment ofdebtors by both governmental units andprivate employers. A governmental unitor private employer may not discrimi-nate against a person solely because theperson was a debtor, was insolventbefore or during the case, or has notpaid a debt that was discharged in thecase. The law prohibits the followingforms of governmental discrimination:terminating an employee; discriminat-ing with respect to hiring; or denying,revoking, suspending, or declining torenew a license, franchise, or similarprivilege. A private employer may notdiscriminate with respect to employ-ment if the discrimination is based sole-ly upon the bankruptcy filing.

ALTERNATIVES TO CHAPTER 7Debtors should be aware that there areseveral alternatives to chapter 7 relief.For example, debtors who are engagedin business, including corporations,partnerships, and sole proprietorships,may prefer to remain in business andavoid liquidation. Such debtors shouldconsider filing a petition under chapter11 of the Bankruptcy Code. Under chap-ter 11, the debtor may seek an adjust-ment of debts, either by reducing thedebt or by extending the time for repay-ment, or may seek a more comprehen-sive reorganization. Sole proprietorshipsmay also be eligible for relief underchapter 13 of the Bankruptcy Code.

In addition, individual debtors whohave regular income may seek an ad-justment of debts under chapter 13 of the Bankruptcy Code. Indeed, thecourt may dismiss a chapter 7 case filedby an individual whose debts are pri-marily consumer rather than businessdebts if the court finds that the grantingof relief would be a substantial abuse ofthe provisions of chapter 7. 11 U.S.C. § 707(b). A number of courts have con-cluded that a chapter 7 case may be dis-missed for substantial abuse when thedebtor has the ability to propose andcarry out a workable and meaning-ful chapter 13 plan.

Debtors should also be aware thatout-of-court agreements with creditors

LiquidationUnder theBankruptcy Code

Chapter 7 of the United

States Bankruptcy Code is

the Bankruptcy Code’s

“liquidation” chapter.

Lawyers sometimes refer

to it as a “straight

bankruptcy.” It is used

primarily by individuals

who wish to free themselves

of debt simply and

inexpensively, but may

also be used by businesses

that wish to liquidate and

terminate their business.

7C H A P T E R

12 • LIQUIDATION UNDER THE BANKRUPTCY CODE

or debt counseling services may providean alternative to a bankruptcy filing.

BACKGROUNDThe potential chapter 7 debtor shouldunderstand that a straight bankruptcycase does not involve the filing of a plan of repayment as in chapter 13,but rather envisions the bankruptcytrustee’s gathering and sale of thedebtor’s nonexempt assets, from whichholders of claims (creditors) will receivedistributions in accordance with theprovisions of the Bankruptcy Code.Part of the debtor’s property may besubject to liens and mortgages thatpledge the property to other creditors.In addition, under chapter 7, the indi-vidual debtor is permitted to retain cer-tain “exempt” property. The debtor’sremaining assets are liquidated by atrustee. Accordingly, potential debtorsshould realize that the filing of a peti-tion under chapter 7 may result in theloss of property.

In order to qualify for relief underchapter 7 of the Bankruptcy Code, thedebtor must be an individual, a part-nership, or a corporation. 11 U.S.C. §§ 109(b); 101(41). Relief is availableunder chapter 7 irrespective of theamount of the debtor’s debts orwhether the debtor is solvent or insol-vent. An individual cannot file underchapter 7 or any other chapter, howev-er, if during the preceding 180 days aprior bankruptcy petition was dis-missed due to the debtor’s willful fail-ure to appear before the court or com-ply with orders of the court or thedebtor voluntarily dismissed the previ-ous case after creditors sought relieffrom the bankruptcy court to recoverproperty upon which they hold liens.11 U.S.C. §§ 109(g), 362(d) and (e).

One of the primary purposes ofbankruptcy is to discharge certain debtsto give an honest individual debtor a“fresh start.” The discharge has theeffect of extinguishing the debtor’s per-sonal liability on dischargeable debts.In a chapter 7 case, however, a dis-charge is available to individual debtorsonly, not to partnerships or corpora-tions. 11 U.S.C. § 727(a)(1). Althoughthe filing of an individual chapter 7petition usually results in a discharge ofdebts, an individual’s right to a dis-charge is not absolute, and some typesof debts are not discharged. Moreover,a bankruptcy discharge does not extin-guish a lien on property.

HOW CHAPTER 7 WORKSA chapter 7 case begins with thedebtor’s filing a petition with the bank-ruptcy court.1 The petition should befiled with the bankruptcy court servingthe area where the individual lives orwhere the business debtor has its prin-cipal place of business or principalassets. 28 U.S.C. § 1408. In addition tothe petition, the debtor is also requiredto file with the court several schedulesof assets and liabilities, a schedule ofcurrent income and expenditures, astatement of financial affairs, and aschedule of executory contracts andunexpired leases. Bankruptcy Rule1007(b). A husband and wife may file ajoint petition or individual petitions.11 U.S.C. § 302(a). (Official Bank-ruptcy Forms can be purchased at alegal stationery store. They are notavailable from the court.)

In order to complete the OfficialBankruptcy Forms which make up thepetition and schedules, the debtor(s)will need to compile the followinginformation:

LIQUIDATION UNDER THE BANKRUPTCY CODE • 13

1. A list of all creditors and the amountand nature of their claims;

2. The source, amount, and frequencyof the debtor’s income;

3. A list of all of the debtor’s property;and

4. A detailed list of the debtor’s month-ly living expenses, i.e., food, clothing,shelter, utilities, taxes, transportation,medicine, etc.

Currently, the courts are required tocharge a $155 case filing fee, a $39 mis-cellaneous administrative fee, and a$15 trustee surcharge (a total of $209).The fees should be paid to the clerk ofthe court upon filing or may, with thecourt’s permission, be paid by individ-ual debtors in installments. 28 U.S.C. § 1930(a); Bankruptcy Rule 1006(b);Bankruptcy Court Miscellaneous FeeSchedule, Item 8. Rule 1006(b) limitsto four the number of installments forthe filing fee. The final installment shallbe payable not later than 120 days afterfiling the petition. For cause shown, thecourt may extend the time of anyinstallment, provided that the lastinstallment is paid not later than 180days after the filing of the petition.Bankruptcy Rule 1006(b). The $39administrative fee and the $15 trusteesurcharge may be paid in installmentsin the same manner as the filing fee. Ifa joint petition is filed, only one filingfee, one administrative fee, and onetrustee surcharge are charged. Debtorsshould be aware that failure to paythese fees may result in dismissal of thecase. 11 U.S.C. § 707(a).

The filing of a petition under chapter7 “automatically stays” most actions

against the debtor or the debtor’s prop-erty. 11 U.S.C. § 362. This stay arisesby operation of law and requires nojudicial action. As long as the stay is ineffect, creditors generally cannot initi-ate or continue any lawsuits, wage gar-nishments, or even telephone callsdemanding payments. Creditors nor-mally receive notice of the filing of thepetition from the clerk.

One of the schedules that will befiled by the individual debtor is aschedule of “exempt” property. Federalbankruptcy law provides that an indi-vidual debtor2 can protect some prop-erty from the claims of creditors eitherbecause it is exempt under federalbankruptcy law or because it is exemptunder the laws of the debtor’s homestate. 11 U.S.C. § 522(b). Many stateshave taken advantage of a provision inthe bankruptcy law that permits eachstate to adopt its own exemption lawin place of the federal exemptions. Inother jurisdictions, the individualdebtor has the option of choosingbetween a federal package of exemp-tions or exemptions available understate law. Thus, whether certain prop-erty is exempt and may be kept by thedebtor is often a question of state law.Legal counsel should be consulted todetermine the law of the state in whichthe debtor lives.

A “meeting of creditors” is usuallyheld 20 to 40 days after the petition isfiled. If the United States trustee orbankruptcy administrator3 designatesa place for the meeting that is not reg-ularly staffed by the United Statestrustee or bankruptcy administrator,the meeting may be held no more than60 days after the order for relief.Bankruptcy Rule 2003(a). The debtormust attend this meeting, at which


creditors may appear and ask questionsregarding the debtor’s financial affairsand property. 11 U.S.C. § 343. If a hus-band and wife have filed a joint peti-tion, they both must attend the credi-tors’ meeting. The trustee also willattend this meeting. It is important forthe debtor to cooperate with the trusteeand to provide any financial records ordocuments that the trustee requests.The trustee is required to examine thedebtor orally at the meeting of creditorsto ensure that the debtor is aware of thepotential consequences of seeking a dis-charge in bankruptcy, including theeffect on credit history, the ability tofile a petition under a different chapter,the effect of receiving a discharge, andthe effect of reaffirming a debt. In somecourts, trustees may provide writteninformation on these topics at or inadvance of the meeting, to ensure thatthe debtor is aware of this information.In order to preserve their independentjudgment, bankruptcy judges are pro-hibited from attending the meeting ofcreditors. 11 U.S.C. § 341(c).

In order to accord the debtor com-plete relief, the Bankruptcy Code allowsthe debtor to convert a chapter 7 case toeither a chapter 11 reorganization caseor a case under chapter 13,4 as long asthe debtor meets the eligibility standardsunder the chapter to which the debtorseeks to convert, and the case has notpreviously been converted to chapter 7from either chapter 11 or chapter 13.Thus, the debtor will not be permitted toconvert the case repeatedly from onechapter to another. 11 U.S.C. § 706(a).

ROLE OF THE CASETRUSTEEUpon the filing of the chapter 7 petition,an impartial case trustee is appointed by

the United States trustee (or by the courtin Alabama and North Carolina) toadminister the case and liquidate thedebtor’s nonexempt assets. 11 U.S.C. §§ 701, 704. If, as is often the case, allof the debtor’s assets are exempt or sub-ject to valid liens, there will be no distri-bution to unsecured creditors. Typically,most chapter 7 cases involving individ-ual debtors are “no asset” cases. If thecase appears to be an “asset” case at theoutset, however, unsecured creditors5

who have claims against the debtor mustfile their claims with the clerk of courtwithin 90 days after the first date set forthe meeting of creditors. BankruptcyRule 3002(c). In the typical no assetchapter 7 case, there is no need for cred-itors to file proofs of claim. If the trusteelater recovers assets for distribution tounsecured creditors, creditors will begiven notice of that fact and additionaltime to file proofs of claim. Althoughsecured creditors are not required to fileproofs of claim in chapter 7 cases inorder to preserve their security interestsor liens, there may be circumstanceswhen it is desirable to do so. A creditorin a chapter 7 case who has a lien on thedebtor’s property should consult anattorney for advice.

The commencement of a bankruptcycase creates an “estate.” The estatetechnically becomes the temporary legalowner of all of the debtor’s property.The estate consists of all legal or equi-table interests of the debtor in propertyas of the commencement of the case,including property owned or held byanother person if the debtor has aninterest in the property. Generallyspeaking, the debtor’s creditors are paidfrom nonexempt property of the estate.

The primary role of a chapter 7trustee in an “asset” case is to liquidate


Upon the filing of

the chapter 7

petition, an impartial

case trustee is

appointed by the

United States trustee

(or by the court

in Alabama and

North Carolina)

to administer the

case and liquidate

the debtor’s

nonexempt assets.

the debtor’s nonexempt assets in amanner that maximizes the return tothe debtor’s unsecured creditors. Toaccomplish this, the trustee attempts toliquidate the debtor’s nonexempt prop-erty, i.e., property that the debtor ownsfree and clear of liens and the debtor’sproperty which has market value abovethe amount of any security interest orlien and any exemption that the debtorholds in the property. The trustee alsopursues causes of action (lawsuits)belonging to the debtor and pursues thetrustee’s own causes of action to recov-er money or property under thetrustee’s “avoiding powers.” Thetrustee’s avoiding powers include thepower to set aside preferential transfersmade to creditors within 90 days beforethe petition, the power to undo securi-ty interests and other prepetition trans-fers of property that were not properlyperfected under nonbankruptcy law atthe time of the petition, and the powerto pursue nonbankruptcy claims suchas fraudulent conveyance and bulktransfer remedies available under statelaw. In addition, if the debtor is a busi-ness, the bankruptcy court may autho-rize the trustee to operate the debtor’sbusiness for a limited period of time, ifsuch operation will benefit the creditorsof the estate and enhance the liquida-tion of the estate. 11 U.S.C. § 721.

The distribution of the property ofthe estate is governed by section 726 ofthe Bankruptcy Code, which sets forththe order of payment of all claims.Under section 726, there are six classesof claims, and each class must be paidin full before the next lower class ispaid anything. The debtor is not partic-ularly interested in the trustee’s disposi-tion of the estate assets, except withrespect to the payment of those debts

which for some reason are not dis-chargeable in the bankruptcy case. Thedebtor’s major interests in a chapter 7case are in retaining exempt propertyand in getting a discharge that covers asmany debts as possible.

DISCHARGEA discharge releases the debtor from per-sonal liability for discharged debts andprevents the creditors owed those debtsfrom taking any action against thedebtor or his property to collect thedebts. The bankruptcy law regarding thescope of a chapter 7 discharge is com-


plex, and debtors should consult compe-tent legal counsel in this regard prior tofiling. As a general rule, however,excluding cases which are dismissed orconverted, individual debtors receive adischarge in more than 99 percent ofchapter 7 cases. In most cases, unless acomplaint has been filed objecting to thedischarge or the debtor has filed a writ-ten waiver, the discharge will be grantedto a chapter 7 debtor relatively early inthe case, that is, 60 to 90 days after thedate first set for the meeting of creditors.Bankruptcy Rule 4004(c).

The grounds for denying an individ-ual debtor a discharge in a chapter 7case are very narrow and are construedagainst a creditor or trustee seeking todeny the debtor a chapter 7 discharge.Among the grounds for denying a dis-charge to a chapter 7 debtor are that thedebtor failed to keep or produce ade-quate books or financial records; thedebtor failed to explain satisfactorilyany loss of assets; the debtor committeda bankruptcy crime such as perjury; thedebtor failed to obey a lawful order ofthe bankruptcy court; or the debtorfraudulently transferred, concealed, ordestroyed property that would havebecome property of the estate. 11 U.S.C.§ 727; Bankruptcy Rule 4005.

In certain jurisdictions, secured cred-itors may retain some rights to seizepledged property, even after a dischargeis granted. Depending on individual cir-cumstances, a debtor wishing to keeppossession of the pledged property,such as an automobile, may find itadvantageous to “reaffirm” the debt. Areaffirmation is an agreement betweenthe debtor and the creditor that thedebtor will pay all or a portion of themoney owed, even though the debtorhas filed bankruptcy. In return, the

creditor promises that, as long as pay-ments are made, the creditor will notrepossess or take back the automobileor other property. Because there is adisagreement among the courts con-cerning whether a debtor whose debt isnot in default may retain the propertyand pay under the original contractterms without reaffirming the debt,legal counsel should be consulted toensure that the debtor’s rights are pro-tected and that any reaffirmation is inthe debtor’s best interest.

If the debtor elects to reaffirm thedebt, the reaffirmation should be accom-plished prior to the granting of a dis-charge. A written agreement to reaffirma debt must be filed with the court and,if the debtor is not represented by anattorney, must be approved by the judge.11 U.S.C. § 524(c). The BankruptcyCode requires that reaffirmation agree-ments contain an explicit statementadvising the debtor that the agreement isnot required by bankruptcy or non-bankruptcy law. In addition, the debtor’sattorney is required to advise the debtorof the legal effect and consequences ofsuch an agreement, including a defaultunder such an agreement. The Coderequires a reaffirmation hearing only ifthe debtor has not been represented byan attorney during the negotiating of theagreement. 11 U.S.C. § 524(d). Thedebtor may repay any debt voluntarily,however, whether or not a reaffirmationagreement exists. 11 U.S.C. § 524(f).

Most claims against an individualchapter 7 debtor are discharged. A cred-itor whose unsecured claim is dischargedmay no longer initiate or continue anylegal or other action against the debtorto collect the obligation. A dischargeunder chapter 7, however, does not dis-charge an individual debtor from certain


specific types of debts listed in section523 of the Bankruptcy Code. Among thetypes of debts which are not dischargedin a chapter 7 case are alimony and childmaintenance and support obligations,certain taxes, debts for certain educa-tional benefit overpayments or loansmade or guaranteed by a governmentalunit, debts for willful and maliciousinjury by the debtor to another entity orto the property of another entity, debtsfor death or personal injury caused bythe debtor’s operation of a motor vehiclewhile the debtor was intoxicated fromalcohol or other substances, and debtsfor criminal restitution orders under title18, United States Code. 11 U.S.C. § 523(a). To the extent that these typesof debts are not fully paid in the chapter7 case, the debtor is still responsible forthem after the bankruptcy case has con-cluded. Debts for money or propertyobtained by false pretenses, debts forfraud or defalcation while acting in afiduciary capacity, debts for willful andmalicious injury by the debtor to anoth-er entity or to the property of anotherentity, and debts arising from a propertysettlement agreement incurred during orin connection with a divorce or separa-tion are discharged unless a creditortimely files and prevails in an action tohave such debts declared excepted fromthe discharge. 11 U.S.C. § 523(c);Bankruptcy Rule 4007(c).

The court may revoke a chapter 7discharge on the request of the trustee,a creditor, or the United States trustee ifthe discharge was obtained throughfraud by the debtor or if the debtoracquired property that is property ofthe estate and knowingly and fraudu-lently failed to report the acquisition ofsuch property or to surrender the prop-erty to the trustee. 11 U.S.C. § 727(d).

NOTES

1. An involuntary chapter 7 case maybe commenced under certain circum-stances by the filing of a petition bycreditors holding claims against thedebtor. 11 U.S.C. § 303.

2. Each debtor in a joint case (both hus-band and wife) can claim exemptionsunder the federal bankruptcy laws. 11U.S.C. § 522(m).

3. United States trustees and bankruptcyadministrators are responsible for estab-lishing a panel of private trustees toserve as trustees in chapter 7 cases andfor supervising the administration ofcases and trustees in cases under chap-ters 7, 11, 12, and 13 of the BankruptcyCode. Bankruptcy administrators servein the judicial districts in the states ofAlabama and North Carolina.

4. A fee of $645 is charged for convert-ing, on request of the debtor, a caseunder chapter 7 to a case under chapter11. There is no fee for converting fromchapter 7 to chapter 13.

5. Unsecured debts generally may bedefined as those for which the extensionof credit was based purely upon an eval-uation by the creditor of the debtor’sability to pay, as opposed to secureddebts, for which the extension of creditwas based upon the creditor’s right toseize pledged property on default, inaddition to the debtor’s ability to pay.

BACKGROUNDChapter 13 is designed for individualswith regular income who desire to paytheir debts but are currently unable todo so. The purpose of chapter 13 is toenable financially distressed individualdebtors, under court supervision andprotection, to propose and carry out arepayment plan under which creditorsare paid over an extended period oftime. Under this chapter, debtors arepermitted to repay creditors, in full orin part, in installments over a three-year period, during which time credi-tors are prohibited from starting orcontinuing collection efforts. A planproviding for payments over morethan three years must be “for cause”and be approved by the court. In nocase may a plan provide for paymentsover a period longer than five years.11 U.S.C. § 1322(d).

Any individual, even if self-employedor operating an unincorporated busi-ness, is eligible for chapter 13 relief aslong as the individual’s unsecured debtsare less than $307,675 and secureddebts are less than $922,975. 11 U.S.C.§ 109(e). A corporation or partnershipmay not be a chapter 13 debtor. Id.

An individual cannot file under chap-ter 13 or any other chapter if, duringthe preceding 180 days, a prior bank-ruptcy petition was dismissed due tothe debtor’s willful failure to appearbefore the court or comply with orders

Chapter 13 of the

United States Bankruptcy

Code is frequently referred

to as a “wage earner”

chapter, although it is

available to individuals

with regular income

from any source, not

just wages.

13C H A P T E R

Individual DebtAdjustment

INDIVIDUAL DEBT ADJUSTMENT • 19

of the court or was voluntarily dis-missed after creditors sought relieffrom the bankruptcy court to recoverproperty upon which they hold liens.11 U.S.C. §§ 109(g), 362(d) and (e).

HOW CHAPTER 13 WORKSA chapter 13 case begins with the filingof a petition with the bankruptcy courtserving the area where the debtor has adomicile or residence. Unless the courtorders otherwise, the debtor also shallfile with the court (1) schedules ofassets and liabilities, (2) a schedule ofcurrent income and expenditures, (3) aschedule of executory contracts andunexpired leases, and (4) a statement offinancial affairs. Bankruptcy Rule1007(b). A husband and wife may file ajoint petition or individual petitions.11 U.S.C. § 302(a). (Official Bank-ruptcy Forms can be purchased at alegal stationery store. They are notavailable from the court.)

Currently, the courts are required tocharge a $155 case filing fee and a $39miscellaneous administrative fee. Thefees should be paid to the clerk of thecourt upon filing or may, with thecourt’s permission, be paid in install-ments. 28 U.S.C. § 1930(a); Bankrupt-cy Rule 1006(b); Bankruptcy CourtMiscellaneous Fee Schedule, Item 8.Rule 1006(b) limits to four the numberof installments for the filing fee. Thefinal installment shall be payable notlater than 120 days after filing the peti-tion. For cause shown, the court mayextend the time of any installment,provided that the last installment ispaid not later than 180 days after thefiling of the petition. Bankruptcy Rule1006(b). If a joint petition is filed, onlyone filing fee and one administrativefee are charged.

In order to complete the OfficialBankruptcy Forms which make up thepetition, statement of financial affairs,and schedules, the debtor will need tocompile the following information:

1. A list of all creditors and theamounts and nature of their claims;

2. The source, amount, and frequencyof the debtor’s income;


4. A detailed list of the debtor’s month-ly living expenses, i.e., food, clothing,shelter, utilities, taxes, transportation,medicine, etc.

When a husband and wife file a jointpetition or each spouse files an individ-ual petition, the above detailed datamust be gathered for both spouses. Sothat financial responsibilities can beaccurately assessed when only onespouse files, the income and expensesof the non-filing spouse should beincluded in the debtor’s schedules andstatement of financial affairs.

Upon the filing of the petition, animpartial trustee is appointed to admin-ister the case. 11 U.S.C. § 1302. If thenumber of cases so warrants, theUnited States trustee may appoint astanding trustee to serve in all chapter13 cases in a district. 28 U.S.C. § 586(b). A primary role of the chapter13 trustee is to serve as a disbursingagent, collecting payments fromdebtors and making distributions tocreditors. 11 U.S.C. § 1302.

The filing of the petition under chap-ter 13 “automatically stays” most col-lection actions against the debtor or

20 • INDIVIDUAL DEBT ADJUSTMENT

the debtor’s property. 11 U.S.C. § 362.As long as the “stay” is in effect, cred-itors generally cannot initiate or con-tinue any lawsuits, wage garnishment,or even telephone calls demandingpayments. Creditors receive notice ofthe filing of the petition from the clerkor the trustee. Further, chapter 13 con-tains a special automatic stay provisionapplicable to creditors. Specifically,after the commencement of a chapter13 case, unless the bankruptcy courtauthorizes otherwise, a creditor maynot seek to collect a “consumer debt”from any individual who is liable withthe debtor. 11 U.S.C. § 1301. Con-sumer debts are those incurred for con-sumer, as opposed to business, needs.

By virtue of the automatic stay, anindividual debtor faced with a threat-ened foreclosure of the mortgage on hisor her principal residence can preventan immediate foreclosure by filing achapter 13 petition. Chapter 13 thenaffords the debtor a right to curedefaults on long-term home mortgagedebts by bringing the payments currentover a reasonable period of time. Thedebtor is permitted to cure a defaultwith respect to a lien on the debtor’sprincipal residence up until the comple-tion of a foreclosure sale under statelaw. 11 U.S.C. § 1322(c).

The debtor must file a plan of repay-ment with the petition or within fifteendays thereafter, unless extended by thecourt for cause. Bankruptcy Rule 3015.The chapter 13 plan must provide forthe full payment of all claims entitled topriority under section 5071 (unless theholder of a particular claim agrees todifferent treatment of the claim); if theplan classifies claims, provide the sametreatment for each claim within eachclass; and provide for the submission of

such portion of the debtor’s futureincome to the supervision of the trusteeas is necessary for the execution of theplan. 11 U.S.C. § 1322. Other planprovisions are permissive. Id. Plans,which must be approved by the court,provide for payments of fixed amountsto the trustee on a regular basis, typi-cally biweekly or monthly. The trusteethen distributes the funds to creditorsaccording to the terms of the plan,which may offer creditors less than fullpayment on their claims. If the trusteeor a creditor with an unsecured claim2

objects to confirmation of the plan, thedebtor is obligated to pay the amountof the claim or commit to the proposedplan all projected “disposable income”during the period in which the plan isin effect. 11 U.S.C. § 1325(b). Dispos-able income is defined as income notreasonably necessary for the mainte-nance or support of the debtor ordependents. If the debtor operates abusiness, disposable income is definedas excluding those amounts which are necessary for the payment of ordi-nary operating expenses. 11 U.S.C. § 1325(b)(2)(A) and (B).

A meeting of creditors is held inevery case, during which the debtor isexamined under oath. It is usually held20 to 50 days after the petition is filed.If the United States trustee or bank-ruptcy administrator3 designates aplace for the meeting which is not reg-ularly staffed by the United Statestrustee or bankruptcy administrator,the meeting may be held no more than60 days after the order for relief.Bankruptcy Rule 2003(a). The debtormust attend the meeting, at which cred-itors may appear and ask questionsregarding the debtor’s financial affairsand the proposed terms of the plan.


11 U.S.C. § 343. If a husband and wifehave filed a joint petition, they bothmust attend the creditors’ meeting. Thetrustee will also attend the meeting andquestion the debtor on the same mat-ters. In order to preserve their indepen-dent judgment, bankruptcy judges areprohibited from attending. 11 U.S.C. § 341(c). If there are problems with theplan, they are typically resolved duringor shortly after the creditors’ meeting.Generally, problems may be avoided ifthe petition and plan are complete andaccurate and the trustee has been con-sulted prior to the meeting.

In a chapter 13 case, unsecured cred-itors who have claims against thedebtor must file their claims with thecourt within 90 days after the first dateset for the meeting of creditors.Bankruptcy Rule 3002(c). A govern-mental unit, however, may file a proofof claim until the expiration of 180days from the date the case is filed.11 U.S.C. § 502(b)(9).

After the meeting of creditors is con-cluded, the bankruptcy judge mustdetermine at a confirmation hearingwhether the plan is feasible and meetsthe standards for confirmation set forthin the Bankruptcy Code. 11 U.S.C. §§ 1324 and 1325. Creditors, who willreceive 25 days’ notice of the hearing,may object to confirmation. While avariety of objections may be made, themost frequent ones are that paymentsoffered under the plan are less thancreditors would receive if the debtor’sassets were liquidated or that thedebtor’s plan does not commit all of thedebtor’s projected disposable incomefor the three-year period of the plan.

Within thirty days after the filing ofthe plan, even if the plan has not yetbeen approved by the court, the debtor

must start making payments to thetrustee. 11 U.S.C. § 1326(a)(1). If theplan is confirmed by the bankruptcyjudge, the chapter 13 trustee commencesdistribution of the funds received inaccordance with the plan “as soon aspracticable.” 11 U.S.C. § 1326(a)(2). Ifthe plan is not confirmed, the debtor hasa right to file a modified plan. 11 U.S.C.§ 1323. The debtor also has a right toconvert the case to a liquidation caseunder chapter 7. 11 U.S.C. § 1307. Ifthe plan or modified plan is not con-firmed and the case is dismissed, the

court may authorize the trustee to retaina specified amount for costs, but allother funds paid to the trustee arereturned to the debtor. 11 U.S.C. § 1326(a)(2).

On occasion, changed circumstanceswill affect a debtor’s ability to makeplan payments, a creditor may objector threaten to object to a plan, or adebtor may inadvertently have failed

If the number of

cases so warrants,

the United States

trustee may appoint

a standing trustee

to serve in all

chapter 13 cases

in a district.

22 • INDIVIDUAL DEBT ADJUSTMENT

to list all creditors. In such instances,the plan may be modified either beforeor after confirmation. 11 U.S.C. §§ 1323 & 1329. Modification afterconfirmation is not limited to an initia-tive by the debtor, but may be at therequest of the trustee or an unsecuredcreditor. 11 U.S.C. § 1329(a).

MAKING THE PLAN WORKThe provisions of a confirmed plan arebinding on the debtor and each credi-tor. 11 U.S.C. § 1327. Once the courtconfirms the plan, it is the responsibili-ty of the debtor to make the plan suc-

ceed. The debtor must make regularpayments to the trustee, which willrequire adjustment to living on a fixedbudget for a prolonged period. Alter-natively, the debtor’s employer canwithhold the amount of the paymentfrom the debtor’s paycheck and trans-mit it to the chapter 13 trustee.Furthermore, while confirmation of theplan entitles the debtor to retain prop-erty as long as payments are made, thedebtor may not incur any significantnew credit obligations without consult-ing the trustee, as such credit obliga-tions may have an impact upon theexecution of the plan. 11 U.S.C. §§ 1305(c), 1322(a)(1) & 1327.

A debtor may consent to the deduc-tion of the plan payments from thedebtor’s paycheck. Experience hasshown that this practice increases thelikelihood that payments will be madeon time and that the plan will be com-pleted. In any event, failure to make thepayments in accordance with the con-firmed plan may result in dismissal ofthe case or its conversion to a liquida-tion case under chapter 7 of theBankruptcy Code. 11 U.S.C. § 1307(c).

THE CHAPTER 13DISCHARGEThe bankruptcy law regarding thescope of the chapter 13 discharge iscomplex and has recently undergonemajor changes. Therefore, debtorsshould consult competent legal counselprior to filing regarding the scope ofthe chapter 13 discharge.

The chapter 13 debtor is entitled to adischarge upon successful completionof all payments under the chapter 13plan. 11 U.S.C. § 1328(a). The dis-charge has the effect of releasing thedebtor from all debts provided for by

Once the court

confirms the plan,

it is the responsibility

of the debtor to

make the plan

succeed. The debtor

must make regular

payments to the

trustee, which will

require adjustment

to living on a fixed

budget for a

prolonged period.


the plan or disallowed (under section502), with limited exceptions. Thosecreditors who were provided for in fullor in part under the chapter 13 planmay no longer initiate or continue anylegal or other action against the debtorto collect the discharged obligations.

In return for the willingness of thechapter 13 debtor to undergo the disci-pline of a repayment plan for three tofive years, a broader discharge is avail-able under chapter 13 than in a chapter7 case. As a general rule, the debtor isdischarged from all debts provided forby the plan or disallowed, except cer-tain long term obligations (such as ahome mortgage), debts for alimony orchild support, debts for most govern-ment funded or guaranteed educationalloans or benefit overpayments, debtsarising from death or personal injurycaused by driving while intoxicated orunder the influence of drugs, and debtsfor restitution or a criminal fine includ-ed in a sentence on the debtor’s convic-tion of a crime. 11 U.S.C. § 1328(a). Tothe extent that these types of debts arenot fully paid pursuant to the chapter13 plan, the debtor will still be respon-sible for these debts after the bankrupt-cy case has concluded.

THE CHAPTER 13HARDSHIP DISCHARGEAfter confirmation of a plan, there arelimited circumstances under which thedebtor may request the court to grant a“hardship discharge” even though thedebtor has failed to complete plan pay-ments. 11 U.S.C. § 1328(b). Generally,such a discharge is available only to adebtor whose failure to complete planpayments is due to circumstancesbeyond the debtor’s control andthrough no fault of the debtor, after

creditors have received at least as muchas they would have received in a chap-ter 7 liquidation case and when modifi-cation of the plan is not possible. Injuryor illness that precludes employmentsufficient to fund even a modified planmay serve as the basis for a hardshipdischarge. The hardship discharge ismore limited than the dischargedescribed above and does not apply toany debts that are nondischargeable ina chapter 7 case. 11 U.S.C. § 523.

NOTES

1. Section 507 sets forth nine cate-gories of unsecured claims whichCongress has, for public policy reasons,given priority of distribution over otherunsecured claims.

2. Unsecured debts generally may bedefined as those for which the exten-sion of credit was based purely upon anevaluation by the creditor of thedebtor’s ability to pay. In contrast,secured debts are those for which theextension of credit was based upon notonly the creditor’s evaluation of thedebtor’s ability to pay, but upon thecreditor’s right to seize pledged proper-ty on default.

3. Bankruptcy Administrators, ratherthan U.S. trustees, serve in the judicialdistricts in the states of Alabama andNorth Carolina.

HOW CHAPTER 11 WORKSA bankruptcy case commences when abankruptcy petition is filed with thebankruptcy court. Fed. R. Bankr. P.1002. A petition may be a voluntarypetition, which is filed by the debtor, orit may be an involuntary petition, whichis filed by creditors that meet certainrequirements. 11 U.S.C. §§ 301, 303.A voluntary petition should adhere tothe format of Form 1 of the OfficialForms prescribed by the JudicialConference of the United States. TheOfficial Forms may be purchased atlegal stationery stores or downloadedfrom the Internet at www.uscourts.gov/bankform/. The voluntary petition willinclude standard information concern-ing the debtor’s name(s), social securitynumber or tax identification number,residence, location of principal assets (ifa business), the debtor’s plan or inten-tion to file a plan, and a request forrelief under the appropriate chapter ofthe Bankruptcy Code. In addition, thevoluntary petition will indicate whetherthe debtor qualifies as a small businessas defined in 11 U.S.C. § 101(51C) andwhether the debtor elects to be consid-ered a small business under 11 U.S.C.§ 1121(e).

Upon the filing of a voluntary peti-tion for relief under chapter 11 or, inan involuntary case, the entry of anorder for such relief, the debtor auto-matically assumes an additional iden-

A case filed under

chapter 11 of the

United States Bankruptcy

Code is frequently referred

to as a “reorganization”

bankruptcy.

11C H A P T E R

ReorganizationUnder theBankruptcy Code

REORGANIZATION UNDER THE BANKRUPTCY CODE • 25

tity as the “debtor in possession.”11 U.S.C. § 1101. The term refers toa debtor that keeps possession andcontrol of its assets while undergoinga reorganization under chapter 11,without the appointment of a casetrustee. A debtor will remain a debtorin possession until the debtor’s plan ofreorganization is confirmed, thedebtor’s case is dismissed or convertedto chapter 7, or a chapter 11 trustee isappointed. The appointment or elec-tion of a trustee occurs only in a smallnumber of cases. Generally, thedebtor, as “debtor in possession,”operates the business and performsmany of the functions that a trusteeperforms in cases under other chap-ters. 11 U.S.C. § 1107(a).

A written disclosure statement and aplan of reorganization must be filedwith the court. 11 U.S.C. § 1121. Thedisclosure statement is a documentthat must contain information con-cerning the assets, liabilities, and busi-ness affairs of the debtor sufficient toenable a creditor to make an informedjudgment about the debtor’s plan ofreorganization. 11 U.S.C. § 1125. Theinformation required is governed byjudicial discretion and the circum-stances of the case. The contents of theplan must include a classification ofclaims and must specify how each classof claims will be treated under theplan. 11 U.S.C. § 1123. Creditorswhose claims are “impaired,” i.e.,those whose contractual rights are to be modified or who will be paid lessthan the full value of their claimsunder the plan vote on the plan by bal-lot. 11 U.S.C. § 1126. After the disclo-sure statement is approved and the bal-lots are collected and tallied, the bank-ruptcy court will conduct a confirma-

tion hearing to determine whether toconfirm the plan. 11 U.S.C. § 1128.

THE CHAPTER 11 DEBTORIN POSSESSIONWhile individuals are not precludedfrom using chapter 11, it is more typi-cally used to reorganize a business,which may be a corporation, sole pro-prietorship, or partnership. A corpora-tion exists separate and apart from itsowners, the stockholders. The chapter11 bankruptcy case of a corporation(corporation as debtor) does not put thepersonal assets of the stockholders atrisk other than the value of their invest-ment in the company’s stock. A soleproprietorship (owner as debtor), onthe other hand, does not have an identi-ty separate and distinct from itsowner(s); accordingly, a bankruptcycase involving a sole proprietorshipincludes both the business and personalassets of the owners-debtors. Like a cor-poration, a partnership exists separateand apart from its partners. In a part-nership bankruptcy case (partnership asdebtor), however, the partners’ personalassets may, in some cases, be used topay creditors in the bankruptcy case orthe partners may, themselves, be forcedto file for bankruptcy protection.

Section 1107 of the Code places thedebtor in possession in the position of afiduciary, with the rights and powers ofa chapter 11 trustee, and requires theperformance of all but the investigativefunctions and duties of a trustee. Theseduties are set forth in the BankruptcyCode and Federal Rules of BankruptcyProcedure. 11 U.S.C. §§ 1106, 1107;Fed. R. Bankr. P. 2015(a). Such powersand duties include accounting for prop-erty, examining and objecting to claims,and filing informational reports as

26 • REORGANIZATION UNDER THE BANKRUPTCY CODE

required by the court and the UnitedStates trustee, such as monthly operat-ing reports. The debtor in possessionalso has many of the other powers andduties of a trustee including the right,with the court’s approval, to employattorneys, accountants, appraisers, auc-tioneers, or other professional personsto assist the debtor during its bank-ruptcy case. Other responsibilitiesinclude filing tax returns and filing suchreports as are necessary or as the courtorders after confirmation, such as afinal accounting. The United Statestrustee is responsible for monitoringthe compliance of the debtor in posses-sion with the reporting requirements.

It should be noted that railroad reor-ganizations have specific requirementsunder subsection IV of chapter 11which will not be addressed here andthat stock and commodity brokers areprohibited from filing under chapter 11and are restricted to chapter 7.11 U.S.C. § 109(d).

THE SMALL BUSINESSDEBTORA small business debtor is defined bythe Bankruptcy Code as a personengaged in commercial or businessactivities (not including a person thatprimarily owns or operates real proper-ty) that has aggregate noncontingentliquidated secured and unsecured debtsthat do not exceed $2,000,000.11 U.S.C. § 101(51C). If a debtor qual-ifies and elects to be considered a smallbusiness under 11 U.S.C. § 1121(e), thecase is put on a “fast track” and treat-ed differently than a regular chapter 11case under the Code. For example, theappointment of a creditors’ committeeand a separate hearing to approve thedisclosure statement are not mandatory

in a small business case. 11 U.S.C. § 1102(a)(3). A small business caseproceeds faster than a regular chapter11 case because the court may condi-tionally approve a disclosure statement,subject to final approval after noticeand a hearing and solicitation of votesfor acceptance or rejection of the plan.Thereafter, the disclosure statementhearing may be combined with the con-firmation hearing. 11 U.S.C. § 1125(f).In addition, the debtor has a shortenedperiod of time (100 days from the dateof the order for relief) within whichonly the debtor may file a plan. Afterthe 100-day period expires, any partyin interest may file a plan; however, allplans must be filed within 160 daysfrom the date of the order for relief.11 U.S.C. § 1121(e).

THE SINGLE ASSET REALESTATE DEBTORAnother type of debtor that has specialprovisions under the Bankruptcy Codeis a single asset real estate debtor. Theterm “single asset real estate” isdefined as “a single property or pro-ject, other than residential real proper-ty with fewer than four residentialunits, which generates substantially allof the gross income of a debtor and onwhich no substantial business is beingconducted by a debtor” other thanoperating the real property and whichhas aggregate noncontingent liquidat-ed secured debts of no more than$4,000,000. 11 U.S.C. § 101(51B).The Bankruptcy Code provides cir-cumstances under which creditors of asingle asset real estate debtor mayobtain relief from the automatic staywhich are not available to creditors inordinary bankruptcy cases. 11 U.S.C.§ 362(d). On request of a creditor with


a claim secured by the single asset realestate and after notice and a hearing,the court will grant relief from theautomatic stay to the creditor unlessthe debtor files a feasible plan of re-organization or begins making interestpayments to the creditor within 90days from the date of the order forrelief. The interest payments must be equal to the current fair marketinterest rate on the value of the credi-tor’s interest in the real estate.11 U.S.C. § 362(d)(3).

THE AUTOMATIC STAY The automatic stay provides for aperiod of time in which all judgments,collection activities, foreclosures, andrepossessions of property are suspend-ed and may not be pursued by thecreditors on any debt or claim thatarose before the filing of the bank-ruptcy petition. As with cases underother chapters of the BankruptcyCode, a stay of creditor actionsagainst the debtor automatically goesinto effect when the bankruptcy peti-tion is filed. 11 U.S.C. § 362(a). Thefiling of a petition, however, does notoperate as a stay for certain types of actions listed under 11 U.S.C. § 362(b). The stay provides a breath-ing spell for the debtor, during whichnegotiations can take place to try toresolve the difficulties in the debtor’sfinancial situation.

Under specific circumstances, thesecured creditor can obtain an orderfrom the court granting relief from theautomatic stay. For example, when thedebtor has no equity in the propertyand that property is not necessary foran effective reorganization, the securedcreditor can seek an order of the courtlifting the stay to permit the creditor to

foreclose on the property, sell it, andapply the proceeds to the debt.11 U.S.C. § 362(d).

It should be noted that, althoughcreditors are stayed from actionagainst the debtor unless relief is grant-ed by the court, section 331 of theBankruptcy Code permits applicationsfor fees to be made by certain profes-sionals during the case. Thus, a trustee,a debtor’s attorney, or any professionalperson appointed by the court mayapply to the court at intervals of 120days for interim compensation andreimbursement payments. In very largecases with extensive legal work thecourt may permit more frequent appli-cations. Although professional feesmay be paid pursuant to authorizationby the court, the debtor cannot makepayments to professional creditors onprepetition obligations, i.e., obliga-tions which arose before the filing of

While individuals are

not precluded from

using chapter 11,

it is more typically

used to reorganize a

business, which may

be a corporation,

sole proprietorship,

or partnership.


the bankruptcy petition. The ordinaryexpenses of the ongoing business, how-ever, continue to be paid.

CREDITORS’ COMMITTEESCreditors’ committees can play amajor role in chapter 11 cases. TheUnited States trustee, a federal employ-ee to be distinguished from a privatecase trustee or panel trustee, appointsthe committee, which ordinarily con-sists of unsecured creditors who holdthe seven largest unsecured claimsagainst the debtor. 11 U.S.C. § 1102.The committee may consult with thedebtor in possession on the administra-tion of the case, investigate the conductof the debtor and the operation of thebusiness, and participate in the formu-lation of a plan. 11 U.S.C. § 1103. Acreditors’ committee may, with thecourt’s approval, hire an attorney orother professionals to assist in the per-formance of the committee’s duties. Acreditors’ committee can be an impor-tant safeguard to the proper manage-ment of the business by the debtor inpossession.

WHO CAN FILE A PLANThere is no specific statutory time limitset for the filing of a plan; however, thedebtor (unless a “small business”debtor, as set out above) has a 120-dayperiod during which it has an exclusiveright to file a plan. 11 U.S.C. § 1121(b). The debtor’s exclusive peri-od in which to file a plan may beextended or reduced by the court. Afterthe exclusive period has expired, a cred-itor or the case trustee may file a com-peting plan. The United States trusteemay not file a plan. 11 U.S.C. § 307.

A chapter 11 case may continue formany years unless the court, the United

States trustee, the committee, or anoth-er party in interest acts to ensure thecase’s timely resolution. The creditors’right to file a competing plan providesincentive for the debtor to file a planwithin the exclusive period and acts asa check on excessive delay in the case.

AVOIDABLE TRANSFERSThe debtor in possession or the trustee,as the case may be, has what are called“avoiding” powers. Such powers maybe used to undo a transfer of money orproperty made during a certain periodof time prior to the filing of the bank-ruptcy petition. By avoiding a particu-lar transfer of property, the debtor inpossession can cancel the transactionand force the return or “disgorgement”of the payments or property, whichthen are available to pay all creditors.Generally, the power to avoid transfersis effective against transfers made with-in 90 days prior to the filing of the peti-tion. However, transfers to insiders (i.e.,relatives, general partners, and direc-tors or officers of the debtor) made upto a year prior to filing can be avoided.11 U.S.C. §§ 101(31), 101(54), 547,548. In addition, under 11 U.S.C. § 544, the trustee is given the authorityto avoid transfers under applicable statelaw, which often provides for longertime periods. Avoiding powers are used,for example, to prevent unfair prepeti-tion payments to one creditor at theexpense of all other creditors.

CASH COLLATERAL,ADEQUATE PROTECTION,AND OPERATING CAPITALAlthough the preparation, confirma-tion, and implementation of a plan ofreorganization is at the heart of a chap-ter 11 case, other issues may arise


which must be addressed by the debtorin possession. The debtor in possessionmay use, sell, or lease property of theestate in the ordinary course of its busi-ness, without prior approval, unless the court orders otherwise. 11 U.S.C. § 363(c). If the intended sale or use isoutside the ordinary course of its busi-ness, the debtor must obtain permissionfrom the court. A debtor in possessionmay not use “cash collateral,” i.e., col-lections of accounts subject to securityinterests or proceeds from the sale ofpledged inventory or equipment, with-out the consent of the secured party orauthorization by the court which mustfirst examine whether the interest of thesecured party is adequately protected.11 U.S.C. § 363.

When “cash collateral” is used(spent), the secured creditors are enti-tled to receive additional protectionunder section 363 of the BankruptcyCode. Section 363 defines “cash collat-eral” as cash, negotiable instruments,documents of title, securities, depositaccounts, or other cash equivalents,whenever acquired, in which the estateand an entity other than the estate havean interest. It includes the proceeds,products, offspring, rents, or profits ofproperty and the fees, charges,accounts or payments for the use oroccupancy of rooms and other publicfacilities in hotels, motels, or otherlodging properties subject to a credi-tor’s security interest. The debtor inpossession must file a motion request-ing an order from the court authorizingthe use of the cash collateral. Pendingconsent of the secured creditor or courtauthorization for the debtor in posses-sion’s use of cash collateral, the debtorin possession must segregate andaccount for all cash collateral in its pos-

session. 11 U.S.C. § 363(c)(4). A partywith an interest in property being usedby the debtor may request that thecourt prohibit or condition this use tothe extent necessary to provide “ade-quate protection” to the creditor.

Adequate protection may be requiredto protect the value of the creditor’sinterest in the property being used bythe debtor in possession. This is espe-cially important when there is adecrease in value of the property. Thedebtor may make periodic or lump sumcash payments, or provide an addition-al or replacement lien that will result inthe creditor’s property interest beingadequately protected. 11 U.S.C. § 361.

When a chapter 11 debtor needsoperating capital, it may be able toobtain it from a lender by giving thelender a court-approved “superpriori-ty” over other unsecured creditors or a lien on property of the estate.11 U.S.C. § 364.

APPOINTMENT ORELECTION OF A CASETRUSTEEAlthough the appointment of a casetrustee is a rarity in a chapter 11 case,a party in interest or the United Statestrustee can request the appointment ofa case trustee or examiner at any timeprior to confirmation in a chapter 11case. The court, on motion by a partyin interest or the United States trusteeand after notice and hearing, shallorder the appointment of a casetrustee for cause, including fraud, dishonesty, incompetence, or grossmismanagement, or if such anappointment is in the interest of credi-tors, any equity security holders, andother interests of the estate. 11 U.S.C.§ 1104(a). The trustee is appointed by


the United States trustee, after consul-tation with parties in interest and sub-ject to the court’s approval. Fed. R.Bankr. P. 2007.1. Alternatively, atrustee in a case may be elected if aparty in interest requests the electionof a trustee within 30 days after thecourt orders the appointment of atrustee. In that instance, the United

States trustee convenes a meeting ofcreditors for the purpose of electing aperson to serve as trustee in the case.11 U.S.C. § 1104(b).

The case trustee is responsible formanagement of the property of theestate, operation of the debtor’s busi-

ness, and, if appropriate, the filing ofa plan of reorganization. Section 1106of the Code requires the trustee to filea plan “as soon as practicable” or,alternatively, to file a report explain-ing why a plan will not be filed or to recommend that the case be con-verted to another chapter or dis-missed. 11 U.S.C. § 1106(a)(5).

The court, after notice and hearing,may, at any time before confirmation,upon the request of a party in interestor the United States trustee, terminatethe trustee’s appointment and restorethe debtor to possession and manage-ment of the property of the estate andof the operation of the debtor’s busi-ness. 11 U.S.C. § 1105.

THE ROLE OF ANEXAMINERThe appointment of an examiner in achapter 11 case is rare. The role of anexaminer is generally more limitedthan that of a trustee. The examiner isauthorized to perform the investigato-ry functions of the trustee and isrequired to file a statement of anyinvestigation conducted. If ordered todo so by the court, however, an exam-iner may carry out any other duties ofa trustee that the court orders thedebtor in possession not to perform.11 U.S.C. § 1106. Each court has theauthority to determine the duties of anexaminer in each particular case. Insome cases, the examiner may file aplan of reorganization, negotiate orhelp the parties negotiate, or reviewthe debtor’s schedules to determinewhether some of the claims areimproperly categorized. Sometimes,the examiner may be directed to deter-mine if objections to any proofs ofclaim should be filed or whether caus-

Although the

appointment of a

case trustee is a rarity

in a chapter 11 case,

a party in interest or

the United States

trustee can request

the appointment of

a case trustee or

examiner at any time

prior to confirmation

in a chapter 11 case.


es of action have sufficient merit sothat further legal action should betaken. An examiner may not serve as atrustee. 11 U.S.C. § 321.

THE UNITED STATESTRUSTEE OR BANKRUPTCYADMINISTRATOR In addition to the case trustee or exam-iner and the creditors’ committee, theUnited States trustee plays a major rolein monitoring the progress of a chapter11 case and supervising its administra-tion. The United States trustee isresponsible for monitoring the debtorin possession’s operation of the busi-ness, and the submission of operatingreports and fees. Additionally, the U.S.Trustee monitors applications for com-pensation and reimbursement by pro-fessionals, plans and disclosure state-ments filed with the court, and credi-tors’ committees. The United Statestrustee conducts a meeting of the cred-itors, often referred to as the “section341 meeting,” in a chapter 11 case. 11U.S.C. § 341. The United States trusteeand creditors may question the debtoror the debtor’s corporate representa-tive under oath at the section 341meeting concerning the debtor’s acts,conduct, property, and the administra-tion of the case.

The United States trustee also impos-es certain requirements on the debtor inpossession concerning matters such asreporting its monthly income and oper-ating expenses, the establishment ofnew bank accounts, and the payment ofcurrent employee withholding andother taxes. By law, the debtor in pos-session must pay a quarterly fee to theUnited States trustee for each quarter ofa year until the case is converted or dis-missed. 28 U.S.C. § 1930(a)(6). The

amount of the fee, which may rangefrom $250 to $10,000, depends uponthe amount of the debtor’s disburse-ments during each quarter. Should adebtor in possession fail to comply withthe reporting requirements of theUnited States trustee or orders of thebankruptcy court or fail to take theappropriate steps to bring the case toconfirmation, the United States trusteemay file a motion with the court to havethe debtor’s chapter 11 case convertedto a case under another chapter of theCode or to have the case dismissed.

It should be noted that in NorthCarolina and Alabama, bankruptcyadministrators perform similar func-tions that United States trustees per-form in the remaining forty-eightstates. The bankruptcy administratorprogram is administered by theAdministrative Office of the UnitedStates Courts, while the United Statestrustee program is administered by theDepartment of Justice. For purposes ofthis fact sheet, references to UnitedStates trustees are also applicable tobankruptcy administrators.

MOTIONSPrior to confirmation of a plan, thereare several activities that may takeplace in a chapter 11 case. The contin-ued operation of the debtor’s businessmay lead to the filing of a number ofcontested motions. The most commonare those seeking relief from the auto-matic stay, the use of cash collateral, orto obtain credit. There may also be liti-gation over executory (i.e., unfulfilled)contracts and unexpired leases and theassumption or rejection of those execu-tory contracts and unexpired leases by the debtor in possession. 11 U.S.C.§ 365. Delays in formulating, filing,


and obtaining confirmation of a planoften cause creditors to file motions forrelief from stay or motions to convertthe case to a chapter 7 or to dismiss thecase altogether.

ADVERSARYPROCEEDINGSFrequently, the debtor in possession willinstitute a lawsuit, known as an adver-sary proceeding, to recover money orproperty for the estate. Adversary pro-ceedings may take the form of lienavoidance actions, actions to avoidpreferences, actions to avoid fraudulenttransfers, or actions to avoid post peti-tion transfers. Such proceedings aregoverned by Part VII of the FederalRules of Bankruptcy Procedure. Attimes, a creditors’ committee may beauthorized by the bankruptcy court topursue these actions against insiders ofthe debtor if the plan provides for thecommittee to do so or if the debtor hasrefused a demand to do so. Creditorsmay also initiate adversary proceedingsby filing complaints to determine thevalidity or priority of a lien, to revokean order confirming a plan, to deter-mine the dischargeability of a debt, toobtain an injunction, or to subordinatea claim of another creditor.

CLAIMSA claim is a right to payment or a rightto an equitable remedy for a failure ofperformance if the breach gives rise to aright to payment. 11 U.S.C. § 101(5).In some instances, a creditor must file aproof of claim form along with docu-mentation evidencing the validity andamount of the claim. When proofs ofclaim are required to be filed, creditorsmust file the proofs of claim with thebankruptcy clerk in the district where

the case is pending. The clerk isrequired to keep a list of claims filed ina case when it appears that there will bea distribution to unsecured creditors.Fed. R. Bankr. P. 5003(b). Most credi-tors whose claims are scheduled (i.e.,claims listed by the debtor on thedebtor’s schedules), but not listed asdisputed, contingent, or unliquidated,need not file claims because the sched-ule of liabilities is deemed to constituteevidence of the validity and amount ofthose claims. 11 U.S.C. § 1111. Anycreditor whose claim is not scheduled,or is scheduled as disputed, contingent,or unliquidated, must file a proof ofclaim in order to be treated as a credi-tor for purposes of voting on the planand distribution under it. Fed. R.Bankr. P. 3003(c)(2). If a scheduledcreditor chooses to file a claim, a prop-erly filed proof of claim supersedes anyscheduling of that claim. Fed. R. Bankr.P. 3003(c)(4). It is the responsibility ofthe creditor to determine whether theclaim is accurately listed. The debtormust provide notification to those cred-itors whose names are added andwhose claims are listed as a result of anamendment to the schedules. The noti-fication also should advise such credi-tors of their right to file proofs of claimand that their failure to do so may pre-vent them from voting upon thedebtor’s plan of reorganization or par-ticipating in any distribution under thatplan. When a debtor amends the sched-ule of liabilities to add a creditor orchange the status of any claims to dis-puted, contingent, or unliquidatedclaims, the debtor must provide noticeof the amendment to any entity affect-ed. Fed. R. Bankr. P. 1009(a).


EQUITY SECURITYHOLDERSAn equity security holder is a holder ofan equity security of the debtor.Examples of an equity security are ashare in a corporation, an interest of alimited partner in a limited partnership,or a right to purchase, sell, or subscribeto a share, security, or interest of a sharein a corporation or an interest in a lim-ited partnership. 11 U.S.C §§ 101(16) ,(17). An equity security holder may voteon the plan of reorganization and mayfile a proof of interest, rather than aproof of claim. A proof of interest isdeemed filed for any interest thatappears in the debtor’s schedules, unlessit is scheduled as disputed, contingent,or unliquidated. 11 U.S.C. § 1111. Anequity security holder whose interest isnot scheduled or scheduled as disputed,contingent, or unliquidated must file aproof of interest in order to be treatedas a creditor for purposes of voting onthe plan and distribution under it. Fed.R. Bankr. P. 3003(c)(2). A properly filedproof of interest supersedes any sched-uling of that interest. Fed. R. Bankr. P.3003(c)(4). Generally, most of the pro-visions that apply to proofs of claim, asdiscussed above, are also applicable toproofs of interest.

CONVERSION ORDISMISSALA debtor in a case under chapter 11 hasa one-time absolute right to convert thechapter 11 case to a case under chapter 7unless (1) the debtor is not a debtor inpossession, (2) the case originally wascommenced as an involuntary case underchapter 11, or (3) the case was convertedto a case under chapter 11 other than at the debtor’s request. 11 U.S.C. § 1112(a). A debtor in a chapter 11 case

does not have an absolute right to havethe case dismissed upon request.

Generally, upon the request of a partyin interest in the case or the UnitedStates trustee, after notice and hearingand “for cause,” the court may converta chapter 11 case to a case under chap-ter 7 or dismiss the case, whichever is inthe best interest of creditors and theestate. 11 U.S.C. § 1112(b). The courtmay convert or dismiss a case “forcause” when there is a continuing lossto the estate, an inability to effectuate aplan, unreasonable delay that is prejudi-cial to creditors, denial or revocation ofconfirmation, or inability to consum-mate a confirmed plan.

There are important exceptions tothe conversion process in a chapter 11case. One exception is that, unless thedebtor requests the conversion, section1112(c) of the Code prohibits the courtfrom converting a case involving afarmer or charitable institution to a liq-uidation case under chapter 7.

THE DISCLOSURESTATEMENTThe filing of a written disclosure state-ment is preliminary to the voting on aplan of reorganization, and the disclo-sure statement must provide “adequateinformation” concerning the affairs ofthe debtor to enable the holder of aclaim or interest to make an informedjudgment about the plan. 11 U.S.C. § 1125. After the disclosure statement isfiled, the court must hold a hearing todetermine whether the disclosure state-ment should be approved. Acceptanceor rejection of a plan cannot be solicit-ed without prior court approval of thewritten disclosure statement. 11 U.S.C.§ 1125(b). After the disclosure state-ment has been approved, the debtor or


proponent of a plan can begin to solicitacceptances of the plan, and creditorsmay also solicit rejections of the plan.Fed. R. Bankr. P. 3017(d) requires that,upon approval of a disclosure state-ment, the following must be mailed tothe United States trustee and all credi-tors and equity security holders: (1) theplan, or a court approved summary ofthe plan; (2) the disclosure statementapproved by the court; (3) notice of thetime within which acceptances andrejections of the plan may be filed; and(4) such other information as the courtmay direct, including any opinion of thecourt approving the disclosure state-ment or a court-approved summary ofthe opinion. Fed. R. Bankr. P. 3017(d).In addition, the debtor must mail to thecreditors and equity security holdersentitled to vote on the plan or plans (1)notice of the time fixed for filing objec-tions; (2) notice of the date and time forthe hearing on confirmation of the plan;and (3) a ballot for accepting or reject-ing the plan and, if appropriate, a desig-nation for the creditors to identify theirpreference among competing plans. Id.However, in a small business case, thecourt may conditionally approve a dis-closure statement subject to finalapproval after notice and a combineddisclosure statement/plan confirmationhearing. 11 U.S.C. § 1125(F).

ACCEPTANCE OF THE PLANOF REORGANIZATIONAs noted earlier, during the first 120-day period after the filing of the volun-tary bankruptcy petition, which filingalso acts as the order of relief, only thedebtor in possession may file a plan ofreorganization. The debtor in posses-sion has 180 days after the filing of thevoluntary petition (or in a case com-

menced by an involuntary petition, afterthe order for relief) to obtain accep-tances of the plan. 11 U.S.C. § 1121.For cause, the court may extend orreduce this exclusive period. 11 U.S.C.§ 1121(d). The exclusive right of thedebtor in possession to file a plan is lostand any party in interest, including thedebtor, may file a plan if and only if (1)a trustee has been appointed in the case,(2) the debtor has not filed a plan with-in the 120-day exclusive period or anyextension granted by the court, or (3)the debtor has not filed a plan whichhas been accepted by each class ofclaims or interests that is impairedunder the plan within the 180-day peri-od or any extensions granted by thecourt. 11 U.S.C. § 1121.

If the exclusive period expires beforethe debtor has filed and obtainedacceptance of a plan, other parties ininterest in a case, such as the creditors’committee or a creditor, may file aplan. Such a plan may compete with aplan filed by another party in interestor by the debtor. If a trustee is appoint-ed, the trustee is responsible for filing aplan, a report of why the trustee willnot file a plan, or a recommendationfor the conversion or dismissal of thecase. 11 U.S.C. § 1106(a)(5). A propo-nent of a plan is subject to the samerequirements as the debtor with respectto disclosure and solicitation.

It should be noted that, in a chapter11 case, a liquidating plan is permissi-ble. Such a plan often allows the debtorin possession to liquidate the businessunder more economically advanta-geous circumstances than a chapter 7liquidation. It also permits the creditorsto take a more active role in fashioningthe liquidation of the assets and the


distribution of the proceeds than in achapter 7 case.

Section 1123(a) of the BankruptcyCode lists the mandatory provisions ofa chapter 11 plan and section 1123(b)lists the discretionary provisions.Section 1123(a)(1) provides that achapter 11 plan shall designate classesof claims and interests for treatmentunder the reorganization. Generally, aplan will classify claim holders assecured creditors, unsecured creditorsentitled to priority, general unsecuredcreditors, and equity security holders.

Under section 1126(c) of the Code,an entire class of claims accepts a planif the plan is accepted by creditors thathold at least two-thirds in amount andmore than one-half in number of theallowed claims in the class. Under sec-tion 1129(a)(10), if there are impairedclasses of claims, the court cannot con-firm a plan unless the plan has beenaccepted by at least one class of non-insiders who hold impaired claims.“Impaired” claims are claims that arenot going to be paid completely or inwhich some legal, equitable, or con-tractual right is altered. Moreover,under section 1126(f), holders of unim-paired claims are deemed to haveaccepted the plan.

Under section 1127(a) of theBankruptcy Code, the proponent maymodify the plan at any time beforeconfirmation, but the plan as modifiedmust meet all the requirements ofchapter 11. Federal Rule ofBankruptcy Procedure 3019 providesthat, when there is a proposed modifi-cation after balloting has been con-ducted and the court finds after a hear-ing that the proposed modificationdoes not adversely affect the treatmentof any creditor who has not accepted

the modification in writing, the modi-fication shall be deemed to have beenaccepted by all creditors who previous-ly accepted the plan. If it is determinedthat the proposed modification doeshave an adverse effect on the claims ofnonconsenting creditors, then anotherballoting must take place.

Because more than one plan may be submitted to the creditors forapproval, Federal Rule of BankruptcyProcedure 3016(a) requires that everyproposed plan and modification be dated and identified with the name

In a chapter 11

case, a liquidating

plan is permissible.

Such a plan often

allows the debtor

in possession to

liquidate the

business under

more economically

advantageous

circumstances

than a chapter 7

liquidation.


of the entity or entities submittingsuch plan or modification. When com-peting plans are presented and meetthe requirements for confirmation, the court must consider the preferencesof the creditors and equity securityholders in determining which plan to confirm.

Any party in interest may file anobjection to confirmation of a plan.The Bankruptcy Code requires thecourt, after notice, to hold a hearing onthe confirmation of a plan. If no objec-tion to confirmation has been timelyfiled, the Code allows the court todetermine that the plan has been pro-posed in good faith and according to

law. Fed. R. Bankr. P. 3020(b)(2).Before confirmation can be granted, thecourt must be satisfied that there hasbeen compliance with all the otherrequirements of confirmation set forthin section 1129 of the Code, even in theabsence of any objections. In order toconfirm the plan, the court must findthat (1) the plan is feasible, (2) it is pro-posed in good faith, and (3) the planand the proponent of the plan are incompliance with the Code. In addition,the court must find that confirmationof the plan is not likely to be followedby liquidation or the need for furtherfinancial reorganization.

THE DISCHARGEWhile some courts have a practice ofissuing a discharge order in a caseinvolving an individual, a separateorder of discharge is usually notentered in a chapter 11 case. Section1141(d)(1) specifies that the confirma-tion of a plan discharges the debtorfrom any debt that arose before thedate of confirmation. After the plan isconfirmed, the debtor is required tomake plan payments and is bound bythe provisions of the plan of reorgani-zation. The confirmed plan creates newcontractual rights, replacing or super-seding pre-bankruptcy contracts.

There are, of course, exceptions tothe general rule that an order confirm-ing a plan operates as a discharge.Confirmation of a plan of reorganiza-tion will discharge any type ofdebtor—corporation, partnership, orindividual—from most types of prepe-tition debts. It does not, however, dis-charge an individual debtor from anydebt made nondischargeable by section523 of the Bankruptcy Code.Confirmation does not discharge the

Confirmation of a

plan discharges the

debtor from any debt

that arose before the

date of confirmation.

After the plan is

confirmed, the debtor

is required to make

plan payments and

is bound by the

provisions of the plan

of reorganization.


debtor if the plan is a liquidation plan,as opposed to one of reorganization,and the debtor is not an individual.When the debtor is an individual, con-firmation of a liquidation plan willeffect a discharge unless groundswould exist for denying the debtor adischarge if the case were proceedingunder chapter 7 instead of chapter 11.11 U.S.C. §§ 1141(d)(2), 727(a).

POSTCONFIRMATIONMODIFICATION OFTHE PLANAt any time after confirmation andbefore “substantial consummation” ofa plan, the proponent of a plan maymodify a plan if the modified planwould meet certain Bankruptcy Coderequirements. 11 U.S.C. § 1127(b).This should be distinguished from pre-confirmation modification of the plan.A modified postconfirmation plan doesnot automatically become the plan. Amodified postconfirmation plan in achapter 11 case becomes the plan only“if circumstances warrant such modifi-cation” and the court, after notice andhearing, confirms the plan as modifiedpursuant to chapter 11 of the Code.

POSTCONFIRMATIONADMINISTRATIONFederal Rule of Bankruptcy Procedure3020(d) provides that, “[n]otwithstand-ing the entry of the order of confirma-tion, the court may issue any otherorder necessary to administer theestate.” This authority would includethe postconfirmation determination ofobjections to claims or adversary pro-ceedings which must be resolved beforea plan can be fully consummated.Sections 1106(a)(7) and 1107(a) of theBankruptcy Code require a debtor in

possession or a trustee to report on theprogress made in implementing a planafter confirmation. A chapter 11 trusteeor debtor in possession has a number ofresponsibilities to perform after confir-mation, including consummating theplan, reporting on the status of consum-mation, and applying for a final decree.

REVOCATION OF THECONFIRMATION ORDERA revocation of the confirmation orderis an undoing or cancellation of theconfirmation of a plan. A request forrevocation of confirmation, if made atall, must be made by a party in interestwithin 180 days of confirmation. Thecourt, after notice and hearing, mayrevoke a confirmation order “if andonly if [the confirmation] order wasprocured by fraud.” 11 U.S.C. § 1144.

THE FINAL DECREEA final decree closing the case must beentered after the estate has been “fullyadministered.” Fed. R. Bankr. P. 3022.Local bankruptcy court policies maydetermine when the final decree shouldbe entered and the case closed.

BACKGROUNDIn tailoring chapter 12 to meet the eco-nomic realities of family farming, thislaw has eliminated many of the barriersthat family farmers had faced whenseeking to reorganize successfullyunder either chapter 11 or 13 of theBankruptcy Code. For example, chap-ter 12 is more streamlined, less compli-cated, and less expensive than chapter11, which is better suited to the largecorporate reorganization. In addition,few family farmers find chapter 13 tobe advantageous, because it wasdesigned for wage earners who havesmaller debts than those facing familyfarmers. In chapter 12, Congresssought to combine the features of theBankruptcy Code which can provide aframework for successful family farmreorganizations. At the time of theenactment of chapter 12, Congresscould not be sure whether chapter 12relief for the family farmer would berequired indefinitely. Accordingly, thelaw (which first provided that no chap-ter 12 cases could be filed afterSeptember 30, 1993) currently providesthat no cases may be filed under chap-ter 12 after January 1, 2004. As of March 2004, legislation to extendchapter 12 is pending in Congress.

The Bankruptcy Code provides thatonly a family farmer with “regularannual income” may file a petition forrelief under chapter 12. 11 U.S.C.

Family FarmerBankruptcy

Chapter 12 of the

Bankruptcy Code was

enacted by Congress in

1986, specifically to meet

the needs of financially

distressed family farmers.

The primary purpose of

this legislation was to

give family farmers facing

bankruptcy a chance to

reorganize their debts

and keep their farms.

12C H A P T E R

FAMILY FARMER BANKRUPTCY • 39

§§ 101(18), 109(f). The purpose of thisrequirement is to ensure that the debtor’sannual income is sufficiently stable andregular to permit the debtor to makepayments under a chapter 12 plan.Allowance is made under chapter 12,however, for situations in which familyfarmers may have income that is season-al in nature. Relief under this chapter isvoluntary; thus, only the debtor may filea petition under chapter 12.

Under the Bankruptcy Code, thoseeligible to file as “family farmers” fallinto two categories: (1) an individual orindividual and spouse and (2) a corpo-ration or partnership. Those falling intothe first category must meet each of thefollowing four criteria as of the date thepetition is filed in order to qualify forrelief under chapter 12.

1. The individual or husband and wifemust be engaged in a farming operation.

2. The total debts (secured and unse-cured) of that farming operation mustnot exceed $1.5 million.

3. Not less than 80% of the total debtswhich are fixed in amount must berelated to the farming operation.

4. More than 50% of the gross incomeof the individual or the husband andwife for the receding tax year must havecome from the farming operation.

In order for a corporation or part-nership to fall within the second cate-gory of debtors eligible to file as “fam-ily farmers,” the corporation or part-nership must meet each of the follow-ing criteria as of the date of the filing ofthe petition.

1. More than one-half of the outstand-ing stock or equity in the corporation orpartnership must be owned by one fam-ily or by one family and its relatives.

2. The family or the family and its rela-tives must conduct the farming operation.

3. More than 80% of the value of thecorporate or partnership assets must berelated to the farming operation.

4. The total indebtedness of the corpo-ration or partnership must not exceed$1.5 million.

5. Not less than 80% of the corpora-tion’s or partnership’s total debts whichare fixed in amount must come from thefarming operation owned or operated bythe corporation or partnership.

6. If the corporation issues stock, thestock cannot be publicly traded.

HOW CHAPTER 12 WORKSA chapter 12 case begins with the filingof a petition and several additionalforms, such as schedules of assets andliabilities, a statement of financialaffairs, a schedule of current incomeand expenditures, and a schedule ofexecutory contracts and unexpired leas-es. Bankruptcy Rule 1007(b)(1). Thepetition and other forms are filed withthe bankruptcy court serving the areawhere the individual lives or where thecorporation or partnership debtor hasits principal place of business or princi-pal assets. The exact filing require-ments in each jurisdiction are specifiedin local rules of court which can beobtained from the clerk’s office.(Official Bankruptcy Forms can be pur-

40 • FAMILY FARMER BANKRUPTCY

chased at a legal stationery store. Theyare not available from the court.) Ahusband and wife may file one jointpetition. 11 U.S.C. § 302(a).

In order to complete the OfficialBankruptcy Forms which make upthe petition and schedules, the debtorwill need to compile the followinginformation:

1. A list of all creditors;

2. The source, amount, frequency, andreliability of the debtor’s income;


4. A detailed list of the debtor’s month-ly farming and living expenses, i.e.,food, shelter, utilities, taxes, trans-portation, medicine, feed, fertilizer, etc.

When a husband and wife intend tofile a single, joint petition, they shouldgather the above-detailed data for bothspouses. Even when only one spousefiles, however, the income and expensesof the non-filing spouse should beincluded in the petition and schedules,so that the court can assess accuratelythe debtor’s financial responsibilities.

Currently, the courts are required tocharge a $200 filing fee. This fee shouldbe paid in full upon filing or, with thecourt’s permission, the fee for an indi-vidual debtor may be paid in up to four installments. Bankruptcy Rule1006(b)(1). If a joint petition is filed,only one $200 fee is charged.

Upon the filing of the petition, animpartial trustee is appointed by thecourt or the United States trustee toadminister the case. 11 U.S.C. § 1202;28 U.S.C. § 586(b). As in chapter 13,

the trustee’s primary responsibility is toact as a disbursing agent, receiving pay-ments from debtors and making distri-butions to creditors.

The filing of the petition also “auto-matically stays” most actions by credi-tors to collect money or property owedto them. 11 U.S.C. § 362. Creditors, bylaw, generally cannot initiate or contin-ue any lawsuits, wage garnishments, oreven telephone calls demanding pay-ment. Creditors (whose identities andmailing addresses are provided by thedebtor) will receive notice of the filingof the petition from the court.

The debtor must file a plan ofrepayment with the petition or within90 days afterward, unless the courtdetermines that the need for an exten-sion is attributable to circumstancesfor which the debtor should not beheld accountable. 11 U.S.C. § 1221.Plans, which must be approved by thecourt, provide for payments of fixedamounts to the trustee on a regularbasis. The trustee then distributes thefunds to creditors according to theterms of the plan.

There are three types of debt:secured, priority, and unsecured.Secured debts are those for which thecreditor has the right to pursue specificpledged property upon default. Prioritydebts are those granted special statusby the bankruptcy law, such as mosttaxes and the costs of the bankruptcyproceeding. Unsecured debts generallyare characterized as those debts forwhich credit was extended based solelyon the creditor’s assessment of thedebtor’s future ability to pay.

The debtor’s plan usually lasts threeto five years. It must provide for pay-ment in full to all priority creditors.11 U.S.C. § 1222(a)(2). The plan need


not provide that unsecured creditorsbe paid in full, as long as the debtorpays under the plan all projected “dis-posable income” over the three to fiveyears that the plan is in effect and aslong as the plan provides that unse-cured creditors are to receive at leastas much as they would receive if thedebtor’s nonexempt assets were liqui-dated under chapter 7. 11 U.S.C. § 1225. “Disposable income” isdefined as income which is not rea-sonably necessary for the mainte-nance or support of the debtor orhis/her dependents or for the paymentof expenditures necessary for the con-tinuation, preservation, and operationof the debtor’s business. 11 U.S.C. § 1225(b)(2)(A) and (B).

Secured creditors must be paid atleast as much as the value of the col-lateral pledged for the debt. One of thefeatures of Chapter 12 is that, in cer-tain circumstances, payments tosecured creditors can continue longerthan the three-to-five-year period theplan provides for payment to unse-cured and priority creditors.

Approximately 20 to 35 days afterthe petition is filed, a “meeting of cred-itors” is held. The debtor must attendthis meeting, at which creditors mayappear and ask questions regarding thedebtor’s financial affairs and the pro-posed terms of the plan. 11 U.S.C. § 343; Bankruptcy Rule 4002. (If a hus-band and wife have filed a joint peti-tion, both must attend the creditors’meeting.) The trustee will also attendthe meeting and question the debtor. Inorder to preserve their independentjudgment, bankruptcy judges are pro-hibited from attending meetings of cred-itors. 11 U.S.C. § 341(c). Any problemswith the plan are typically resolved dur-

ing or shortly after the creditors’ meet-ing. Generally, problems may be avoid-ed if the petition and plan are completeand accurate and the trustee has beenconsulted prior to the meeting.

Within 45 days after the filing of theplan, the presiding bankruptcy judgemust determine at a “confirmationhearing” whether the plan is feasibleand meets the standards for confir-mation under the Bankruptcy Code.11 U.S.C. §§ 1224 and 1225. Creditorsmay appear at the hearing and objectto confirmation. While a variety ofobjections may be made, the typical

The debtor must file

a plan of repayment

with the petition

or within 90 days

afterward, unless

the court determines

that the need for

an extension is

attributable to

circumstances for

which the debtor

should not be held

accountable.

42 • FAMILY FARMER BANKRUPTCY

arguments are that payments offeredunder the plan are less than creditorswould receive if the debtor’s assetswere liquidated or that the plan doesnot commit all of the debtor’s dispos-able income for the three-to-five-yearperiod of the plan.

If the plan is confirmed by the bank-ruptcy judge, the trustee commencesdistribution of the funds the trusteehas received from the debtor. If the

plan is not confirmed, the funds paidto the trustee are returned to thedebtor after deducting the trustee’spercentage fee and any unpaid claimallowed for administrative expenses.11 U.S.C. § 1226(a).

On occasion, changed circumstanceswill affect a debtor’s ability to makepayments or a debtor may inadvertent-ly have failed to list all creditors. Insuch instances, the plan may be modi-fied either before or after confirmation.11 U.S.C. §§ 1223 and 1229.

MAKING THE PLAN WORKOnce the court confirms the plan, it isincumbent upon the debtor to makethe plan succeed. The debtor mustmake regular payments to the trustee.Further, while confirmation of the planentitles the debtor to retain property aslong as payments are made, 11 U.S.C.§ 1227(b), the debtor should not incurany significant new credit obligationswithout consulting the trustee, becausethey may impact upon the successfulexecution of the plan. In any event,failure to make the plan payments may result in dismissal of the case.11 U.S.C. § 1208(c). In addition, thecourt may dismiss the case or convertthe case to a liquidation case underchapter 7 of the Bankruptcy Codeupon a showing that the debtor hascommitted fraud in connection withthe case. 11 U.S.C. § 1208(d).

THE CHAPTER 12DISCHARGEAs is the case under chapter 13, uponsuccessful completion of all paymentsunder a chapter 12 plan, the debtor willreceive a “discharge” which extinguish-es the debtor’s obligation to pay anyunsecured debts that were included in

Upon successful

completion of all

payments under a

chapter 12 plan, the

debtor will receive a

“discharge” which

extinguishes the

debtor’s obligation

to pay any unsecured

debts that were

included in the plan,

even though they

may not have been

paid in full.


the plan, even though they may nothave been paid in full. 11 U.S.C. § 1228. After the discharge has beengranted, those creditors whose claimswere provided for in full or in partunder the plan no longer may initiateor continue any legal or other actionagainst the debtor to collect the dis-charged obligations.

Certain categories of debts are notdischarged in chapter 12 proceedings.11 U.S.C. § 1228(a). Those categoriesinclude debts for alimony and childsupport; money obtained through fil-ing false financial statements; debts forwillful and malicious injury to personor property; debts for death or person-al injury caused by the debtor’s opera-tion of a motor vehicle while thedebtor was intoxicated; and debtsfrom fraud or defalcation while actingin a fiduciary capacity, embezzlementor larceny. In fact, the discharge ismore limited in chapter 12 than it is ina chapter 13 case. The bankruptcy lawregarding the scope of a chapter 12discharge is complex, however, anddebtors should consult competent legalcounsel in this regard prior to filing.Those debts which will not be dis-charged should be paid in full under aplan. With respect to secured obliga-tions, those debts may be paid beyondthe end of the plan payment periodand, accordingly, are not discharged.

CHAPTER 12HARDSHIP DISCHARGEIf payments under a plan are not com-pleted due to circumstances for whichthe family farmer “should not justlybe held accountable,” 11 U.S.C. § 1228(b)(1), and other statutory cri-teria have been met, a family farmermay be excused from completing pay-

ments under a plan of reorganization.If the court finds that such circum-stances exist and that unsecured credi-tors already have received at leastwhat they would have received if thedebtor’s estate had been liquidatedunder chapter 7 of the BankruptcyCode, the bankruptcy court may grantthe debtor a discharge of all unsecureddebts provided for in the plan or disal-lowed by the court, with the exceptionof those types of debts which areexcepted from discharge. Injury or ill-ness that precludes employment suffi-cient to fund even a modified planmay serve as the basis for a dischargeunder section 1228(c). A dischargegranted under section 1228(c) is oftenreferred to as a “hardship discharge.”

In the more than 60 years

since Congress established

a federal mechanism for

the resolution of municipal

debts, there have been

fewer than 500 municipal

bankruptcy petitions filed.

Although chapter 9 cases

are rare, a filing by a large

municipality can—like the

1994 filing by Orange

County, California—involve

many millions of dollars in

municipal debt.

9C H A P T E R

MunicipalityBankruptcy

HISTORY OF CHAPTER 9The first municipal bankruptcy legisla-tion was enacted in 1934 during theGreat Depression. Pub. L. No. 251, 48Stat. 798 (1934). Although Congresstook care to draft the legislation so asnot to interfere with the sovereign pow-ers of the states as guaranteed by theTenth Amendment to the Constitution,the Supreme Court held the 1934 Act unconstitutional as an improperinterference with the sovereignty of the states. Ashton v. Cameron CountyWater Improvement District No. 1,298 U.S. 513 (1936). Congress enacteda revised Municipal Bankruptcy Act in1937, Pub. L. No. 302, 50 Stat. 653(1937), which was upheld by theSupreme Court. United States v.Bekins, 304 U.S. 27 (1938). The lawhas been amended several times since1937, most recently in 1994 (amendingsection 109(c)) as part of theBankruptcy Reform Act of 1994, Pub.L. No. 103–394, 108 Stat. 4106 (codi-fied as amended at 11 U.S.C. §§ 901 to946) (1994). In the more than 60 yearssince Congress established a federalmechanism for the resolution of munic-ipal debts, there have been fewer than500 municipal bankruptcy petitionsfiled. Although chapter 9 cases are rare,a filing by a large municipality can—like the 1994 filing by Orange County,California—involve many millions ofdollars in municipal debt.

MUNICIPALITY BANKRUPTCY • 45

PURPOSE OF MUNICIPALBANKRUPTCYThe purpose of chapter 9 is to providea financially-distressed municipalityprotection from its creditors while itdevelops and negotiates a plan foradjusting its debts. Reorganization ofthe debts of a municipality is typicallyaccomplished either by extending debtmaturities, reducing the amount ofprincipal or interest, or refinancing thedebt by obtaining a new loan.

Although similar to other chapters insome respects, chapter 9 is significantlydifferent in that there is no provision inthe law for liquidation of the assets ofthe municipality and distribution of theproceeds to creditors. Such a liquida-tion or dissolution would undoubtedlyviolate the Tenth Amendment to theConstitution and the reservation to thestates of sovereignty over their internalaffairs. Indeed, due to the severe limita-tions placed upon the power of thebankruptcy court in chapter 9 cases(required by the Tenth Amendment andthe Supreme Court’s decisions in casesupholding municipal bankruptcy legis-lation), the bankruptcy court generallyis not as active in managing a munici-pal bankruptcy case as it is in corporatereorganizations under chapter 11. Thefunctions of the bankruptcy court inchapter 9 cases are generally limited toapproval of the petition (if the debtor iseligible), confirmation of a plan of debtadjustment, and ensuring implementa-tion of the plan. As a practical matter,however, the municipality may consentto have the court exercise jurisdictionin many of the traditional areas ofcourt oversight in bankruptcy, in orderto obtain the protection of court ordersand eliminate the need for multipleforums to decide issues.

MEDIA INTERESTThe news media frequently is moreinterested in municipal bankruptcycases than in cases filed by individualsor small businesses. As a consequence,some courts have a written policy forcourt personnel regarding the infor-mation that may or may not bereleased to the media in a case filedunder chapter 9. Some courts also des-ignate a public information officer toact as the contact person for all mediainquiries concerning the municipalbankruptcy case.

ELIGIBILITYOnly a “municipality” can file for reliefunder chapter 9. The term “municipali-ty” is defined in the Code to mean“political subdivision or public agencyor instrumentality of a State.” 11 U.S.C.§ 101(40). The definition is broadenough to include cities, counties, town-ships, school districts, and publicimprovement districts. It also includesrevenue-producing bodies that provideservices which are paid for by usersrather than by general taxes, such asbridge authorities, highway authorities,and gas authorities.

There are three additional eligibilityrequirements for chapter 9:

1. the entity must be specifically autho-rized to be a debtor under such chapterby State law or by a governmental offi-cer or organization empowered byState law to authorize such entity to bea debtor under such chapter,

2. the municipality must be insolvent asdefined in 11 U.S.C. § 101(32)(C), and

3. the municipality must desire to effecta plan to adjust such debts and either

46 • MUNICIPALITY BANKRUPTCY

• has obtained the agreement of cred-itors holding at least a majority inamount of the claims of each class thatthe debtor intends to impair under aplan in a case under chapter 9;

• has negotiated in good faith withcreditors and has failed to obtain theagreement of creditors holding at leasta majority in amount of the claims ofeach class that the debtor intends toimpair under a plan;

• is unable to negotiate with credi-tors because such negotiation isimpracticable; or

• reasonably believes that a creditormay attempt to obtain a preference.

11 U.S.C. § 109(c).

COMMENCEMENTOF THE CASEMunicipalities must voluntarily seekprotection under the Bankruptcy Code.11 U.S.C. §§ 303, 901(a). They mayfile a petition only under chapter 9. Acase under chapter 9 concerning anunincorporated tax or special assess-ment district that does not have suchdistrict’s own officials is commenced bythe filing of a voluntary “petition underthis chapter by such district’s governingauthority or the board or body havingauthority to levy taxes or assessmentsto meet the obligations of such dis-trict.” 11 U.S.C. § 921(a).

A municipal debtor is required to filea list of creditors. 11 U.S.C. § 924.Normally, the list of creditors is filedwith the petition. However, in some sit-uations, the debtor may not have ade-quate time to prepare a list of creditorsin the form and with the detail requiredby the Bankruptcy Rules. Thus, theBankruptcy Rules permit the court tofix a time within which the list must befiled. Fed. R. Bankr. P. 1007.

ASSIGNMENT OF CASE TOA BANKRUPTCY JUDGEOne significant difference betweenchapter 9 cases and cases filed underother chapters is that the clerk ofcourt does not automatically assignthe case to a particular judge. “Thechief judge of the court of appeals forthe circuit embracing the district inwhich the case is commenced [desig-nates] the bankruptcy judge to con-duct the case.” 11 U.S.C. § 921(b).This provision was designed to removepolitics from the issue of which judgewill preside over the chapter 9 case ofa major municipality and to ensurethat a municipal case will be handledby a judge who has the time and capa-bility of doing so. S. Rep. No. 458,94th Cong., 1st Sess. 15 (1975) (leg-islative history of Bankruptcy Act—Debts of Municipalities, Pub. L. No.94–260, 90 Stat. 315 (1976)). See alsoS. Rep. No. 989, 95th Cong., 2d Sess.110 (1978).

NOTICE OFCASE/OBJECTIONS/ORDER FOR RELIEFThe Bankruptcy Code requires thatnotice be given of the commencement of the case and the order for relief.11 U.S.C. § 923. The Bankruptcy Rulesprovide that the clerk, or such otherperson as the court may direct, is to givenotice. Fed. R. Bankr. P. 2002(f). Suchnotice must also be published “at leastonce a week for three successive weeksin at least one newspaper of general cir-culation published within the district inwhich the case is commenced, and insuch other newspaper having a generalcirculation among bond dealers andbondholders as the court designates.”11 U.S.C. § 923. The court typically


enters an order designating who is togive and receive notice by mail andidentifying the newspapers in which theadditional notice is to be published.Fed. R. Bankr. P. 9008.

The Bankruptcy Code permits objec-tions to the petition to be filed.11 U.S.C. § 921(c). Typically, objec-tions concern issues like whether nego-tiations have been conducted in goodfaith, whether the state has authorizedthe municipality to file, and whetherthe petition was filed in good faith. Ifan objection to the petition is filed, thecourt must hold a hearing on the objec-tion. Id. The court may dismiss a peti-tion if it determines that the debtor didnot file the petition in good faith orthat the petition does not meet therequirements of title 11. Id.

If the petition is not dismissed uponan objection, the Bankruptcy Coderequires the court to order relief, allow-ing the case to proceed under chapter 9.11 U.S.C. § 921(d).

AUTOMATIC STAYThe automatic stay of section 362 ofthe Bankruptcy Code is applicable inchapter 9 cases. 11 U.S.C. §§ 362(a),901(a). The stay operates to stop allcollection actions against the debtorand its property upon the filing of thepetition. There is another provision ofthe Code, however, which expands thestay to entities other than the debtor.The additional automatic stay provi-sions under section 922(a) prohibitactions against officers and inhabi-tants of the debtor if the action seeksto enforce a claim against the debtor.Thus, the stay prohibits a creditorfrom bringing a mandamus actionagainst an officer of a municipality onaccount of a prepetition debt. It also

prohibits a creditor from bringing anaction against an inhabitant of thedebtor to enforce a lien on or arisingout of taxes or assessments owed tothe debtor. Section 922(d) of title 11limits the applicability of the stay.Pursuant to that section, a chapter 9petition does not operate to stay appli-cation of pledged special revenues topayment of indebtedness secured bysuch revenues. Thus, an indenturetrustee or other paying agent mayapply pledged funds to payments com-ing due or distribute the pledged fundsto bondholders without violating theautomatic stay.

PROOFS OF CLAIMIn a chapter 9 case, the court fixes thetime within which proofs of claim orinterest may be filed. Fed. R. Bankr. P.3003(c)(3). Many creditors may not berequired to file a proof of claim in achapter 9 case. For example, a proof ofclaim is deemed filed if it appears onthe list of creditors filed by the debtor,unless the debt is listed as disputed,contingent, or unliquidated. 11 U.S.C.§ 925. Thus, a creditor must file aproof of claim, if the creditor’s claimappears on the list of creditors as dis-puted, contingent, or unliquidated.

COURT’S LIMITED POWERTwo of chapter 9’s provisions aredesigned to recognize the court’s limitedpower over operations of the debtor:sections 903 and 904. Section 904 of theCode limits the power of the bankrupt-cy court to “interfere with (1) any of thepolitical or governmental powers of thedebtor; (2) any of the property or rev-enues of the debtor; or (3) the debtor’suse or enjoyment of any income-produc-ing property,” unless the debtor consents


or the plan so provides. The provisionmakes it clear that the debtor’s day-to-day activities are not subject to courtapproval and that the debtor may bor-row money without court authority. Inaddition, the court cannot appoint atrustee (except for limited purposesspecified in section 926(a)) and cannot

convert the case to a liquidation pro-ceeding. The court also cannot interferewith the operations of the debtor orwith the debtor’s use of its property andrevenues. This is due, at least in part, tothe fact that in a chapter 9 case there isno property of the estate and thus noestate to administer. 11 U.S.C. § 902(1).

Moreover, the chapter 9 debtor mayemploy professionals without courtapproval, and the only court review offees is in the context of plan confirma-tion, when the court determines the rea-sonableness of the fees. The restrictionsimposed by section 904 are necessary inorder to ensure the constitutionality ofchapter 9 and to avoid the possibilitythat the court might substitute its con-trol over the political or governmentalaffairs or property of the debtor for thatof the state and the elected officials ofthe municipality.

Similarly, section 903 of the Codestates that “chapter [9] does not limitor impair the power of a State to con-trol, by legislation or otherwise, amunicipality of or in such State in theexercise of the political or governmen-tal powers of the municipality, includ-ing expenditures for such exercise,”with two exceptions—a state law pre-scribing a method of composition ofmunicipal debt does not bind any non-consenting creditor, nor does any judg-ment entered under such state law binda nonconsenting creditor.

ROLE OF THE UNITEDSTATES TRUSTEE/BANKRUPTCYADMINISTRATORThe role of the United States trustee inchapter 9 cases is typically more limit-ed than in chapter 11 cases. Althoughthe United States trustee appoints acreditors’ committee, the United Statestrustee does not examine the debtor ata meeting of creditors (there is no meet-ing of creditors), does not have theauthority to move for appointment of atrustee or examiner or for conversionof the case, and does not supervise theadministration of the case. Nor does

Although similar

to other chapters

in some respects,

chapter 9 is

significantly different

in that there is no

provision in the

law for liquidation

of the assets of the

municipality and

distribution of the

proceeds to creditors.


the United States trustee monitor thefinancial operations of the debtor orreview the fees of professionals retainedin the case. Bankruptcy Administratorsserve a similar limited function in chap-ter 9 cases filed in the six judicial dis-tricts in the states of Alabama andNorth Carolina.

ROLE OF CREDITORSThe creditors’ role is more limited inchapter 9 than in other cases. There isno first meeting of creditors and credi-tors may not propose a plan of adjust-ment. If certain requirements are met,the debtor’s plan of adjustment is bind-ing on dissenting creditors. The chapter9 debtor has more freedom to operatewithout court-imposed restrictions. Ineach chapter 9 case, however, there is acreditors’ committee that has powersand duties that are very similar to thoseof a committee in a chapter 11 case.These powers and duties include select-ing and authorizing the employment ofone or more attorneys, accountants, orother agents to represent the committee,consulting with the debtor concerningadministration of the case, investigatingthe acts, conduct, assets, liabilities, andfinancial condition of the debtor, partic-ipating in the formulation of a plan, andperforming such other services as are in the interest of those represented.11 U.S.C. §§ 901(a), 1103.

INTERVENTION/RIGHT OFOTHERS TO BE HEARDWhen cities or counties file for reliefunder chapter 9, there may be a greatdeal of interest in the case from entitieswanting to appear and be heard. TheBankruptcy Rules provide that “[t]heSecretary of the Treasury of the UnitedStates may, or if requested by the court

shall, intervene in a chapter 9 case.” Fed.R. Bankr. P. 2018(c). In addition,“[r]epresentatives of the state in whichthe debtor is located may intervene in achapter 9 case. Id. In addition, section1109 of the Bankruptcy Code permitsthe Securities and Exchange Commissionto appear and be heard on any issue andgives parties in interest the right toappear and be heard on any issue in acase. 11 U.S.C. § 901(a). Among thosethat may be interested in being heard ina chapter 9 case are municipal employ-ees, local residents, non-resident ownersof real property, special tax payers, secu-rities firms, and local banks.

POWERS OF THE DEBTORDue to statutory limitations placedupon the power of the court in amunicipal debt adjustment proceeding,the court is far less involved in the con-duct of a municipal bankruptcy case(and in the operation of the municipalentity) while the debtor’s financialaffairs are undergoing reorganization.The debtor has broad powers to use itsproperty, raise taxes, and make expen-ditures as it sees fit. The debtor is alsopermitted to adjust burdensome non-debt contractual relationships underthe power to reject executory contractsand unexpired leases, subject to courtapproval. Municipalities may alsoreject collective bargaining agreementsand retiree benefit plans without goingthrough the usual procedures requiredin chapter 11 cases. The municipalityalso has the authority to borrow moneyduring a chapter 9 case as an adminis-trative expense. 11 U.S.C. §§ 364,901(a). This ability is important to thesurvival of a municipality that hasexhausted all other resources. A chap-ter 9 municipality has the same power


to obtain credit as it does outside ofbankruptcy. The court does not havesupervisory authority over the amountof debt the municipality incurs in itsoperation. The municipality also hasthe same avoiding powers as otherdebtors, may employ professionalswithout court approval, and fees arereviewed only within the context ofplan confirmation.

DISMISSALAs noted above, if an objection is filed,the court may dismiss the petition afternotice and a hearing if the debtor didnot file the petition in good faith or ifthe petition does not meet the require-ments of chapter 9. 11 U.S.C. § 921(c).A chapter 9 case may also be dismissed,after notice and a hearing, for cause,including lack of prosecution, unrea-sonable delay by the debtor that is prej-udicial to creditors, failure to propose aplan within the time fixed by the court,nonacceptance of a plan within the timefixed by the court, denial of plan confir-mation and denial of additional time forfiling another plan, material default bythe debtor under a confirmed plan, ortermination of a confirmed plan by rea-son of the occurrence of a conditionspecified in the plan. 11 U.S.C. § 930.

TREATMENT OFBONDHOLDERS ANDOTHER LENDERSDifferent types of bonds receive differ-ent treatment in municipal bankruptcycases. General obligation bonds aretreated as general debt in the chapter 9case. The municipality is not requiredto make payments of either principal orinterest on account of such bonds dur-ing the case. The obligations created bygeneral obligation bonds are subject to

negotiation and possible restructuringunder the plan of adjustment.

Special revenue bonds, by contrast,will continue to be secured and servicedduring the pendency of the chapter 9case through continuing application andpayment of ongoing special revenues.11 U.S.C. § 928. Holders of special rev-enue bonds can expect to receive pay-ment on such bonds during the chapter 9case if special revenues are available. Theapplication of pledged special revenuesto indebtedness secured by such revenuesis not stayed as long as the pledge is consistent with section 928 [§ 922(d)erroneously refers to § 927 rather than § 928] of the Code, which insures that alien of special revenues is subordinate tothe operating expenses of the project orsystem from which the revenues arederived. 11 U.S.C. § 922(d).

Bondholders generally do not have toworry about the threat of preference lia-bility with respect to any prepetitionpayments on account of bonds or notes,whether special revenue or generalobligations. Any transfer of the munici-pal debtor’s property to a noteholder orbondholder on account of a note orbond cannot be avoided as a preference,i.e., as an unauthorized payment to acreditor made while the debtor wasinsolvent. 11 U.S.C. § 926(b).

PLAN FOR ADJUSTMENTOF DEBTSThe Bankruptcy Code provides that thedebtor shall file a plan. 11 U.S.C. § 941. The plan must be filed with thepetition or at such later time as thecourt fixes. There is no provision inchapter 9 allowing creditors or otherparties in interest to file a plan. Thislimitation is required by the SupremeCourt’s pronouncements in Ashton,


298 U.S. at 513, and Bekins, 304 U.S.at 27, which interpreted the TenthAmendment as requiring that a munic-ipality be left in control of its govern-mental affairs during a chapter 9 case.Neither creditors nor the court maycontrol the affairs of a municipalityindirectly through the mechanism ofproposing a plan of adjustment of themunicipality’s debts that would ineffect determine the municipality’sfuture tax and spending decisions.

CONFIRMATIONSTANDARDSThe standards for plan confirmation inchapter 9 cases are a combination of thestatutory requirements of 11 U.S.C. § 943(b) and those portions of 11 U.S.C.§ 1129 (the chapter 11 confirmationstandards) that are made applicable by11 U.S.C. § 901(a). Section 943(b) listsseven general conditions to confirmationof a plan. The court must confirm a planif the following conditions are met:

1. the plan complies with the provisionsof title 11 made applicable by sections103(e) and 901;

2. the plan complies with the provisionsof chapter 9;

3. all amounts to be paid by the debtoror by any person for services or expens-es in the case or incident to the plan havebeen fully disclosed and are reasonable;

4. the debtor is not prohibited by lawfrom taking any action necessary tocarry out the plan;

5. except to the extent that the holder ofa particular claim has agreed to a differ-ent treatment of such claim, the plan

provides that on the effective date of theplan each holder of a claim of a kindspecified in section 507(a)(1) will receiveon account of such claim cash equal tothe allowed amount of such claim;

6. any regulatory or electoral approvalnecessary under applicable nonbank-ruptcy law in order to carry out anyprovision of the plan has been ob-tained, or such provision is expresslyconditioned on such approval; and

7. the plan is in the best interests ofcreditors and is feasible.

11 U.S.C. § 943(b).

Section 943(b)(1) requires as a condi-tion to confirmation that the plan com-ply with the provisions of theBankruptcy Code made applicable bysections 103(e) and 901(a) of the Code.The most important of these for purpos-es of confirming a plan are those provi-sions of section 1129 of the Code(1129(a)(2), (a)(3), (a)(6), (a)(8), (a)(10))that are made applicable by section901(a). Section 1129(a)(8) requires as acondition to confirmation that the planhas been accepted by each class ofclaims or interests that is impaired underthe plan. Therefore, if the plan proposestreatment for a class of creditors suchthat the class is impaired (the creditor’slegal, equitable, or contractual rights arealtered), then that class’s acceptance isrequired. If the class is not impaired,then acceptance by that class is notrequired as a condition to confirmation.Under section 1129(a)(10), the courtmay confirm the plan only if, should anyclass of claims be impaired under theplan, at least one impaired class hasaccepted the plan. Even if no impaired


classes of creditors consent to the plan,plan confirmation is still possible underthe “cram down” provisions of section1129(b). Under “cram down,” if allother requirements are met except thesection 1129(a)(8) requirement that allclasses either be unimpaired or haveaccepted the plan, then the plan is con-firmable if it does not discriminateunfairly and is fair and equitable.

The requirement that the plan be inthe “best interests of creditors” meanssomething different in chapter 9 thanunder chapter 11. Under chapter 11, aplan is said to be in the “best interestsof creditors” if creditors would receiveas much under the plan as they wouldif the debtor were liquidated. 11 U.S.C.§ 1129(a)(7)(A)(ii). Obviously, a differ-ent interpretation is needed in chapter 9cases because a municipality’s assetscannot be liquidated to pay creditors.In the chapter 9 context, the “bestinterests of creditors” test has generallybeen interpreted to mean that the planmust be better than other alternativesavailable to the creditors. See 4 Collieron Bankruptcy ¶ 943.03[7] (15th ed.1994). Generally speaking, the alterna-tive to chapter 9 is dismissal of the case,permitting every creditor to fend foritself. An interpretation of the bestinterests of creditors test to require thatthe municipality devote all resourcesavailable to the repayment of creditorswould appear to exceed the standard.The courts generally apply the test torequire a reasonable effort by themunicipal debtor that is a better alter-native for its creditors than dismissal ofthe case. Id.

A special tax payer affected by theplan may object to confirmation of theplan. 11 U.S.C. § 943(a). Other partiesin interest may also object to confirma-

tion, including creditors whose claimsare affected by the plan, an organizationof employees of the debtor, and othertax payers, as well as the Securities and Exchange Commission. 11 U.S.C.§§ 1109(a), 1128(b), 901(a).

DISCHARGEA municipal debtor receives a dischargein a chapter 9 case after (1) confirma-tion of the plan, (2) deposit by thedebtor of any consideration to be dis-tributed under the plan with the dis-bursing agent appointed by the court,and (3) a determination by the courtthat securities deposited with the dis-bursing agent will constitute valid legalobligations of the debtor and that any provision made to pay or securepayment of such obligations is valid.11 U.S.C. § 944(b). Thus, the dischargeis conditioned not only upon confirma-tion, but also upon deposit of the con-sideration to be distributed under theplan and a court determination of thevalidity of securities to be issued.

There are two exceptions to the dis-charge in chapter 9 cases. The first isfor any debt excepted from dischargeby the plan or order confirming theplan. The second exception is for a debtowed to an entity that, before confir-mation of the plan, had neither noticenor actual knowledge of the case.11 U.S.C. § 944(c).

At any time within 180 days afterentry of the confirmation order, thecourt may, after notice and a hearing,revoke the order of confirmation if theorder was procured by fraud. 11 U.S.C.§§ 901(a) and 1144.

The court may retain jurisdiction overthe case for such period of time as is nec-essary for the successful implementationof the plan. 11 U.S.C. § 945(a).

OVERVIEWTypically, when a brokerage firm fails,the SIPC will arrange to have the failedbrokerage’s accounts transferred to adifferent securities brokerage firm. Ifthe SIPC is unable to arrange theaccounts’ transfer, the failed firm is liq-uidated. In that case, the SIPC will sendinvestors either certificates for the stockthat was lost or a check for the marketvalue of the shares.

Although the Bankruptcy Code pro-vides for a stockbroker liquidation pro-ceeding, 11 U.S.C. § 741 et seq., it isfar more likely that a failing brokeragewill find itself involved in a SIPA pro-ceeding rather than a Bankruptcy Codeliquidation case. Brokerage firms maybe liquidated under the BankruptcyCode, however, if SIPC does not file anapplication for a protective decree withthe district court or if the district courtfinds that customers of the brokeragefirm are not in need of protection underSIPA. 15 U.S.C. §§ 78eee.

HISTORYPrior to 1938, little protection existedfor customers of a bankrupt stockbrokerunless they could trace cash and securi-ties held by failed stockbrokers. In 1938Congress enacted section 60e of theBankruptcy Act and created a single andseparate fund concept which was intend-ed to minimize losses to customers bygiving them priority over claims of gen-

SecuritiesInvestorProtection Act

Since being established by

Congress in 1970, the

Securities Investor Protection

Corporation has protected

investors who leave stocks,

bonds, other securities and

cash with brokerage firms by

ensuring that every customer

gets back what he or she left

with the firm—up to $500,000

per customer, including no

more than $100,000 cash. The

sole function of SIPC is to

return to investors securities

and cash left with failed bro-

kerages. It does not protect

investors against losses in the

securities markets.

SIPA

54 • SECURITIES INVESTOR PROTECTION ACT

eral creditors. 1898 Bankruptcy Act §60(e)(2) (repealed). Because the fundwas normally inadequate, however, cus-tomer losses continued.

Following a period of great expan-sion in the securities industry duringthe 1960’s, a serious business contrac-tion hit the industry in 1969–1970.This situation led to voluntary liquida-tions, mergers, receiverships, and bank-ruptcies of a substantial number of bro-kerage houses. Annotation, Validity,Construction, and Application ofSecurities Investor Protection Act of1970 (15 U.S.C.S. §§ 78aaa et seq.), 23A.L.R. Fed. 157, 179 (1975). Cus-tomers of these firms found the cashand securities which they had ondeposit dissipated or tied up in lengthybankruptcy proceedings. Along withthe concern over mounting customerlosses and the subsequent erosion ofinvestor confidence, the Congress wasalso concerned with a possible “domi-no effect” involving otherwise solventbrokers that had substantial opentransactions with firms that failed. Inreaction to this growing concern, theCongress enacted the SecuritiesInvestor Protection Act of 1970 (here-inafter referred to as SIPA). The goalwas to arrest this process, restoreinvestor confidence in the capital mar-kets, and upgrade the financial respon-sibility requirements for registered bro-kers and dealers. Securities InvestorProtection Corp. v. Barbour, 421 U.S.412, 414 (1975). SIPA was designed toapportion responsibility for carryingout the various goals of the legislationto several groups. Among them are theSecurities and Exchange Commission(hereinafter referred to as SEC), varioussecurities industry self-regulatory orga-nizations, and the Securities Investor

Protection Corporation (hereinafterreferred to as SIPC). SIPA was designedto create a new form of liquidationproceeding. It is applicable only tomember firms and was designed toaccomplish the completion of opentransactions and the speedy return ofmost customer property. Id.

SIPASIPA is codified as Title 15, UnitedStates Code, Sections 78aaa–111. SIPAcreated SIPC, a nonprofit, private mem-bership corporation to which most reg-istered brokers and dealers are requiredto belong. 15 U.S.C. § 78ccc. The SIPCfund, which constitutes an insuranceprogram, is authorized under 15 U.S.C.§ 78ddd(a) and assessments againstmembers are authorized by 15 U.S.C.§§ 78ddd(c) and (d). The fund isdesigned to protect the customers ofbrokers or dealers subject to SIPA fromloss in case of financial failure of themember. The fund is supported byassessments upon its members. If thefund should become inadequate, SIPAauthorizes borrowing against the U.S.Treasury. An analogy could be made tothe role of the Federal Deposit InsuranceCorporation in the banking industry.

BANKRUPTCYLIQUIDATION VERSUSSIPA LIQUIDATION INBANKRUPTCY COURTThe essential difference between a liquidation under the Bankruptcy Code (11 U.S.C. §§ 741–752) and one underSIPA is that under the Code the trusteeis charged with converting securities tocash as quickly as possible and, withthe exception of the delivery of cus-tomer name securities, making cash dis-tributions to customers of the debtor in

SECURITIES INVESTOR PROTECTION ACT • 55

satisfaction of their claims. A SIPCtrustee, on the other hand, is required todistribute securities to customers to thegreatest extent practicable in satisfac-tion of their claims against the debtor.

There is a fundamental difference inorientation between the two proceed-ings. There is a statutory grant ofauthority to a SIPC trustee to purchasesecurities to satisfy customer net equityclaims to specified securities. 15 U.S.C.§ 78fff–2(d). The trustee is required to return customer name securities to customers of the debtor (15 U.S.C. § 78fff–2)(c)(2)), distribute the fund of“customer property” ratably to cus-tomers (15 U.S.C. § 78fff–2(b)), andpay, with money from the SIPC fund,remaining customer net equity claims,to the extent provided by the Act (15 U.S.C. §§ 78fff–2(b) and 3(a)). Atrustee operating under the Code lackssimilar resources. The Code seeks toprotect the filing date value of a cus-tomer’s securities account by liquidat-ing all non-customer name securities.SIPA seeks to preserve an investor’sportfolio as it stood on the filing date.Under SIPA, the customer will receivesecurities whenever possible.

ROLE OF THEDISTRICT COURT15 U.S.C. § 78eee(a)(3)(A) providesthat SIPC may file an application for aprotective decree with the United Statesdistrict court if SIPC determines thatany member has failed or is in dangerof failing to meet obligations to customers and meets one of the fourconditions specified in 15 U.S.C. § 78eee(b)(1). This application will befiled as a civil case in which SIPC or theSEC or both are named as plaintiff, andthe member securities firm is named as

the debtor-defendant. In the event thatthe SIPC refuses to act under the SIPA,the SEC may apply to the United StatesDistrict Court for the District ofColumbia to require the SIPC to dis-charge its obligations under SIPA.15 U.S.C. § 78ggg(b). By contrast, cus-tomers of failing broker-dealers do nothave an implied right of action underSIPA to compel the SIPC to exercise itsstatutory authority for their benefit.Barbour at 425. Upon the filing of anapplication, the district court has exclu-sive jurisdiction of the debtor-defen-dant and its property.

The institution of a case under SIPAbrings a pending bankruptcy liquidationto a halt. Irrespective of the automaticstay, SIPC may file an application for aprotective decree under SIPA. 11 U.S.C.§ 742; 15 U.S.C. § 78aaa et seq. The fil-ing stays all proceedings in the bank-ruptcy case until the SIPC action is com-pleted. Id. Pending issuance of a protec-tive decree, the district court:

[i.] shall stay any pending bankruptcy,mortgage foreclosure, equity receiver-ship, or other proceeding to reorganize,conserve, or liquidate the debtor or itsproperty and any other suit against anyreceiver, conservator, or trustee of thedebtor or its property, and shall contin-ue such stay upon appointment of atrustee …

[ii.] may stay any proceeding to enforcea lien against property of the debtor orany other suit against the debtor,including a suit by stockholders of thedebtor which interferes with prosecu-tion by the trustee of claims against for-mer directors, officers, or employees ofthe debtor, and may continue such stayupon appointment of a trustee ...


[iii.] may stay enforcement of, andupon appointment of a trustee ... [if aprotective decree is issued] ... may con-tinue the stay for such period of time asmay be appropriate, but shall not abro-gate,[sic] any right of setoff, except tothe extent such right may be affectedunder section 553 of Title 11 of theUnited States Code ... and shall notabrogate the right to enforce a valid,nonpreferential lien or pledge againstthe property of the debtor; and

[iv.] may appoint a temporary receiver.

15 U.S.C. § 78eee(b)(2)(B)(I–iv) (em-phasis added).

In addition, upon the filing of a SIPCapplication, 11 U.S.C. § 362 comesinto effect.

SIPA provides that the district courtshall issue a protective decree if thedebtor consents, the debtor fails to contest the application for a protec-tive decree, or the district court findsthat one of the conditions specified in15 U.S.C. § 78eee(b)(1) exist. If thecourt issues a protective decree, thenthe court will appoint a trustee and anattorney for the trustee whom SIPC, inits sole discretion, specifies. 15 U.S.C. § 78eee(b)(3). Upon the issuance of aprotective decree and appointment of atrustee, or a trustee and counsel, thedistrict court shall order the removal ofthe entire liquidation proceeding to thebankruptcy court in the same judicialdistrict. 15 U.S.C. § 78eee(b)(4).

REMOVAL TOBANKRUPTCY COURTThe case is removed to the bankruptcycourt as an adversary proceeding forliquidation. No filing or removal fee is

charged. The reason for using an adver-sary proceeding number is historical.While these SIPA proceedings are notbankruptcy cases, by law certain proce-dures prescribed in chapters 1, 3, and 5,and subchapters I and II of chapter 7 ofTitle 11 of the United States Code areapplicable in SIPA proceedings. In addi-tion, there is no related bankruptcy casenumber. Statistical reports to theAdministrative Office should repeat theadversary number so that the StatisticsDivision will know it is a SIPA matter.For adversary proceedings withinthe adversary SIPA proceeding, theclerk's office should use the originaladversary proceeding number for the related case number.

SIPA requires that the bankruptcycourt hold a hearing with 10 daysnotice to customers, creditors, andstockholders on the disinterestedness ofthe trustee or attorney for the trustee.15 U.S.C. § 78eee(b)(6)(B). At the hear-ing, the court will entertain grounds forobjection to the retention of the trusteeor attorney for the trustee including,among other things, insider considera-tions. 15 U.S.C. § 78eee(b)(6)(A). IfSIPC appoints itself as trustee, it shouldbe deemed disinterested, and where aSIPC employee has been specified, theemployee shall not be disqualified sole-ly because of his employment. Id.Neither the Bankruptcy Code, Bank-ruptcy Rules, nor SIPA provide forUnited States trustee or BankruptcyAdministrator involvement.

SIPA provides for noticing of bothcustomers and creditors. The noticingrequirements provided for in 15 U.S.C.


§ 78fff–2(a)(1) are performed by thetrustee, not the clerk of the bankruptcycourt. While SIPA does not require aformal proof of claim for customers(other than certain insiders and their rel-atives), it does require a written state-ment of claim. The trustee will normal-ly provide customers with claim formsand instructions. The claim form mustbe filed with the trustee rather than theclerk of the bankruptcy court. 15 U.S.C.§ 78fff2(a)(2). With limited, specifiedexceptions, no claim of a customer orother creditor can be allowed unless it isreceived by the trustee within sixmonths after the initial publication ofnotice. 15 U.S.C. § 78fff–2(a)(3).

LIQUIDATIONPROCEEDINGSThe purposes of a SIPA liquidation are:(1) to deliver customer name securities toor on behalf of customers; (2) to distrib-ute customer property and otherwise sat-isfy net equity claims of customers; (3) tosell or transfer offices and other produc-tive units of the debtor’s business; (4) toenforce the rights of subrogation; and (5)to liquidate the business as promptly aspossible. 15 U.S.C. § 78fff(a). To theextent possible, consistent with SIPA, theliquidation is conducted in accordancewith chapters 1, 3, 5 and subchapters Iand II of chapter 7 of Title 11. 15 U.S.C.§ 78fff(b). A section 341 meeting of cred-itors is conducted by the trustee.Noncustomer claims are handled as in anasset case. Costs and expenses, and pri-orities of distribution from the estate, areallowed as provided in section 726 ofTitle 11. Funds advanced by SIPC to thetrustee for costs and expenses arerecouped from the estate, to the extentthere is any estate, pursuant to section507 of Title 11.

POWERS OF THE TRUSTEEThe powers of the trustee in a SIPCcase are essentially the same as thosevested in a chapter 7 trustee appointedunder Title 11. “In addition, a trustee

The purposes of a

SIPA liquidation are:

(1) to deliver customer

name securities to or

on behalf of cus-

tomers; (2) to distrib-

ute customer property

and otherwise satisfy

net equity claims of

customers; (3) to sell

or transfer offices and

other productive units

of the debtor’s busi-

ness; (4) to enforce

the rights of subroga-

tion; and (5) to liqui-

date the business as

promptly as possible.


may, with the approval of SIPC butwithout any need for court approval:

1. hire and fix the compensation of allpersonnel (including officers andemployees of the debtor and of itsexamining authority) and other persons(including accountants) that are deemedby the trustee necessary for all or anypurposes of the liquidation proceeding;

2. utilize SIPC employees for all or anypurposes of a liquidation proceeding; and

3. margin and maintain customeraccounts of the debtor …”

15 U.S.C. § 78fff–1(a).

A SIPC trustee may reduce to moneycustomer securities constituting customerproperty or in the general estate of thedebtor. 15 U.S.C. § 78fff–1(b). Thetrustee shall, however, deliver securitiesto customers to the maximum extentpracticable. 15 U.S.C. § 78fff–1(b)(1).Subject to prior approval of SIPC, butagain without any need for courtapproval, the trustee may also pay orguarantee any part of the debtor’sindebtedness to a bank, person, or otherlender when certain conditions exist.15 U.S.C. § 78fff–1(b)(2).

The trustee is responsible for investi-gating the acts, conduct, and conditionof the debtor and reporting thereon tothe court. 15 U.S.C. § 78fff–1(d)(1). Thetrustee must also provide a statement on the investigation to SIPC and to otherpersons as the court might direct.15 U.S.C. § 78fff–1(d)(4). Moreover, thetrustee must make periodic reports tothe court and to SIPC on the progress ofdistribution of cash and securities to cus-tomers. 15 U.S.C. § 78fff–1(c).

CLAIMSUpon receipt of a written statement ofclaim, the trustee promptly dischargesobligations of the debtor relating tocash and securities by delivering securi-ties or making payments to or onbehalf of the customer insofar as suchobligations are ascertainable frombooks and records of the debtor, or areotherwise established to the satisfac-tion of the trustee. The value of securi-ties delivered in this regard are calcu-lated as of the close of business on thefiling date. 15 U.S.C. § 78fff–2(b).

The court must authorize the trusteeto satisfy claims out of moniesadvanced by SIPC for this purpose,notwithstanding that the estate maynot have sufficient funds for such pay-ment. 15 U.S.C. § 78fff–2(b)(1). Thecourt is generally not involved in theprocess except to the extent that a dis-pute arises between the trustee and cus-tomers regarding specific claims.Simple objections stay with the initialadversary proceeding. Occasionally,however, significant litigation arises inthis area which generates relatedactions in the form of additional adver-sary proceedings.

DISTRIBUTIONCustomer related property of thedebtor is allocated as follows:

A. First, to SIPC in repayment ofadvances made to the extent they wereused to recover securities apportionedto customer property;

B. Second, to customers of the debtoron the basis of their net equities;

C. Third, to SIPC as subrogee for theclaims of customers; and


D. Fourth, to SIPC in repayment ofadvances made by SIPC to transfer orsell customer accounts to another SIPCmember firm.

15 U.S.C. § 78fff–2(c)(1).

The trustee must deliver customername securities to the customer if suchcustomer is not indebted to the debtor.If indebted, then the customer may,with the approval of the trustee, reclaimsecurities in his name upon payment to the trustee of all such indebtedness.15 U.S.C. § 78fff–2(c)(2).

The trustee may, with the approvalof SIPC, sell or otherwise transfer to another member of SIPC, withoutconsent of any customer, all or any partof the account of a customer. 15 U.S.C.§ 78fff–2(f). The trustee may also enterinto any agreement, and SIPC willadvance funds as necessary, to indemni-fy the member firm against shortages of cash or securities in customeraccounts sold or transferred. 15 U.S.C.§ 78fff–2(f)(2). In addition, the trusteemay purchase securities in a fair andorderly market in order to deliver secu-rities to customers in satisfaction oftheir claims. 15 U.S.C. § 78fff–2(d).

To the extent customer property andSIPC advances are not sufficient to payor satisfy in full the net equity claims ofcustomers, then customers are entitledto participate in the estate as unsecuredcreditors. 15 U.S.C. § 78fff–2(c)(1).

ADVANCESThe law requires that SIPC makeadvances to the trustee in order to satis-fy claims and otherwise liquidate thebusiness. These advances are made tosatisfy customer claims in cash, to pur-chase securities to satisfy net equity

claims in lieu of cash, and to pay all nec-essary costs and expenses of administra-tion and liquidation of the estate to theextent the estate of the debtor is insuffi-cient to pay said costs and expenses.Any amount advanced in satisfaction ofcustomer claims may not exceed$500,000 per customer. 15 U.S.C. § 78fff–3(a). If part of the claim is forcash, the total amount advanced forcash payment must not exceed$100,000. 15 U.S.C. § 78fff–3(a)(1).The difference between cash paymentsand the maximum amount allowed canbe satisfied by the delivery of securities,or cash in lieu of securities.

DIRECT PAYMENT UNDERSIPA OUTSIDE THEBANKRUPTCY COURTIn certain situations, SIPC may elect toutilize a direct payment procedure to thecustomers of a debtor, thereby avoiding atrustee and the courts. Certain precondi-tions must exist. The claims of all cus-tomers must aggregate less than$250,000, the debtor must be financiallydistressed as defined in the law, and thecost to SIPC for direct payment processmust be less than for liquidation throughthe courts. 15 U.S.C. § 78fff–4(a).

If direct payment is utilized, theentire proceeding remains outside thecourt. The process remains essentially atransaction between SIPC and thedebtor’s customers.

Although SIPA provides for a directpayment procedure in lieu of institutinga liquidation proceeding, the bankrupt-cy court may still become involved indisputes regarding the direct paymentprocedure. A person aggrieved by aSIPC determination with respect to aclaim in a direct payment proceduremay, within six months following mail-


ing of a SIPC determination, seek a finaladjudication of such claim by the court.15 U.S.C. § 78fff–4(e). The courts hav-ing jurisdiction over cases under Title11 have original and exclusive jurisdic-tion of any civil action for the adjudica-tion of such claims. The action is to bebrought in the judicial district where thehead office of the debtor is located. Itwould be brought as an adversary pro-ceeding in the bankruptcy court eventhough there is no main case.

ROLE OF SECURITIES ANDEXCHANGE COMMISSIONThe SEC is responsible for regulating andsupervising the activities of the SIPC. TheSEC promulgates operating rules whichestablish the role of self-regulatory orga-nizations and examining authorities, andtheir reporting responsibilities to SIPC ofinspections and reviews of its memberfirms. SIPC’s member firms are alsorequired to provide information and doc-umentation as necessary to assist inaccomplishing these inspections. Thepenalties for fraud, deceit, or withhold-ing of information throughout theprocesses covered by this law are severe.15 U.S.C. § 78jjj(c).

COMPENSATIONIN A SIPA ACTIONSIPA specifies that the bankruptcycourt must grant reasonable compensa-tion for the services and expenses of thetrustee and the attorney for the trustee.Interim allowances are also permitted.15 U.S.C. § 78eee(b)(5)(A). Any personseeking allowances must file an appli-cation which complies in form and con-tent with provisions in Title 11, andmust also serve a copy on the debtor,SIPC, creditors and other persons thecourt may designate. The court is

required to fix a time for a hearing onthe application. Notice need not begiven to customers whose claims havebeen or will be paid in full or creditorswho cannot reasonably be expected to receive any distribution. 15 U.S.C. § 78eee(b)(5)(B).

SIPC will review the application andfile its recommendation with respectto such allowances prior to the hear-ing on the application. In any casewhere the allowances are to be paid bySIPC without reasonable expectationof recoupment and there is no differ-ence between the amount applied forand the amount recommended bySIPC, the bankruptcy court mustaward that amount. 15 U.S.C. § 78eee(b)(5)(C). If there is a differ-ence, the court must, among otherconsiderations, place considerablereliance on the recommendation ofSIPC. If the estate is insufficient tocover these awards as costs of admin-istration, 15 U.S.C. § 78eee(b)(5)(E)provides that SIPC will advance thenecessary funds to cover the costs.

ADVERSARY PROCEEDING A lawsuit arising in or related to abankruptcy case that is commenced byfiling a complaint with the bankruptcycourt.

ASSUMEAn agreement to continue performingduties under a contract or lease.

AUTOMATIC STAY An injunction that automatically stopslawsuits, foreclosure, garnishments,and all collection activity against thedebtor the moment a bankruptcy peti-tion is filed.

BANKRUPTCY A legal procedure for dealing with debtproblems of individuals and businesses;specifically, a case filed under one ofthe chapters of title 11 of the UnitedStates Code (the Bankruptcy Code).

BANKRUPTCY ADMINISTRATOR An officer of the judiciary serving in thejudicial districts of Alabama and NorthCarolina who, like the United Statestrustee, is responsible for supervisingthe administration of bankruptcy cases,estates, and trustees, monitoring plansand disclosure statements, monitoringcreditors’ committees, monitoring feeapplications, and performing otherstatutory duties.

BankruptcyTerminology

Most debtors who file bankruptcy,

and many of their creditors, know

very little about the bankruptcy

process. The Public Information Series

of the Bankruptcy Judges Division is

designed to provide debtors, credi-

tors, judiciary employees, and the

general public with a basic explana-

tion of bankruptcy and how it works.

The series features eight pamphlets

that discuss chapter 7 (liquidation),

chapter 13 (adjustment of debts of

an individual with regular income),

chapter 12 (adjustment of debts of a

family farmer), chapter 11 (reorgani-

zation), chapter 9 (adjustment of

debts of a municipality), SIPA (the

Securities Investor Protection Act),

the bankruptcy discharge, and bank-

ruptcy terminology. This pamphlet on

bankruptcy terminology explains, in

layman’s terms, many of the legal

terms that are used in cases filed

under the Bankruptcy Code.

TERMSL I S T O F

62 • BANKRUPTCY TERMINOLOGY

BANKRUPTCY CODE The informal name for title 11 of theUnited States Code (11 U.S.C. §§ 101–1330), the federal bankruptcy law.

BANKRUPTCY COURT The bankruptcy judges in regular activeservice in each district; a unit of the dis-trict court.

BANKRUPTCY ESTATE All legal or equitable interests of thedebtor in property at the time of thebankruptcy filing. (The estate includesall property in which the debtor has aninterest, even if it is owned or held byanother person.)

BANKRUPTCY JUDGE A judicial officer of the United Statesdistrict court who is the court officialwith decision-making power over fed-eral bankruptcy cases.

BANKRUPTCY MILL A business not authorized to practicelaw that provides bankruptcy counsel-ing and prepares bankruptcy petitions.

BANKRUPTCY PETITION A formal request for the protection ofthe federal bankruptcy laws. (There isan official form for bankruptcy peti-tions.)

BANKRUPTCY TRUSTEE A private individual or corporationappointed in all chapter 7, chapter 12,and chapter 13 cases to represent theinterests of the bankruptcy estate andthe debtor’s creditors.

BUSINESS BANKRUPTCY A bankruptcy case in which the debtoris a business or an individual involved

in business and the debts are for busi-ness purposes.

CHAPTER 7The chapter of the Bankruptcy Codeproviding for “liquidation,” i.e., thesale of a debtor’s nonexempt propertyand the distribution of the proceeds tocreditors.

CHAPTER 7 TRUSTEE A person appointed in a chapter 7 caseto represent the interests of the bank-ruptcy estate and the unsecured credi-tors. (The trustee’s responsibilitiesinclude reviewing the debtor’s petitionand schedules, liquidating the proper-ty of the estate, and making distribu-tions to creditors. The trustee mayalso bring actions against creditors orthe debtor to recover property of thebankruptcy estate.)

CHAPTER 11 A reorganization bankruptcy, usuallyinvolving a corporation or partnership.(A chapter 11 debtor usually proposesa plan of reorganization to keep itsbusiness alive and pay creditors overtime. People in business or individualscan also seek relief in chapter 11.)

CHAPTER 12The chapter of the Bankruptcy Codeproviding for adjustment of debts of a“family farmer,” as that term is definedin the Bankruptcy Code.

CHAPTER 13The chapter of the Bankruptcy Codeproviding for adjustment of debts of an individual with regular income.(Chapter 13 allows a debtor to keepproperty and pay debts over time, usu-ally three to five years.)

BANKRUPTCY TERMINOLOGY • 63

CHAPTER 13 TRUSTEE A person appointed to administer achapter 13 case. (A chapter 13 trustee’sresponsibilities are similar to those of achapter 7 trustee; however, a chapter13 trustee has the additional responsi-bilities of overseeing the debtor’s plan,receiving payments from debtors, anddisbursing plan payments to creditors.)

CLAIM A creditor’s assertion of a right to pay-ment from a debtor or the debtor’sproperty.

COMPLAINT The first or initiatory document in alawsuit that notifies the court and thedefendant of the grounds claimed bythe plaintiff for an award of money orother relief against the defendant.

CONFIRMATION Approval of a plan of reorganization bya bankruptcy judge.

CONSUMER BANKRUPTCY A bankruptcy case filed to reduce oreliminate debts that are primarily con-sumer debts.

CONSUMER DEBTS Debts incurred for personal, as opposedto business, needs.

CONTINGENT CLAIM A claim that may be owed by the debtorunder certain circumstances, for example,where the debtor is a cosigner on anotherperson’s loan and that person fails to pay.

CREDITOR A person to whom or business to whichthe debtor owes money or that claimsto be owed money by the debtor.

DEBTOR A person who has filed a petition forrelief under the bankruptcy laws.

DEFENDANT An individual (or business) againstwhom a lawsuit is filed.

DISCHARGE A release of a debtor from personal lia-bility for certain dischargeable debts.(A discharge releases a debtor from per-sonal liability for certain debts knownas dischargeable debts (defined below)and prevents the creditors owed thosedebts from taking any action againstthe debtor or the debtor’s property tocollect the debts. The discharge alsoprohibits creditors from communicat-ing with the debtor regarding the debt,including telephone calls, letters, andpersonal contact.)

DISCHARGEABLE DEBT A debt for which the Bankruptcy Codeallows the debtor’s personal liability tobe eliminated.

DISCLOSURE STATEMENTA written document prepared by thechapter 11 debtor or other plan propo-nent that is designed to provide “ade-quate information” to creditors toenable them to evaluate the chapter 11plan of reorganization.

EQUITY The value of a debtor’s interest in prop-erty that remains after liens and othercreditors’ interests are considered.(Example: If a house valued at $60,000is subject to a $30,000 mortgage, thereis $30,000 of equity.)


EXECUTORY CONTRACTOR LEASE Generally includes contracts or leasesunder which both parties to the agree-ment have duties remaining to be per-formed. (If a contract or lease is execu-tory, a debtor may assume it or reject it.)

EXEMPT A description of any property that adebtor may prevent creditors fromrecovering.

EXEMPTIONProperty that the Bankruptcy Code orapplicable state law permits a debtor tokeep from creditors.

EXEMPT PROPERTY Property or value in property that adebtor is allowed to retain, free fromthe claims of creditors who do nothave liens.

FACE SHEET FILING A bankruptcy case filed either withoutschedules or with incomplete sched-ules listing few creditors and debts.(Face sheet filings are often made forthe purpose of delaying an eviction orforeclosure.)

FAMILY FARMER An individual, individual and spouse,corporation, or partnership engaged ina farming operation who meet certaindebt limits and other statutory criteriafor filing a petition under chapter 12.

FRAUDULENT TRANSFERA transfer of a debtor’s property madewith intent to defraud or for which thedebtor receives less than the transferredproperty’s value.

FRESH STARTThe characterization of a debtor’s statusafter bankruptcy, i.e., free of most debts.(Giving debtors a fresh start is one pur-pose of the Bankruptcy Code.)

INSIDER (of individual debtor)Any relative of the debtor or of a gener-al partner of the debtor; partnership inwhich the debtor is a general partner;general partner of the debtor; or corpo-ration of which the debtor is a director,officer, or person in control.

INSIDER (of corporate debtor)A director, officer, or person in controlof the debtor; a partnership in which thedebtor is a general partner; a generalpartner of the debtor; or a relative of ageneral partner, director, officer, or per-son in control of the debtor.

JOINT ADMINISTRATION A court-approved mechanism underwhich two or more cases can be admin-istered together. (Assuming no conflictsof interest, these separate firms or indi-viduals can pool their resources, hire thesame professionals, etc.)

JOINT PETITIONOne bankruptcy petition filed by a hus-band and wife together.

LIEN A charge upon specific property design-ed to secure payment of a debt or per-formance of an obligation.

LIQUIDATION A sale of a debtor’s property with theproceeds to be used for the benefit ofcreditors.


LIQUIDATED CLAIMA creditor’s claim for a fixed amount ofmoney.

MOTION TO LIFTTHE AUTOMATIC STAYA request by a creditor to allow thecreditor to take an action against adebtor or the debtor’s property thatwould otherwise be prohibited by theautomatic stay.

NO-ASSET CASE A chapter 7 case where there are noassets available to satisfy any portion ofthe creditors’ unsecured claims.

NONDISCHARGEABLEDEBTA debt that cannot be eliminated inbankruptcy.

OBJECTION TO DISCHARGEA trustee’s or creditor’s objection to thedebtor’s being released from personalliability for certain dischargeable debts.

OBJECTION TOEXEMPTIONSA trustee’s or creditor’s objection to adebtor’s attempt to claim certain prop-erty as exempt, i.e., not liable for anyprepetition debt of the debtor.

PARTY IN INTERESTA party who is actually and substan-tially interested in the subject matter, asdistinguished from one who has only anominal on technical interest in it.

PLANA debtor’s detailed description of howthe debtor proposes to pay creditors’claims over a fixed period of time.

PLAINTIFFA person or business that files a formalcomplaint with the court.

POSTPETITION TRANSFERA transfer of a debtor’s property madeafter the commencement of the case.

PREBANKRUPTCYPLANNINGThe arrangement (or rearrangement) ofa debtor’s property to allow the debtorto take maximum advantage of exemp-tions. (Prebankruptcy planning typical-ly includes converting nonexemptassets into exempt assets.)

PREFERENTIAL DEBTPAYMENTA debt payment made to a creditor inthe 90-day period before a debtor filesbankruptcy (or within one year if thecreditor was an insider) that gives thecreditor more than the creditor wouldreceive in the debtor’s chapter 7 case.

PRIORITYThe Bankruptcy Code’s statutory rank-ing of unsecured claims that determinesthe order in which unsecured claims willbe paid if there is not enough money topay all unsecured claims in full.

PRIORITY CLAIMAn unsecured claim that is entitled to bepaid ahead of other unsecured claimsthat are not entitled to priority status.Priority refers to the order in whichthese unsecured claims are to be paid.

PROOF OF CLAIMA written statement describing thereason a debtor owes a creditormoney. (There is an official form forthis purpose.)


PROPERTY OF THE ESTATEAll legal or equitable interests of thedebtor in property as of the commence-ment of the case.

REAFFIRMATIONAGREEMENTAn agreement by a chapter 7 debtor tocontinue paying a dischargeable debtafter the bankruptcy, usually for thepurpose of keeping collateral or mort-gaged property that would otherwise besubject to repossession.

SECURED CREDITORAn individual or business holding aclaim against the debtor that is securedby a lien on property of the estate orthat is subject to a right of setoff.

SECURED DEBTDebt backed by a mortgage, pledge ofcollateral, or other lien; debt forwhich the creditor has the right topursue specific pledged property upondefault.

SCHEDULESLists submitted by the debtor alongwith the petition (or shortly thereafter)showing the debtor’s assets, liabilities,and other financial information. (Thereare official forms a debtor must use.)

STATEMENT OFFINANCIAL AFFAIRSA series of questions the debtor mustanswer in writing concerning sources ofincome, transfers of property, lawsuitsby creditors, etc. (There is an officialform a debtor must use.)

STATEMENT OF INTENTIONA declaration made by a chapter 7debtor concerning plans for dealing

with consumer debts that are securedby property of the estate.

SUBSTANTIAL ABUSEThe characterization of a bankruptcycase filed by an individual whose debtsare primarily consumer debts where thecourt finds that the granting of reliefwould be an abuse of chapter 7because, for example, the debtor canpay its debts.

SUBSTANTIVECONSOLIDATIONPutting the assets and liabilities of twoor more related debtors into a singlepool to pay creditors. (Courts are reluc-tant to allow substantive consolidationsince the action must not only justifythe benefit that one set of creditorsreceives, but also the harm that othercreditors suffer as a result.)

341 MEETINGA meeting of creditors at which thedebtor is questioned under oath bycreditors, a trustee, examiner, or theUnited States trustee about his/herfinancial affairs.

TRANSFERAny mode or means by which adebtor disposes of or parts withhis/her property.

TRUSTEEThe representative of the bankruptcyestate who exercises statutory powers,principally for the benefit of the unse-cured creditors, under the generalsupervision of the court and the directsupervision of the United States trusteeor Bankruptcy Administrator.


TYPING SERVICEA business not authorized to practicelaw that prepares bankruptcy petitions.

UNITED STATES TRUSTEEAn officer of the Justice Departmentresponsible for supervising the admin-istration of bankruptcy cases, estates,and trustees, monitoring plans anddisclosure statements, monitoringcreditors’ committees, monitoring feeapplications, and performing otherstatutory duties.

UNDERSECURED CLAIMA debt secured by property that isworth less than the amount of the debt.

UNLAWFUL DETAINERACTIONA lawsuit brought by a landlordagainst a tenant to evict the tenantfrom rental property—usually for non-payment of rent.

UNLIQUIDATED CLAIMA claim for which a specific value hasnot been determined.

UNSCHEDULED DEBTA debt that should have been listed bya debtor in the schedules filed with thecourt but was not. (Depending on thecircumstances, an unscheduled debtmay or may not be discharged.)

UNSECURED CLAIMA claim or debt for which a creditorholds no special assurance of payment,such as a mortgage or lien; a debt forwhich credit was extended based solelyupon the creditor’s assessment of thedebtor’s future ability to pay.

VOLUNTARY TRANSFERA transfer of a debtor’s property withthe debtor’s consent.

SOURCES

Doran, Personal Bankruptcy and DebtAdjustment, 135–139 (1991)

Griffin, Personal Bankruptcy: WhatYou Should Know, 145–149 (1994)

Administrative Office of the United States Courts

Thurgood Marshall Federal Judiciary Building

Washington, D.C. 20544

PHONE: (202) 502-1900

Documents

Bankruptcy BASICS · basic explanation of the different cha- p ters under which a bankruptcy case may be filed and to answer some of the most commonly asked questions about the bankruptcy