Chapter 29BANKRUPTCY AND THE BANKRUPTCY ABUSE

PREVENTION AND CONSUMER PROTECTION ACT OF 2005

Why would anyone want to go bankrupt?

I. Overview

The basic underlying premise of bankruptcy law is founded on a simple reality: bad things happen to good people. How many of us can really provide ourselves with a safe haven from financial disasters brought on by bad health, economic downturns, financial institution failures, and the like? The early bankruptcy laws of England first recognized that businesses can and do fail in spite of the best good faith efforts of their proprietors. That failure should not, in effect, act as a life sentence in keeping that business or its proprietor from reentering the marketplace. Bankruptcy is really one of the earliest forms of recycling, a recycling of economic opportunity for good faith debtors who deserve a second chance.

As with any legal favor, there are people and business entities that get too greedy in asking for the benefit of the law. Bankruptcy is built on a cornerstone of good faith. Where debtors' actions are motivated by bad faith attempts to avoid legitimate obligations, both the law and the larger societal public policies are subverted. The history of the law of bankruptcy is riddled with cases of clear abuse and creditor victimization that have created a dilemma for legislators who must draft our bankruptcy statutes.

The recent history of federal bankruptcy reforms in the U.S. illustrates Congress's attempts to deal with this dilemma of trying to make the law more humane while trying to curb abuses. The Bankruptcy Act of 1978 provided for sweeping reforms that sought to destigmatize bankruptcy in an economy that had grown too dependent on the availability of credit. Unfortunately, with this liberalization came a number of abuses of the law. Graduates of long and expensive professional studies began their lucrative careers with a bankruptcy discharge of school loans. Many consumers loaded up on all sorts of trinkets on credit and kept them debt free under bankruptcy. Corporations began to use the reorganization provisions of the law as a management wedge to get out from under otherwise binding executory contracts, or even worse, tort judgments. Congress responded with the Bankruptcy Amendments and Federal Judgeship Act of 1984 and other subsequent revisions. This legislation sought to pull in the reins on many of these abuses as outlined in the text.

There was still a great need to further balance the basic dichotomy between relief and prevention of abuse. On one side, the mechanics of bankruptcy law needed to be made more cost efficient. The law should probably provide a larger slice of the economic pie for creditors than is presently available while retaining the fresh start opportunities provided for good faith debtors. At the same time, present loopholes in the law needed to be closed. There are still far too many ways to abuse the system. The losses generated add a colossal weight to the cost of credit borne by all of us.

As a response, Congress enacted the Bankruptcy Abuse and Protection Act of 2005. This act makes it more difficult for debtors to escape from their debts. Sides disagree as to its value. The Act is a main focus of this chapter.

Chapter 29II. Hypothetical Multi-issue Essay Question

Describe the options available under the Bankruptcy Code for an individual (non-farmer or fisherman) with financial difficulties.

III. Outline

Fresh Start in BankruptcyThe goal of federal bankruptcy law is to discharge the debtor from the burdensome debts and allow him or her to begin again with a “fresh start”. The Bankruptcy Reform Act of 1978 made it easier for debtors to file for bankruptcy and have their unpaid debts discharged. The Bankruptcy Abuse and Prevention and Consumer Protection Act of 2005 makes it more difficult for debtors to escape from unwanted debt through bankruptcy. The Bankruptcy Code is the name given to the federal bankruptcy law as amended.

Purpose of Federal Bankruptcy Law:Protect debtors from abusive activities by creditors in collecting debts.Prevent certain creditors from obtaining an unfair advantage in collecting debts. Protect creditors from actions of the debtor that could diminish the value of the bankruptcy estate.Provide for the speedy, efficient, and equitable distribution of the debtor’s nonexempt property to creditors.Require debtors to repay debts if they have the means to do so.Preserve existing business relationships.

Bankruptcy Courts – increased in number under the 2005 Act – hear and decide bankruptcy cases.

U.S. Trustee – federal government official responsible for handling and supervising many of the administrative tasks of a bankruptcy case.

Bankruptcy ProcedurePre and Post – petition and financial counseling Filing a petition

Voluntary – debtor has debtsInvoluntary – debtor is not paying debts as due. 12 or more creditors needs 3 to file. Less than 12 needs one. Claims must be at least $12,300.

Individual debtor must submit schedules:Unsecured and secured creditors.Property ownedStatement of financial affairsStatement of debtor’s monthly incomeCurrent income and expensesPayments received form employers within 60 days prior Most recent federal income tax return.

Attorneys must certify information accuracy

Order of relief occurs upon voluntary petition filing, unchallenged involuntary petition, or order granted after trial of challenged involuntary petition. Creditors’ Meeting – must occur within a reasonable time after order for relief.

Proof of Claim must be filed by creditor. Proof of interest must be filed by security holder.

Bankruptcy Trustee is appointed who is empowered to: Take immediate possession of the debtor’s property. Protect domestic-support creditors (e.g., former spouse, children of the debtor), a duty

added by the 2005 Act. Review all materials filed by the debtor. Separate secured and unsecured property. In a Chapter 7 case, file a statement as to whether the case is presumed to be an abuse

under the new means test established by the 2005 Act. Set aside exempt property. Investigate the debtor’s financial affairs. Employ professionals (e.g., attorneys, accountants, appraisers) to assist in the

administration of the case. Examine proof of claims. Defend, bring, and maintain lawsuits on behalf of the estate. Invest the property of the estate. Sell or otherwise dispose of property of the estate. Distribute the proceeds of the estate. Make reports to the court, creditors, debtor, and other parties of interest regarding the

administration of the estate.

Certain actions by creditors against debtors are automatically stayed:- Action to collect pre-petition debts- Enforcing judgments- Liens against property- Nonjudicial collection efforts

Secured creditor may get relief from stay

Discharge of debtor’s liability to pay is granted if all requirements are met

Exceptions to discharge include:

Claims for income or gross receipts taxes owed to federal, state, or local governments accrued within three years prior to the filing of the petition for bankruptcy, or for such taxes for any period where the debtor made a fraudulent return or willfully attempted to evade or defeat such tax, and property taxes accrued within one year prior to filing the petition for bankruptcy.

Certain fines and penalties payable to federal, state, and local governmental units. Claims based on the debtor’s liability for causing willful or malicious injury to a

person or property. Claims arising from the fraud, larceny, or embezzlement by the debtor while acting in

a fiduciary capacity. Domestic support obligations, and alimony, maintenance, and child support payments

resulting from a divorce decree or separation agreement. Unscheduled claims. Claims based on the consumer-debtor’s purchase of luxury goods or services of more

than $500 from a single creditor on or within 90 days of the order for relief. This is a rebuttable presumption that may be challenged by the debtor by proving that the expenses were incurred to support the debtor or dependents are therefore not luxuries.

Cash advances in excess of $750 obtained by a consumer-debtor by use of a revolving line of credit or credit cards on or within 70 days of the order for relief. This is also rebuttable presumption.

Chapter 29 Judgments and consent decrees against the debtor for liability incurred as a result of

the debtor’s operation of a motor vehicle, vessel, or aircraft while legally intoxicated. A debt that would result in a benefit to the debtor that outweighs the detrimental

consequences to a spouse, former spouse, or child of the debtor. Amount owed to a pension, profit-sharing, or stock bonus plan, and loans owed to

employee retirement plans. Debtor and creditor can enter into reaffirmation agreements. Can be enforced with certain requirements.

Bankruptcy Estate – debtor’s property and earnings that comprise the estate of a bankruptcy proceeding. Includes all the debtor’s legal and equitable interests in real, personal, tangible, and intangible property as well as debtor and spouse’s interest in community property. Gifts, inheritances, life insurance proceeds and property from divorce are included if entitled to receive within 180 days after filing. Earnings from estate property are property of the estate. Federal exemptions include:

1. Interest up to $18,450 in equity in property used as a residence and burial plots (called “homestead exemption”) – certain 2005 Act limitations to $125,000

2. Interest up to $2,950 in value in one motor vehicle.3. Interest up to $475 per item in household goods and furnishings, wearing apparel,

appliances, books, animals, crops, or musical instruments, up to an aggregate value of $9,850 for all items.

4. Interest in jewelry up to $1,225.5. Interest in any property the debtor chooses (including cash) up to $975, plus up to

$9,250 of any unused portion of the homestead exemption.6. Interest up to $1,850 in value in implements, tools, or professional books used in the

debtor’s trade.7. Any unmatured life insurance policy owned by the debtor.8. Professionally prescribed health aids.9. Many government benefits, regardless of value, including Social Security benefits,

welfare benefits, unemployment compensation, veteran benefits, disability benefits, and public assistance benefits.

10. Certain rights to receive income, including domestic support payments (e.g., alimony and child support), certain pension benefits, profit sharing, and annuity payments.

11. Interests in wrongful death benefits and life insurance proceeds to the extent necessary to support the debtor or his or her dependants.

12. Personal injury awards up to $18,450.13. Retirement funds that are in a fund or account that is exempt from taxation under the

Internal Revenue Code, except that an exemption for individual retirement accounts (IRAs) shall not exceed $1,000,000 for an individual unless the interest of justice requires this amount to be increased.

Preferential and fraudulent transfers – can be voided by the court and recovered property goes into estate. Good faith purchaser gets value paid.

Preferential Transfer – transfer of interest in property by debtor (1) to our worth any party on or within 90 days of filing the petition or (2) to or with an insider between 90 days and one year of filing the petition, if certain requirements are met. To void court must find:

1. Done for benefit of creditor2. Done for antecedent (preexisting) of debt3. Creditor gets more than from Chapter 7 liquidation4. Debtor was insolvent on or within 90 days prior to filing.

Exceptions include transfers for current consideration, credit payments in the ordinary course of business, payments up to $600 by a consumer-debtor to a creditor, payments of $5,000 for not primarily consumer debts, or not a bona fide payment of a debt for a domestic support obligation.

Fraudulent Transfers – transfer of property or obligation of debtor within 2 years of petition where (1) intent to defraud creditor or (2) while insolvent debtor got less then value. Voidable if for benefit of insider under employment contract and not in the ordinary course of business. Special rules for charities. If made to a living trust can be voided if (1) within 10 years before filing, (2) made to a self-settled trust, (3) debtor is trust beneficiary, and (4) done with intent to defraud.

Chapter 7 Liquidation—voluntary or involuntary (note dollar amounts could be changing)Trustee is appointedDebtor’s nonexempt property is sold for cashCash is distributed to creditorsAny person, including individuals, partnerships, and corporations may be debtors in a Chapter 7 proceedingUnpaid debts are discharged for individuals only. Partnerships, limited liability companies, and corporations must liquidate.Debtor gets a fresh start but only once every six years

To obtain a discharge, an individual debtor must meet median income and dollar based means test (otherwise dismiss or go to Chapter 13)- Median Income Test = income where half of the state’s families of this size have incomes

above the figure and half below. Income = income for prior 6 months divided by six multiplied by twelve. If income is below figure, does not apply. If income is above figure apply a new “means test”. If income is above “means test”, case is dismissed or converted to Chapter 11 or 13.

- Means Test = debtor’s monthly income minus certain deductions for last six months and divide by six. After certain expenditure reductions for certain expenditures = “Net Amount”. Multiply “Net Amount” by 60. Subtract from median income for five years. If:

1) Net amount < $6,000 Chapter 7 eligible2) Net amount between $6,000 and $9,999

- denied if sufficient to pay 25% or more of debt- granted if cannot pay 25%

3) Net amount > $10,000 no Chapter 7 relief. Non exempt property is distributed to:1) Secured creditors (collateral)

a) over-secured secured – excess goes to unsecuredb) under-secured secured – deficiency is unsecured

Note: secured personal property must either be surrendered, redeemed by paying lien in full or assume as unexpired lease.

2) Unsecured (no collateral or collateral deficiency) – paid based on following priorities and then remaining to non-priority unsecured claims:

1. Unsecured claims for domestic support obligations owed to a spouse, former spouse, or child of the debtor.

2. Fees and expenses of administering the estate, including court costs, trustee fees, attorney’s fees, appraisal fees, and other costs of administration.

3. In an involuntary bankruptcy, secured claims of “gap” creditors who sold goods or services on credit to the debtor in the ordinary course of the debtor’s business

Chapter 29between the date of the filing of the petition and the date of the appointment of the trustee or issuance of the order for relief (whichever occurs first).

4. Unsecured claims for wages, salary, commissions, severance pay, and sick leave pay earned by the debtor’s employees within 180 days immediately preceding the filing of the petition, up to $10,000 per employee.

5. Unsecured claims for contributions to employee benefit plans based on services performed within 180 days immediately preceding the filing of the petition, up to $10,000 per employee.

6. Farm producers and fishermen against debtors who operate grain storage facilities for fish storage or processing facilities, respectively, up to $4,925 per claim.

7. Unsecured claims for cash deposited by a consumer with the debtor prior to the filing of the petition in connection with the purchase, lease, or rental of property or the purchases of services that were not delivered or provided by the debtor, up to $2,225 per claim.

8. Unsecured claims for unpaid income and gross receipts taxes owed to governments incurred during the three years preceding the bankruptcy petition, and unpaid property taxes owed to governments incurred within one year preceding the bankruptcy petition.

9. Commitment by the debtor to maintain the capital of an insured depository institution such as a commercial bank or savings bank.

10. Claims against the debtor for personal injuries or death caused by the debtor while he or she was intoxicated form using alcohol or drugs.

Nondischargeable DebtsNondischargeable debts include

Claims for taxes accrued within three years prior to bankruptcy filingCertain fines and penalties payable to federal, state, and local government unitsAlimony, maintenance, and child supportClaims based on the consumer-debtor’s purchase of luxury goods of more than $1000 from a single creditorSchool loans

Certain acts bar discharge: Made false representations about his or her financial position when he or she obtained

an extension of credit. Transferred, concealed, removed, or destroyed property of the estate with the intent to

hinder, delay, or defraud creditors within one year before the date of the filing of the petition.

Falsified, destroyed, or concealed records of his or her financial condition. Failed to account for any assets. Failed to submit to questioning at the meeting of the creditors (unless excused). Failed to complete an instructional course concerning personal financial management

as required by the 2005 Act (unless excused).

Chapter 11 Bankruptcy ReorganizationReorganizes the debtor's financial affairs under the supervision of the Bankruptcy Court to give the debtor a new capital structure so that it will emerge from bankruptcy as a viable concernAvailable to individuals, partnerships, corporations, unincorporated associations, and railroadsMay be filed voluntarily by the debtor or involuntarily by its creditorsWhere the debtor is left to operate business, the debtor is called a debtor-in-possessionCreditors’ Committee is usually appointedUnfavorable executory contracts can be rejectedThe bankruptcy court must approve a plan of reorganization if

The plan is in the best interests of each class of claims and interestsThe plan is feasibleEach class of creditors accepts (at least ½ # of creditors having 2/3 of debt)

A method of confirmation of a plan of reorganization where the court forces an impaired class to participate in the plan of reorganization is the cram-down method

Chapter 12 Adjustment of Debts of a family farmer or fisherman with regular incomeFamily farmer1) individual who has debt < $3,273,000 which > 50% of farming operations and

gross income for preceding year > 50% of farming operations2) corporation or partnership which is > 50% family-owned and debt < $3,273,000

and > 50% of farming operations.Family fisherman:(same as above except $3,273,000 is $1,500,000 and 50% is 80%)

Only voluntary petitions can be filedTrustee is appointedPlan of reorganization is filed and must be court-confirmed

- Done as to secured with special rules- Agreement often reached with unsecured- Plan must:

- be proposed in good faith- be in the best interests of unsecured- be feasible- have provision that future income go to trustee for plan completion

- Cram-down provision does exist- Discharge will be granted after payments are made

Chapter 29Chapter 13 Adjustment of Debts of an Individual with Regular Income

Permits the courts to supervise the debtor’s plan for the payment of unpaid debts by installmentsThe debtor files a plan of repaymentDebtor remains in possession of propertyLess expensive and complicated than Chapter 7Creditors may recover a greater percentage of debtsThe plan must be confirmed by the courtFiling of petition must be voluntary. Debtor has < $307,675 in unsecured debts and < $922,975 in secure debts

Plan may not > 3 years if monthly income x 12 < state’s median income otherwise 5 years.Secured creditors must accept plan with exception.Unsecured creditors must accept plan with exception.Court can confirm if plan was in good faith, passes a feasibility test, is in creditor’s best interest, and

domestic support is paid and tax returns filed.Discharge not available if already discharged under Chapter 13 within 2 years or Chapter 7, 11 or12

within 4 years.

Special Forms of BankruptcyRailroad Reorganization – Chapter 11 of Bankruptcy CodeMunicipality Adjustment of Debts – Chapter 9 of Bankruptcy CodeStockbroker and Commodity Broker Liquidation – Chapter 7 of Bankruptcy CodeCommercial Banks, Savings Banks, and Credit Unions - Federal Governmental Agencies

IV. Objective Questions

Terms:

1. In a Chapter 11 case, the debtor who is authorized to continue to operate her business is known as a _______________ _______________ _______________.

2. The document by which a bankruptcy proceeding is commenced is known as a _______________.

3. The legal representative of the bankrupt debtor's estate is the _______________.

4. Involuntary petitions can be filed if claims are at least _________________.

5. __________________ must certify accuracy of information in petition.

6. _________________ _______________ include debtor’s property for a bankruptcy petition.

7. Homestead exemption now equals _______________.

8. ______________ _______________ is done for the benefit of the creditors.

9. ______________ _______________ of the code applies to farmers.

10. ______________ _______________ creditors are secured with collateral > debt.

True/False:

1 ____ A debtor who was granted a discharge in bankruptcy five years ago will be denied a discharge of debts.

2. ____ The creditor is the party owing money.

3. ____ Voluntary bankruptcy proceedings are commenced by the creditor.

4. ____ Debtor must file proof of claim.

5. ____ Bankruptcy trustee must be appointed in a Chapter 7 case.

6. ____ All taxes are discharged in bankruptcy.

7. ____ Student loans are dischargeable.

8. ____ There are more bankruptcy courts under the 2005 Act.

9. ____ A Chapter 13 petition can be involuntary.

10. ____ Chapter 11 is a liquidation.

Multiple Choice:

1. The purpose of the Federal Bankruptcy laws include:A. Protect debtors from abusive creditorsB. Help businesses generate a profit.C. Punish the debtorsD. None of the above

2. A bankruptcy petition can be filed by:A. A debtor who has debtB. A creditor with $12,500 in debts if there are 8 creditorsC. The creditors with debts totaling $12,300 if there are 20 creditorsD. All of the above

3. A Bankruptcy trustee:A. Relinquishes possessions of the debtor’s propertyB. Includes exempt property.C. Examines proof of claimsD. All of the above

4. Certain actions by creditors against debtors that are automatically stayed include:A. Collecting pre-petition debtsB. Enforcing judgmentsC. Nonjudicial collection effortsD. All of the above

5. Exceptions to discharge in bankruptcy include:A. Fines due to governmentsB. Claims based on luxury goods of more than $200C. Cash advances by a consumer – debtor > $400D. No pensions.

Chapter 296. Bankruptcy estate includes:

A. Debtor’s personal propertyB. Life insurance proceeds to be received within 180 days after filing.C. Spouse’s interest in community propertyD. All of the above.

7. A fraudulent transfer is a:A. transfer while insolvent debtor gets less than value.B. done within 3 years of petition.C. voidable always if made to a living trust.D. None of the above.

8. To obtain a discharge, an individual debtor must:A. meet median income test.B. always meet means testC. have claims always assigned to chapter 13 if tests are not met.D. All of the above.

9. Priority unsecured creditor claims:A. Include support as a 2nd levelB. general unsecured as a 1st levelC. administration fees as a 2nd levelD. certain salaries as a 7th level

10. The following involve special forms of bankruptcy:A. railroadsB. municipality adjustmentsC. stockholdersD. All of the above.

V. Answers to Objective Questions

Terms:

1. Debtor-in-possession. Most cases will allow this unless there is a showing of some sort of bad faith on the part of management.

2. Petition. This is the opening procedural step.3. Trustee. The trustee is responsible to the court.4. $12,300. Needs 3 if 12 or more creditors and 1 if under 12.5. Attorneys. This is new under 2005 Act.6. Bankruptcy Estate. Also includes debtor’s earnings.7. $18,450. There are certain 2005 Act limitations to $125,000.8. Preferential Transfer. This can be voided by the courts.9. Chapter 12. Also applies to fishermen.10. Over-Secured Secured. Excess goes to unsecured.

True/False:

1. True. A debtor will be denied discharge if discharge was granted within six years of the commencement of the present case.

2. False. The debtor owes, the creditor is owed. 3. False. The debtor commences voluntary proceedings. 4. False. Creditor must file.5. True. This is required for Chap. 7.6 False. Discharge only for those accrued within 3 years unless fraud.7. False. This is usually not the case unless it creates a hardship for the student.8. True. This has been adjusted by the Act.9. False. Only voluntary petitions are permitted under Chapter 13.10 False. Chapter 7 is a liquidation while chapter 11 is a reorganization.

Multiple Choice:

1. A. B is up to the owners and C would defeat the code’s purpose.2. D. A is a voluntary petition while B and C are involuntarily filed.3. C. Trustee must take possession of the property and set aside exempt property.4. D. All of these actions are stayed.5. A. Luxury goods claims have a minimum of $500 from a single creditor and cash advances > $750

are an exception. Pensions are also an exception.6. D. All are included as well as intangible property, real property and gifts and inheritances with 180

day provision. 7. A. B requires a 2 year limit and only sometimes voidable to a living trust.8. A. Means test is contingent upon median income test results. 9. C. Support is level 1. General unsecured go last. Certain salaries are level 4.10. D. A involves chapter 11 of the Bankruptcy Code. B involves chapter 9 and C involves Chapter 7.

VI. Answers to Essay Question:

Chapter 7, 11 or 13 are available if rules are followed. This includes a liquidation, reorganization or adjustment.