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Page 1: Chapter 30 – Bankruptcy

Introduction to Credit and

Secured Transactions

Security Interests in Personal Property

Bankruptcy

© 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: Chapter 30 – Bankruptcy

Bankruptcy

© 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Success is not built on success. It's built on failure. It's built on frustration. Sometimes its built on catastrophe.

Sumner RedstoneExecutive Chairman

andFounder of Viacom

Page 3: Chapter 30 – Bankruptcy

Learning Objectives

The Bankruptcy ActChapter 7 – liquidationDischarge in bankruptcyChapter 11 -- reorganizationsChapter 12 – family enterprisesChapter 13 – consumer debt

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Sometimes debtors are faced with financial ruin and the right to file for bankruptcy is guaranteed by the U.S. Constitution

Overview

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The federal Bankruptcy Code provides an organized procedure for insolvent debtors and is supervised by a federal court

Primary proceedings include: 1. Straight bankruptcy (liquidations)

2. Reorganizations

3. Family farms and commercial fishing operations

4. Consumer debt adjustments

The Bankruptcy Code

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All bankruptcy proceedings begin by filing a petition, either voluntary or involuntary

A voluntary petition may be filed by an individual, partnership, or corporate debtor

An involuntary petition may be filed by creditors of a debtor in an attempt to reach debtor’s assets in lieu of payment on debts

The Bankruptcy Code

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Filing a bankruptcy petition operates as an automatic stay, halting creditor action against a debtor or the property, including: Beginning or continuing judicial proceedings

against the debtor Actions to repossess the debtor’s property; Actions to create, perfect, or enforce a lien

against the debtor’s property; and Setoff of indebtedness owed to debtor before

commencement of the bankruptcy proceeding

The Automatic Stay

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Once a bankruptcy petition has been filed, the court must first determination that relief should be ordered This step automatic for a voluntary petition or

no-contest of involuntary petition If debtor contests involuntary petition, then a

trial is held on question of whether court should grant relief.

Order of Relief

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To participate in the estate of a bankrupt debtor, unsecured creditors must file a proof of claim within a certain time, usually six months after the first meeting of creditors

The Bankruptcy Code declares ten types of claims to have priority over other claims Priority claims are paid after secured creditors

but before other unsecured creditors are paid

Creditor Claims

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In a liquidation proceeding (straight bankruptcy), the debtor must disclose all property s/he owns and surrender this bankruptcy estate to a bankruptcy trustee

The trustee segregates property that debtor may keep and then administers, liquidates, and distributes the remainder of the estate

Creditors’ relative rights determined by law

Liquidation (Chapter 7)

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Bankrupt person required to file a list of assets, liabilities, and creditors, plus a statement of bankrupt’s financial affairs

Failure to file the information within 45 days of petition results in automatic dismissal Extension of time possible

The Bankrupt’s Filings

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Creditors meet and may elect a trustee Whether appointed or elected, the trustee:

Sets aside property a debtor may keep Takes possession of debtor’s property and has it

appraised Examines creditor claims, objecting if necessary Separates unsecured property from the secured

and otherwise exempt property

Trustee Duties in Chapter 7

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The trustee also: Sells debtor’s nonexempt property as soon as

possible, consistent with best interests of creditors Operates debtor’s business for a time if necessary Keeps an accurate account of all property and

money received and promptly deposits money into the estate’s accounts

Trustee Duties

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The estate includes all of debtor’s legal and equitable interests in property

Exemptions permit the bankrupt person to retain a minimum amount of assets considered necessary to life and an ability to continue to earn a living Exemptions vary from state to state See In Re Kyllogen

The Bankruptcy Estate

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Bankruptcy Code permits court to dismiss cases for abuse of process if debtor acted in bad faith or had present or future means to pay a significant portion of their current debts Means test determines debtor’s ability to repay

general unsecured claims In re Siegenberg: court dismissed a Chapter 7

case on the grounds it was filed in bad faith

Dismissal for Abuse

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Debtor may void some liens against exempt properties that impair the exemptions

Debtors may redeem exempt personal property from secured creditors by paying the full value of the collateral at the time the property is redeemed

A debtor and creditors may engage in ordinary business transactions

Liens and Business Transactions

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If a debtor transfers property or incurs an obligation with intent to hinder, delay, or defraud creditors, the transfer is voidable by the trustee Includes transfers of property for less than

reasonable value See In re Manhattan Investment Fund Ltd.:

margin payments to brokerage firm presumed to be made with intent to hinder, delay, or defraud

Fraudulent Transfers

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Chapter 11 offers a procedure in which the debtor’s financial affairs can be reorganized rather than liquidated because creditors would benefit more from the continuation of a bankrupt debtor’s business than from the liquidation of debtor’s property

Chapter 11 is available to individuals and business enterprises

Chapter 11 Reorganization

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Rather than liquidating the debtor’s estate, a trustee for a Chapter 11 proceeding develops a plan for handling creditor claims and the various interests of persons such as shareholders

The reorganization plan is essentially a contract between a debtor and its creditors and may involve recapitalization or giving creditors some equity

Trustee Duties Under Chapter 11

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Plan must: (1) divide creditors into classes; (2) set forth how each creditor will be satisfied; (3) state which claims, or classes of claims, are impaired or adversely affected by the plan; & (4) provide equal treatment to each creditor in a particular class, unless creditors in the class consent to other treatment

In re Made In Detroit, Inc.: plan not feasible, therefore court unable to confirm plan

The Bankruptcy Plan

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A reorganization plan must be confirmed by the court before it becomes effective

Plans may be confirmed by voluntary agreement of creditors or a cram down: Court forces dissenting creditors whose claims

would be impaired to accept the plan if the court finds it is fair and equitable to the creditors

If confirmed, debtor must implement plan

The Bankruptcy Plan

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Bankruptcy petitions have been filed to avoid obligations under divorce judgments, collective bargaining agreements, and mass tort and product liability litigation (asbestos, breast implant, and birth control device litigation)

These cases aren’t merely a matter of economics, but are a matter of ethics

Bankruptcy & Ethics

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Chapter 12 is modeled after Chapter 13 and is available only for family farmers and fishermen with regular income

Chapter 12

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Chapter 13 gives individuals who do not want to be declared bankrupt the right to file a voluntary petition for federal bankruptcy protection, obtaining the opportunity to pay debts in installments and free of such problems as garnishments and attachments of property by creditors

Chapter 13 – Consumer Debt

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Only individuals with regular incomes (including business sole proprietors) who owe individually (or with a spouse) liquidated, unsecured debts of less than $336,900 and secured debts of less than $1,010,650 may file for bankruptcy relief

Chapter 13 – Consumer Debt

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After filing, the debtor submits a plan of payment to secured creditors for acceptance 3-5 year payment plan

If acceptable to creditors and the court, the court will approve the plan and appoint a trustee to carry out the plan In re Burt: unacceptable plan because it was a

“cram-down” of creditor’s secured interest

Chapter 13 – Consumer Debt

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A bankrupt person not guilty of dishonest acts and who fulfilled duties as a bankrupt is entitled to a discharge in bankruptcy

A discharge relieves the bankrupt person of further responsibility for dischargeable debts and gives him a fresh start.

A corporation or partnership is not eligible for a discharge in bankruptcy

Discharge

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Certain debts, including educational loans, are not dischargeable in bankruptcy

In re Gerhardt: court denied the request of a debtor that his student loans be discharged because their repayment would constitute an undue hardship to him

Discharge

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Test Your Knowledge

True=A, False = B All bankruptcy proceedings begin by filing a

voluntary bankruptcy petition Once a voluntary bankruptcy petition has

been filed, the automatic stay prevents a creditor from filing suit against the debtor for repossession of the property.

Chapter 11 is available only to business enterprises

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Test Your Knowledge

True=A, False = B A reorganization plan under Chapter 11

requires unanimous consent by all creditors before it becomes effective

To participate in the estate of a bankrupt debtor, unsecured creditors must file a proof of claim within a certain time, usually six months after the first meeting of creditors.

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Test Your Knowledge Multiple Choice

Days before filing for reorganization, Bernie gave six of his properties to friends in return for an agreement that they would sell the property back to him in five years. Has Bernie done anything wrong?

(a) Yes, he must have sold the properties for at least $1 minimum value

(b) Yes, he engaged in fraudulent transfer(c) No, properties given to friends are exempt

from inclusion in the bankruptcy estate(d) None of the above

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Test Your Knowledge

Multiple Choice In JarlCo’s reorganization, the bankruptcy

court forced dissenting creditors whose claims would be impaired to accept the reorganization plan. The court:

(a) Improperly abused its power and will be reversed on appeal

(b) Prioritized execution of the plan

(c) Engaged in a cram down

(d) none of the above

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Thought Questions

Why did the founding fathers incorporate bankruptcy into the U.S. Constitution as a constitutional guarantee? What is your opinion of the current bankruptcy laws?

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