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Bankruptcy

PA ET RHC 30Success 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

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Learning Objectives

• Explain purpose of bankruptcy code and types of bankruptcy proceedings (Chapters 7, 11, 12, 13)

• Describe process by which property in a debtor’s estate is distributed to creditors and the debtor is granted discharge in bankruptcy

• Identify dischargeable debts

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• When debtors are faced with financial ruin, 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. Reorganizations3. Family farms and commercial fishing

operations4. 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 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 determine whether 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

• 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– Trustee segregates property that debtor

may keep and then administers, liquidates, and distributes the remainder of the estate

• Relative rights of creditors established 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:– Operates debtor’s business if necessary– Sells debtor’s nonexempt property as soon

as possible and consistent with best interests of creditors

– Keeps an accurate account of all property and money received and promptly deposits money into the estate’s accounts

Trustee Duties in Chapter 7

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• Bankruptcy 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

The Bankruptcy Estate

Texas is a “homestead” state

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• Issue and Opinion:– Does homestead exemption cap in Bankruptcy

Abuse Prevention and Consumer Protection Act apply to a homestead interest established within 1,215-day period before bankruptcy

• Statutory text & legislative history indicate that “interest” refers to vested economic interests in property acquired by a debtor within specific period preceding petition

– Debtor acquired title to property as inheritance long before the statutory period

– Debtor entitled to full homestead exemption under Texas state law

In Re Rogers

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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

Fraudulent Transfers

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• Facts: – A Trustee sought to avoid monies paid out to

certain investors pursuant to a Ponzi scheme as preferential and fraudulent transfers

• Opinion:– “Breadth and notoriety” of Madoff Ponzi scheme

leave no basis for disputing the application of the Ponzi scheme presumption to this case, particularly in light of Madoff’s criminal admission

– BLMIS’s fraudulent intent is established as a matter of law and trustee sufficiently pled actual fraud

In re Bernard Madoff Investment Securities LLC

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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, such as 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

Gerhardt is a professional cellist and had over $77,000 in student loan debt at the time of

the bankruptcy petition

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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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• 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

• 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 Bankruptcy

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

– Must be an individual with regular incomes owing less than a specific amount of debt

Chapter 13 – Consumer Debt

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• In re Burt: court agreed with Ford Motor Credit’s objection to the confirmation of a proposed Chapter 13 plan that would cram down the creditor’s secured interest in truck– Cram-down refers to bifurcation of an under-secured

creditor’s claim into secured and unsecured portions, so a creditor’s claim is allowed as secured only up to the value of collateral securing its debt

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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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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• 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.

Test Your Knowledge

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• 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 transferc) No, properties given to friends are exempt

from inclusion in the bankruptcy estated) None of the above

Test Your Knowledge

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• 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 planc) Engaged in a cram down d) none of the above

Test Your Knowledge

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Thought Questions

• Why was the right to file for banruptcy protection incorporated into the U.S. Constitution? What is your opinion of the bankruptcy process?