Fundamentals of Bankruptcy

Transcription

1 2015 Fundamentals of Bankruptcy

2 TABLE OF CONTENTS INTRODUCTION... 1 I. Sources of Bankruptcy Law... 2 A. Federal Law... 2 B. The Bankruptcy Code Generally... 2 C. The Chapters of Bankruptcy... 2 D. Bankruptcy Rules... 3 E. Jurisdiction of the Bankruptcy Court... 4 F. Other Sources of Law and Rules II. The Main Players A. The Debtor B. Creditors C. The Judge D. The U.S. Trustee E. The Trustee F. Committees G. Ombudsman III. Particular Types of Bankruptcy A. Chapter 7 (Liquidation) Who May File Chapter 7? Dismissal of Case or Conversion to Chapters 11 or Conversion Administration of a Chapter Distribution of the Property of the Estate Fresh Start B. Chapter 9 (Municipal Reorganization) C. Chapter 11 (Reorganization) Who May File a Chapter 11? Administration of a Chapter The Plan Disclosure Statement Confirmation of a Plan i

3 6. Effect of Confirmation Post Confirmation Modification Conversion or Dismissal Small Business Chapter 11's Single Asset Real Estate Cases Individual Chapter 11 Cases D. Chapter 12 (Family Farmer/Fisherman Bankruptcy) Who May File Chapter 12? Administration of Chapter The Debtor's Plan Special Treatment of Secured Creditors Under Chapter Conversion or Dismissal of Cases Discharge in a Chapter 12 ( 1228) E. Chapter 13 (Individual Wage Earner Plan) Who May File Chapter 13? Administration of a Chapter Chapter 13 Plan F. Chapter 15 (Ancillary and Cross Border Cases) G. Credit Counseling Requirements for All Chapters for Individuals Counseling Requirement Qualified Non Profit Credit Counseling Agencies IV. Involuntary Bankruptcy A. What is Involuntary Bankruptcy? B. Limitation on Chapters C. Who May Be an Involuntary Debtor? D. How is an Involuntary Bankruptcy Commenced? E. Preliminaries to and Hearing on Involuntary Petition Debtor's Response Bond Trustee The Order for Relief Failure to Establish Involuntary Bankruptcy Dismissal ii

4 7. Miscellaneous Rules for Involuntary Bankruptcies V. Property of the Estate ( 541) A. Legal and Equitable Interests B. Community Property C. Recovered Property D. Preserved Transfers E. Certain Property Acquired within 180 Days after Filing F. Proceeds, Product, Offspring, Rents or Profits G. After Acquired and Earned Property in a Chapter H. Exceptions to Property of the Estate VI. Exemptions A. Purpose of Exemptions B. Federal Exemptions C. Election Under California Law D. Special Homestead Rules E. No Stacking of Exemptions F. California CCP (b) Exemptions The debtor's right to receive, or property that is traceable to, any of the following: G. Avoidance of Liens Impairing Exemptions VII. Conversion of a Case to Another Chapter A. Generally B. Effect of Conversion C. Pre-Conversion, Post-Filing Claims D. Chapter E. Chapter F. Chapter 12 (See III.D.5) G. Chapter VIII. The Automatic Stay A. Scope of the Automatic Stay B. Duration of the Automatic Stay C. Relief from the Automatic Stay Relief by Abandonment iii

5 2. Relief by Stipulation Relief by Motion Grounds for Relief From the Stay D. Scope of Relief E. Effect of Conversion or Dismissal on Relief from the Automatic Stay F. Violation of the Automatic Stay G. Effect of the Stay on Co-debtors (Chapters 12 and 13) IX. Proofs of Claim ( ) A. When to File Chapter 7, 12 and Chapter Filing a Claim as a Grant of Jurisdiction B. Where to File The Court The Trustee The Debtor's Attorney The U.S. Trustee C. Amount of Claim Unsecured Claims Secured Claims Ordinary Leases (claims on financing leases should be filed like any secured claim) D. Claims Arising After the Filing of Bankruptcy Chapter Chapter Chapter Chapter X. Payment of Claims A. Allowance of Claims B. Secured Claims C. Unsecured Claims D. Priority of Claims Domestic Support Obligations (1st Priority Claim) iv

6 2. Administrative Claims (2nd Priority Claim) Gap Creditor Claims (3rd Priority Claim) Wages, Salaries or Commissions Claims (4th Priority Claim) Employee Benefit Plan Claims (5th Priority Claim) Grain Producers and Fisherman Claims (6th Priority Claim) Deposit for Goods or Service Claims (7th Priority Claim) Tax Claims (8 th Priority Claim) Obligations to Maintain Capital in a Federally Insured Financial Institution (9 th Priority Claim) General Unsecured Claims E. Payments Made Under the Doctrine of Necessity F. Reduction of Claim Amount for Failure to Cooperate with Debtor Before Bankruptcy G. Miscellaneous Comments on Claim Payments XI. Statement of Intention A. Time for Filing B. The Debtor's Options Retain the Collateral Surrender the Collateral Redeem the Collateral Reaffirmation Agreements C. Performance of Intentions D. Trustee Duty E. Debtor's Performance F. Trustee Rights XII. Use, Sale or Lease of Property Including Cash Collateral A. Cash Collateral B. Use, Sale or Lease in the Ordinary Course of Business C. Use, Sale or Lease not in the Ordinary Course D. Use of Cash Collateral E. Provision of Adequate Protection F. Sales of Estate Property Free and Clear of Others Interest G. Sale of Co-Owner Interest in Estate Property v

7 H. Sale or Lease Good Despite Appeal I. Bid Fixing Will Allow a Sale to be Unwound XIII. Use of Cash Collateral and Debtor-In-Possession ( DIP ) Financing A. Conceptual Overview B. Use of Cash Collateral - Chapters 7, 11, 12, and Definition of Cash Collateral: 11 U.S.C. 363(a) Applicable Bankruptcy Code Sections and Rules C. DIP Financing - Chapters 7, 11, 12, and Debt Incurred in Ordinary Course of Business Debt Incurred in Other than Ordinary Course of Business XIV. Leases & Executory Contracts ( 365) A. Definitions Executory Contract Unexpired Lease B. Assumption, Assignment, or Rejection of a Lease or Executory Contract Assumption Assignment Rejection C. Time in Which to Assume or Reject Lease Chapter Chapters 11, 12 or Nonresidential Real Property Leases D. Termination or Modification of the Lease or Executory Contract E. When is a Breach Deemed to Have Occurred on a Rejected Lease and What Claim Will Result? Rejected Leases Lease Assumed Then Rejected Lease Assumed Before Conversion Then Rejected Administrative Claim F. Effect of Rejection on the Automatic Stay G. The Debtor as Lessee of Shopping Center Property H. The Debtor as the Lessee of Aircraft Terminal or Gates I. Debtor as the Lessor of Real Property vi

8 J. Other Restrictions on the Assumption and Assignment of Unexpired Leases or Executory Contracts K. The Debtor as the Seller of Real Property L. The Debtor as Licensor of Intellectual Property M. FDIC and other Financial Institutions N. New Provisions for Non Consumer Personal Property Leases after the 1994 Act O. Debtor s Ability to Personally Assume a Personal Property Lease that has been Rejected XV. Preferences A. What is a Preference? B. Exceptions to Preferences C. Action on a Preference XVI. Fraudulent Transfers A. What is a Fraudulent Transfer? B. Constructive Fraud C. Reasonably Equivalent Value D. Religious and Other Charitable Giving E. Foreclosure Sales F. Reach-back Period G. Extended Reach-back Period for Self-Settled Trusts H. Statute of Limitations I. Safe Harbor Against Avoidance XVII. Effect of Discharge A. Chapter All obligations specified in 502 whether or not a claim was filed, including: B. Chapter C. Chapter 12 (Discussed Earlier in Outline) D. Chapter 13 Super Discharge (Not so super anymore) E. Chapter 13 Hardship Discharge Requirements for Hardship Discharge Scope of Hardship Discharge F. Effect of Discharge (applicable to all Chapters) vii

9 G. Revocation and Reaffirmation XVIII. Exceptions to Discharge A. Exception to Discharge of Specific Debts B. Exceptions Denying Discharge Of The Debtor In General Chapter Chapter Chapters 12 and Chapter 13 (Super Discharge) XIX. Setoff Rights Under Bankruptcy A. Setoff Rights Of Creditor B. Set-off of Post-Petition Debts Against Pre-Petition Debts C. Preference Rules for Set-off D. Bank Accounts, Security Interests, and Bankruptcy Set-Off Banker's Lien Administrative Freeze Cash Collateral Recoupment XX. Miscellaneous Bankruptcy Provisions and Issues A. Debt Relief Agency Regulations B. The First Meeting of Creditors C. Status Conferences D. The Avoiding Power E. Return of Goods F. Reclamation G. Loss of Certain Collateral After the Filing of Bankruptcy After Acquired Property Exception to Loss of After Acquired Property Collateral H. Local Practice I. When to Call an Attorney J. Lack of Settled Law viii

10 INTRODUCTION This outline is prepared with a focus on making bankruptcy law understandable to both non-bankruptcy attorneys as well as non-attorneys. When the current Bankruptcy Code was adopted back in 1978, no one could have anticipated the dizzying heights to which the annual number of bankruptcies filed would rise a mere thirty five years later. Bankruptcy remains a growth industry, with the number of filings continuing to trend upward almost annually. Almost every business person will, at some point, find themselves affected by a bankruptcy filing. As this 2014 edition is being prepared, the bankruptcy community remains busy though the number of filings have dropped from the highs of Whether the current economy remains in the doldrums or can be seen as recovering, it can be debated ad nauseam, but the fact is, bankruptcy remains an important topic within the American Economy. Just as we had settled into the reality of all issues presented by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, we find a debate emerging as to whether further wide- ranging changes are needed to cope with our current financial situation. For years, when we referred to the New Economy, it meant something positive that everyone wanted to be a part of. It meant embracing the information age and all the new technology it was bringing to our doorstep. Now we are experiencing a different New Economy, and it is one that everyone is hoping and praying goes away soon. It is possible in that we may experience additional changes to the Code due to the reaction to the Great Recession. Unfortunately, given the current congressional gridlock, as well as some of the other hot button topics drawing more interest, it is unlikely that the Bankruptcy Code is going to get much attention from this Congress. However, this is certainly a different administration than the one that gave us the last legislation, so anything is possible. It is not the author's intention to deal with all of the fine details of bankruptcy law. The effort is to stay with the basic concepts and to avoid being bogged down in various exceptions that often exist to any general principle. To sort out all the details for all of these various areas of bankruptcy law would take multiple volumes. If you want that, please see Collier on Bankruptcy. Additionally, this is not a case book. There is little reference to court decisions of any kind in this outline. You can find a bankruptcy case in existence to support almost any position you want to take. Often, if you line up all the cases on any one subject end to end, they will point in all directions. Instead, this outline focuses on the statutory framework. If the cases have come to a clear conclusion on a particular subject, it may also be stated. Hopefully you will find this to be a handy reference to use for a quick grasp of various bankruptcy concepts. While you will not pick up any fascinating after dinner conversation within its pages, hopefully it will allow you to sound more informed with your clients or superiors. 1

11 I. Sources of Bankruptcy Law A. Federal Law To successfully practice in the bankruptcy arena, a person must be familiar with a number of different sources of law. It is not enough to be familiar with the Bankruptcy Code. The seminal source of bankruptcy law is the Constitution of the United States. The Constitution, Article 1, 8, specifically provides that Congress shall have the power to establish a uniform rule of naturalization, and uniform laws in the subject of bankruptcies throughout the United States. This is important because this clearly establishes that there shall be a uniform, national bankruptcy law. The states shall not have laws on bankruptcy as these are superseded by the federal law. While states have adopted a variety of law dealing with liquidation issues (e.g. assignment for benefit of creditors), none can develop its own bankruptcy law. B. The Bankruptcy Code Generally The primary body of bankruptcy law is codified at Title 11 of the United States Code. This is the Bankruptcy Code, just as Title 26 is the Internal Revenue Code and Title 28 is the Judicial Code. The current Bankruptcy Code was adopted by Congress in 1978 as the Bankruptcy Reform Act. This was the first complete revision of the American bankruptcy laws since the adoption of the Bankruptcy Act of Subsequent major revisions were adopted in 1984, 1986 and Another major revision of the Code took place in the spring of 2005 with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ( BAPCPA ). BAPCPA has affected many sections of the Bankruptcy Code. C. The Chapters of Bankruptcy The Bankruptcy Code is broken down into chapters. With the exception of Chapter 12, all chapters are odd numbered. The first three chapters, 1, 3 and 5, contain code sections which apply to all other chapters of bankruptcy, with certain limitations as described by 103. Chapters 7, 9, 11, 12, 13, and 15 on the other hand, each refer to a particular type of bankruptcy and contain sections that apply almost exclusively to that type of bankruptcy. For example, Sections in Chapter 7 generally apply only to bankruptcies filed under Chapter 7. The same is true for Chapters 9, 11, 12, 13 and 15. Code sections within each chapter are numbered in the 100's, with the first digit being the same as the number of the chapter. In other words, 108 would be found in Chapter 1 and 1322 would be found in Chapter 13, etc. 1. Chapter 1 of the Bankruptcy Code includes general provisions such as definitions, rules of construction, the power of the court, extensions of time, and eligibility requirements. 2

12 2. Chapter 3 deals with administrative provisions such as what constitutes a voluntary versus an involuntary case, the role of the United States Trustee, who can serve as a trustee and what the trustee s role and capacity is, how trustees and other professional persons are employed and compensated, how meetings of creditors and equity security holders are handled under the Bankruptcy Code, what happens when a case is converted or dismissed, the concept of adequate protection, the automatic stay, borrowing money, the use, sale or lease of property, and other administrative matters. 3. Chapter 5 deals with creditors and their claims. This chapter addresses such things as how you file proofs of claim, how the claims are allowed, how you value claims into secured and unsecured portions, subordination, what the debtor's duties are, what constitutes property of the estate, how a turnover of property of the estate is obtained, how such things as preferences, fraudulent transfers, and unlawful post -petition transfers are avoided, abandonment of property of the estate, and the like. 4. Again, it is important to note that Chapters 7, 9, 11, 12, 13, and 15 are particular types of bankruptcy and sections within those chapters apply only to the particular type of bankruptcy, unless made specifically applicable by another Code section Thus, a Section in Chapter 7 does not generally apply in Chapter 11 nor does a Section in Chapter 11 generally apply to a Chapter 12 and so forth. D. Bankruptcy Rules Not only is there the Bankruptcy Code, there are also bankruptcy rules. In fact, there are three types of bankruptcy rules: 1. There are national bankruptcy rules called the Federal Rules of Bankruptcy Procedure (F.R.B.P.). These are rules that have been adopted by the Supreme Court of the United States and apply in all federal districts throughout the United States. (28 U.S.C. 2075). 2. There are also Local Rules which may be adopted in each district. In the Eastern District of California (Bakersfield through Sacramento), the seven judges have adopted a set of local rules that apply to cases in their courts. The Eastern District of California Local Rules are always being updated so you should make sure you are dealing with the current version. You should always review the local rules carefully, as they vary greatly from district to district throughout the United States. 3. Even when you have the local rules, they may vary in application from judge to judge within the district. Judges have their unwritten rules and general orders that have the force of law in bankruptcy cases and are 3

13 adopted judge by judge (these individual rules are sometimes referred to as the local rules). You must be thoroughly familiar with all of the rules and it is important to know that local and unwritten rules can vary dramatically from court to court, region to region, district to district. The admonition of know thy judge truly applies in bankruptcy cases. E. Jurisdiction of the Bankruptcy Court The Bankruptcy Court is a special court created by Congress to administer bankruptcy proceedings. The judicial power of the United States exists under Article III and in order to be an Article III judge, you need to have a lifetime appointment and no possibility of salary diminution during your appointment. Bankruptcy judges, however, are appointed for 14 year terms and do not have salary protection. As such, they are considered Article I judges and their jurisdiction is limited by this fact. Congress tried to give the judges very broad jurisdictional authority when the current bankruptcy law was passed in However, by 1982, in the case of Northern Pipeline Construction Company v. Marathon Pipe Line Company, 450 U.S. 50 (1982), the Supreme Court in a decision without a true majority, struck down the broad jurisdictional grant given to the Bankruptcy Courts. The Supreme Court felt that the Legislative Branch was overstepping its boundaries in creating non-article III courts with a jurisdictional grant that mirrored that power of the Article III courts. For a short period of time, the Marathon decision totally shut down the bankruptcy system. The immediate solution would be to pass all the work of the Bankruptcy Courts up to the District Courts since they were Article III courts. However, the last thing that District Court judges wanted was to start handling bankruptcy cases. Congress did not act to solve the problem and so, the Judicial Council of the United States created an emergency interim rule where the jurisdiction for bankruptcy cases was vested in the District Courts of the United States and made the Bankruptcy Courts adjuncts of the District Courts. The District Courts then referred the bankruptcy cases to the Bankruptcy Courts. It defined what the Bankruptcy Courts could and could not hear and decide. Finally, it allowed the District Court to withdraw the reference of any case or portion of a case at any time. Finally, Congress acted in the Bankruptcy Amendments and Federal Judgeship Act of 1984 to attempt to re-establish a legal operating Bankruptcy Court system. In many ways, it followed the Judicial Council interim order in establishing a legal basis for ongoing operation of the Bankruptcy Courts. The focus was on defining bankruptcy jurisdiction between core and non-core matters and holding that Bankruptcy Court would only have jurisdiction to make final rulings in core matters. They could make advisory opinions in non-core matters subject to de novo review by the District Courts. This solution was launched in 1984 and Congress and the bankruptcy bar held its collective breath. One of the challenges for Congress was that the Supreme Court had not issued an actual majority opinion in Marathon, which meant that any solution would be at best, a guess as to what the Supreme Court felt would be acceptable. 4

14 With only a few hiccups along the way, the 1984 solution worked and provided the Bankruptcy Courts with a jurisdictional grant for almost 20 years. Then along comes Stern v. Marshall 131 S.Ct (2011). It asked the question of whether a Bankruptcy Court, as part of its core jurisdiction, could hear counterclaims against people filing claims against the estate. The Supreme Court, in a 5-4 decision, said that exceeded the power held by an Article I court and the power cannot be conveyed by an Article III court to the Bankruptcy Court. This case involved a Pierce Marshall, who was the son of J. Howard Marshall, a multimulti millionaire. J. Howard, at a very advanced age, married former Playboy Playmate, Anna Nicole Smith. The obviously smitten J. Howard had left a large bequest in his will to Ms. Smith, who was determined to claim her rights as an aggrieved widow. As the legal disputes worked their way through various courts, eventually Ms. Smith filed a bankruptcy and listed as an asset, a claim against Pierce Marshall for tortious interference with her right in the estate. In the meantime, Pierce Marshall had a state law counter claim for defamation against Ms. Smith for disparaging things she had said about him due to this fracas. The Bankruptcy Court, viewing this as a core matter, resolved both the claim and counter claim awarding Anna Nicole Smith $400,000,000 in compensatory damages and $25,000,000 in punitive damages on her counterclaim. However, the Bankruptcy Court was only one place this dispute was heard. There was a lot going on in various courts regarding this and related issues before the Supreme Court. It came down to whether this judgment was within the jurisdiction of the Bankruptcy Court. While the Supreme Court recognized the right of Congress to develop new administrative frameworks and then establish bodies to hear and resolve disputes related to new rights created by Congress, the Court clearly felt, in this case at least, Congress had gone too far. So while they can establish an administrative body (Bankruptcy Court) and a framework to decide matters under those new rights, they cannot give general judicial powers to those bodies. Those belong exclusively to Article III judges. They can create a Bankruptcy Court and imbue it with power to hear bankruptcy matters, but they cannot directly or indirectly give it powers to decide matters beyond that administrative framework. This exception that allows for Article I courts is the ill-defined Public Rights Doctrine. So the Supreme Court had a problem with the Bankruptcy Court claiming jurisdiction to determine a suit for tortious interference that arose totally outside of the Bankruptcy Court with the only nexus being that it was a counter-claim to a claim made against the bankruptcy estate. The Supreme Court agreed that this counter claim was defined as a core proceeding in the Bankruptcy Code ( 157(b)(2)(C)) but that did not mean that Congress had the power to give the Bankruptcy Court the ability to exercise jurisdiction over this matter. If they did that, they would be exercising general jurisdiction, which could only be done by an Article III court. To allow otherwise, would destroy the separation of powers. Congress could emasculate the Article III courts by simply establishing Article I courts and grant them co-equal jurisdiction with Article III courts. The Supreme Court attempted to lessen the impact of its decision in Stern v. Marshall by the majority, describing it as a narrow holding. The narrow reading of the decisions suggests 5

15 that the Supreme Court was simply finding one area where 157(b) (2) overstepped what it could authorize the Bankruptcy Court to do. So the Supreme Court has said that the answer is that you cannot give jurisdiction to the Bankruptcy Court on unrelated counter claims unless the parties consent to jurisdiction (an open question). There is nothing that tells us any other part of 157(b)(2) has been disturbed by this ruling. That is the narrow reading approach. The broader reading of the case creates a lot more problems. When reading Stern v. Marshall in conjunction with Marathon (which found the grant of jurisdiction to hear state law contract dispute to a non-article III court unconstitutional) it becomes more problematic. 28 USC 1334 and 157 were designed to resolve Marathon s concerns, but in all the years since 1984, it has not really been decided how successful those new grants of jurisdiction were. Marathon acknowledged that Article I legislative or administrative courts could be established to adjudicate cases involving public rights. However, to be a public right issue, the government must be on one side of the equation. It is not a public right if it only involves a dispute between private individuals. The court then left things hazy but saying that the right to recover contract damages, even from a debtor, is different from restructuring of the debtor-creditor relationship, which is at the core of the bankruptcy code. This sounds like determining the claim should not be done by the Bankruptcy Court, but the treatment of that claim under a plan is part of the allowable jurisdiction. Later decisions by the Supreme Court on the public rights doctrine have opened this issue up further without clarify it. So it is not necessarily true that the government must be one of the parties to the dispute but what the standard has become remains difficult to deduce. It does appear if the source of the right is from the government, then you have a better argument that a public right is involved, even if the disputants are private. (see Thomas v. Union Carbide 473 U.S. 568 (1985)) In Commodity Futures Trading Comm n v. Schor 478 U.S. 833 (1986) the court seemed to reject outright a distinction between public and private rights as a basis for determining whether an Article I court can determine an issue. The focus is more on balancing the impact on the separation of powers in the particular case. Just when you think the court has moved away from the public rights bright line test in Marathon, you run into Granfinanciera S.A. v. Nordberg, 492 U.S. 33 (1989) regarding jury trials in fraudulent conveyance litigation. There, the public right argument reappeared saying that you must provide for a jury trial unless the matter being adjudicated was a public right. In writing for the majority, they tied the public right issue back into the determination of whether a non-article III court could hear matters that did not involve public rights. So we are back to saying that private rights must not be litigated in an Article I court. In dicta, they then brought into question whether fraudulent conveyance actions could ever be considered core and under the jurisdiction of the Bankruptcy Court. In Stern v. Marshall, the court attempted unsuccessfully to sort this out when it said it is still the case that the right is integrally related to particular federal government action. the claim at issue derives from a federal regulatory scheme, or in which resolution of the claim by an expert government agency is deemed essential to a limited regulatory objective with the agency s 6

16 authority. Basically, if a statutory right does not belong to or is not asserted against the federal government and is not closely intertwined with a federal regulatory program, it must be determined by an Article III court. Bottom line in Stern v. Marshall, the Supreme Court had real problems with a state law tort claim between two private individuals being adjudicated by an Article I court. There were no federally created rights even at issue here. The opinion states that it does not question Bankruptcy Courts authority to determine state law claims, that stem from the bankruptcy itself or would necessarily be resolved in the claims allowance process. The Stern v. Marshall Court also distinguished the Thomas and Schor decisions because they were out of administrative agencies and not out of something with as wide ranging purported jurisdiction as a Bankruptcy Court. So again, you are left uncertain how to properly apply the precedent. An open question remains as to whether the jurisdictional issue can be overcome by the consent of the parties and if so, what will be defined as sufficient for consent to be deemed given? One way to look at the question is, can private individuals do what Congress cannot do, siphon off the authority of the Article III courts to have the full jurisdiction granted them in the Constitution. Subject matter jurisdiction is granted in 28 USC 1334 and rests in the District Court. This is not a case about subject matter jurisdiction. It is about the constitutionality of 28 USC 157. The grant from the District Court of its jurisdiction is unconstitutional, at least as to (b)(2)(c). That we know. We also seem to know that (b)(2)(h) regarding fraudulent conveyances is also unconstitutional as a violation of the 7 th Amendment right to jury trials. What else about 28 USC 157 that might be unconstitutional will have to wait for another day. So the argument here is that parties cannot create subject matter jurisdiction where it does not exist, but they may be able to waive constitutional rights. So it may be that waiver or consent still may allow the Bankruptcy Court to hear the full range of 157(b)(2) core matters. Stern v. Marshall is not about subject matter jurisdiction but rather, constitutionality. After Stern v. Marshall, we still have core and non-core distinction. Nothing has been added, all that has happened is that a couple of items delineated as core are now to be treated as non-core. If a Stern type objection is raised to jurisdiction, the court has three choices 1. Hear the matter and submit proposed findings of fact and conclusions to the District Court.; 2. Have a motion filed to remove the reference sending the case to the District Court. ; or 3. Abstain and send the matter to state court. There is a case called Samson v. Blixseth out of Montana that said option 1 above is not available, but that court confused Stern v. Marshall about being about subject matter jurisdiction, which it was not. 28 USC 1334 distinguishes between bankruptcy cases (where there is original and exclusive jurisdiction) and proceedings that arise within the proceeding. Then it further distinguishes between proceedings arising under title 11 or those that simply arise within or related to cases under title 11. The District Court has original and exclusive jurisdiction of bankruptcy cases themselves. You can only file a bankruptcy case with the District Court (and by reference of 28 USC 157 the Bankruptcy Court). The question is, what do you do with matters that have arisen or will arise related to the bankruptcy? 7

17 Some are core, they arise under the bankruptcy law or arise in the bankruptcy case itself. The noncore cases are those that are simply related in some way to the bankruptcy case, but did not arise within the case nor do they involve the Bankruptcy Code itself. There are two key code sections in Title 28 of the US Code 1334 and USC 1334 Bankruptcy cases and proceedings (Author s annotating comments) (a)except as provided in subsection (b) of this section, the District Courts shall have original and exclusive jurisdiction of all cases under title 11. (This simply says that you cannot file a bankruptcy case in any court but the District Court (except as they have referred this to the Bankruptcy Court under 157.)) (b)except as provided in subsection (e)(2), and notwithstanding any Act of Congress that confers exclusive jurisdiction on a court or courts other than the District Courts, the District Courts shall have original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11. (The District Court has original, but not exclusive jurisdiction over matters arising in the bankruptcy case under the bankruptcy code, cases arising within a bankruptcy case even if not under the Code or any other matter that is related to the bankruptcy case. This provides the District Court with subject matter jurisdiction. They then refer this to the Bankruptcy Court and split it to core and non-core matters. This was to deal with the Marathon concerns.) (c)(1)except with respect to a case under chapter 15 of title 11, nothing in this section prevents a District Court in the interest of justice, or in the interest of comity with State courts or respect for State law, from abstaining from hearing a particular proceeding arising under title 11 or arising in or related to a case under title 11. (This tells the District Court that it can abstain from hearing any matters over which it has original but not exclusive jurisdiction if it shares jurisdiction with the state court. This power is also exercised by the Bankruptcy Court.) (2)Upon timely motion of a party in a proceeding based upon a State law claim or State law cause of action, related to a case under title 11 but not arising under title 11 or arising in a case under title 11, with respect to which an action could not have been commenced in a court of the United States absent jurisdiction under this section, the District Court shall abstain from hearing such proceeding if an action is commenced, and can be timely adjudicated, in a State forum of appropriate jurisdiction. (This subsection tells the District Court when it must abstain and let the state court proceed. The following are the requirements: 1. Based on state law claim or cause of action 2. Cannot involve a core matter 3. Action could not have been commenced in federal court absent the existence of the bankruptcy filing 4. The action is commenced already in state court 5. Can be timely adjudicated in state court.) 8

18 (d)any decision to abstain or not to abstain made under subsection (c) (other than a decision not to abstain in a proceeding described in subsection (c)(2)) is not reviewable by appeal or otherwise by the court of appeals under section 158(d), 1291, or 1292 of this title or by the Supreme Court of the United States under section 1254 of this title. Subsection (c) and this subsection shall not be construed to limit the applicability of the stay provided for by section 362 of title 11, United States Code, as such section applies to an action affecting the property of the estate in bankruptcy. (e)the District Court in which a case under title 11 is commenced or is pending shall have exclusive jurisdiction (1)of all the property, wherever located, of the debtor as of the commencement of such case, and of property of the estate; and (The locus of control of all property of the estate, no matter where it is located, is the court where the case is filed.) (2)over all claims or causes of action that involve construction of section 327 of title 11, United States Code, or rules relating to disclosure requirements under section 327. (All issues involving the employment of professional persons in a bankruptcy are decided in the court where the case is venued.) So 28 USC 1334 assigns jurisdiction to the District Courts. Then 28 USC 157 sets forth the procedures under which District Courts can assign matters within their jurisdiction to Bankruptcy Courts. It is here that the Article I vs. Article III issues arise. The Bankruptcy Courts are basically allowed to hear and determine core matters. 157(2) gives a laundry list of what are considered core. Again, Stern v. Marshall s focus was on the 157 grant of authority from the District Court to the Bankruptcy Court. 28 USC 157 Procedures (Author s annotating comments) (a) Each District Court may provide that any or all cases under title 11 and any or all proceedings arising under title 11 or arising in or related to a case under title 11 shall be referred to the bankruptcy judges for the district. (It should be remembered that the Bankruptcy Court has no independent grant of jurisdiction. All that it has is what is provided in 1334 and then referred to it by the District Court under special reference orders based on this 157.) (b)(1) Bankruptcy judges may hear and determine all cases under title 11 and all core proceedings arising under title 11, or arising in a case under title 11, referred under subsection (a) of this section, and may enter appropriate orders and judgments, subject to review under section 158 (appeals) of this title. (This says that the Bankruptcy Court presides over the bankruptcy itself and it can make final determinations in core matters.) (2) Core proceedings include, but are not limited to - (A) matters concerning the administration of the estate; 9

19 (B) allowance or disallowance of claims against the estate or exemptions from property of the estate, and estimation of claims or interests for the purposes of confirming a plan under chapter 11, 12, or 13 of title 11 but not the liquidation or estimation of contingent or unliquidated personal injury tort or wrongful death claims against the estate for purposes of distribution in a case under title 11; (C) counterclaims by the estate against persons filing claims against the estate; (This is where Stern v. Marshall had a problem. It does not mean that some counter claims could still be core, but in the case of Stern v. Marshall the particular counter-claim was too far divorced from the bankruptcy case itself to be considered core. It was a constitutional issue of giving jurisdiction to a court (Article I Court) beyond what Congress could do.) (D) orders in respect to obtaining credit; (E) orders to turn over property of the estate; (F) proceedings to determine, avoid, or recover preferences; (G) motions to terminate, annul, or modify the automatic stay; (H) proceedings to determine, avoid, or recover fraudulent conveyances; (Bankruptcy Courts do not hold jury trials and so, if you have a 7 th Amendment right to a jury trial and want a jury, then a fraudulent conveyance matter cannot be heard in the Bankruptcy Court at all. This would be true for any core matter where a jury trial right exists.) (I) determinations as to the dischargeability of particular debts; (J) objections to discharges; (K) determinations of the validity, extent, or priority of liens; (L) confirmations of plans; (M) orders approving the use or lease of property, including the use of cash collateral; (N) orders approving the sale of property other than property resulting from claims brought by the estate against persons who have not filed claims against the estate; (O) other proceedings affecting the liquidation of the assets of the estate or the adjustment of the debtor-creditor or the equity security holder relationship, except personal injury tort or wrongful death claims; and (P) recognition of foreign proceedings and other matters under chapter 15 of title 11. (3) The bankruptcy judge shall determine, on the judge's own motion or on timely motion of a party, whether a proceeding is a core proceeding under this subsection or is a 10

20 proceeding that is otherwise related to a case under title 11. A determination that a proceeding is not a core proceeding shall not be made solely on the basis that its resolution may be affected by State law. (This section of the code was not overturned in Stern v. Marshall. The distinction between core and non-core continues.) (4) Non-core proceedings under section 157(b)(2)(B) of title 28, United States Code, shall not be subject to the mandatory abstention provisions of section 1334(c)(2). (This keeps determination of claims and exemption matters in the Bankruptcy Court, even if they would otherwise meet the requirements of mandatory abstention.) (5) The District Court shall order that personal injury tort and wrongful death claims shall be tried in the District Court in which the bankruptcy case is pending, or in the District Court in the district in which the claim arose, as determined by the District Court in which the bankruptcy case is pending. (Personal injury and wrongful death claims against the estate will not be tried in the Bankruptcy Court. They must go to the District Court.) (c)(1) A bankruptcy judge may hear a proceeding that is not a core proceeding but that is otherwise related to a case under title 11. In such proceeding, the bankruptcy judge shall submit proposed findings of fact and conclusions of law to the District Court, and any final order or judgment shall be entered by the district judge after considering the bankruptcy judge's proposed findings and conclusions and after reviewing de novo those matters to which any party has timely and specifically objected. (The process for hearing non-core matters. The bankruptcy judge will simply prepare proposed findings of fact and conclusions of law for review and finalization to the District Court, subject to de novo review on any issues upon which a timely objection has been filed.) (2) Notwithstanding the provisions of paragraph (1) of this subsection, the District Court, with the consent of all the parties to the proceeding, may refer a proceeding related to a case under title 11 to a bankruptcy judge to hear and determine and to enter appropriate orders and judgments, subject to review under section 158 of this title. (Parties can consent to the Bankruptcy Court s jurisdiction of a non-core matter and allow the Bankruptcy Court to make a final decision. Section 158 covers appeals.) (d) The District Court may withdraw, in whole or in part, any case or proceeding referred under this section, on its own motion or on timely motion of any party, for cause shown. The District Court shall, on timely motion of a party, so withdraw a proceeding if the court determines that resolution of the proceeding requires consideration of both title 11 and other laws of the United States regulating organizations or activities affecting interstate commerce. (The District Court can withdraw in whole or part any case that is referred under this section at any time.) (e) If the right to a jury trial applies in a proceeding that may be heard under this section by a bankruptcy judge, the bankruptcy judge may conduct the jury trial if specially designated to exercise such jurisdiction by the District Court and with the express consent of all the parties. In order to have a jury trial in Bankruptcy Court you must have the approval of the District Court and the consent of the parties. 11

21 F. Other Sources of Law and Rules 1. In addition to the F.R.B.P. and local rules, bankruptcy cases are also governed by many of the Federal Rules of Civil Procedure (F.R.C.P.). Remember that bankruptcy is a federal question and therefore the F.R.C.P. in use throughout the District Courts in the country have application. Some of the F.R.C.P. have been specifically adopted and in some cases slightly modified, by the F.R.B.P. 2. Because bankruptcy arises as a federal question and because the Bankruptcy Court is an adjunct of the District Court, you must also be familiar with the Federal Rules of Evidence. 3. Not only must a bankruptcy practitioner be familiar with the above federal rules and laws, he or she must also be familiar with state law. This is especially true in situations where there is no applicable federal statutory law or rule. In those situations state law will be applied. This means that you must be familiar with such things as property exemptions under state law, as well as state law on foreclosure, commercial transactions, inheritance, and the like. Bankruptcy is a very complicated matter because of this complex interplay between the several bodies of federal and state law. II. The Main Players A. The Debtor The debtor is the person or entity that files the bankruptcy or has a bankruptcy filed against him or her. Only in the case of spouses may more than one person or entity be in the same bankruptcy. ( 101(13)). B. Creditors Creditors are either persons or entities that have a claim against the debtor that primarily arose prior to the filing of the bankruptcy or the debtor's estate. Creditors can be secured or unsecured, priority or non-priority based on the nature of the claim. ( 101(10)). C. The Judge The bankruptcy judge is federally appointed and serves under the jurisdiction of the federal District Court. He hears and decides all disputes within the bankruptcy case. (28 U.S.C ). D. The U.S. Trustee The Attorney General of the United States appoints a U.S. Trustee for each of 12

22 twenty-one separate judicial districts in the United States. The U.S. Trustee's office then administers and supervises cases, as well as the bankruptcy trustees serving in individual cases. They may appear and be heard on a wide range of subjects in bankruptcy cases. They basically focus on Chapter 11 cases. ( 307). E. The Trustee A trustee is appointed to take over the debtor's estate (assets) and manage them for the interested parties in the bankruptcy. Trustees are always appointed in cases under Chapter 7, 12 and 13. They may be appointed by court order in Chapter 11 but their appointment is not automatic. ( ). F. Committees There are a variety of types of committees that can exist in bankruptcy cases. Usually committees only exist in Chapter 11 cases, though the creditors can elect a committee in a Chapter 7 case. In almost every Chapter 11 case, the U.S. Trustee will attempt to appoint a committee of unsecured creditors. The court may be petitioned to appoint other types of committees (i.e.an equity holders committee). Committees give a particular group participants with common interests in the case a collective voice in the proceedings. ( 705, 1102 & 1103). G. Ombudsman BAPCPA created new positions to be established by court order to protect consumer privacy and medical patient interests. The consumer privacy ombudsman will be appointed when, in the transfer of business assets, personal consumer information will be transferred and such transfer is not part of a preexisting policy of the business. ( 332 & 363(b)(1)). Whenever the debtor is in the health care business, the Court shall appoint a patient care ombudsman to monitor quality of care and represent the interests of patients unless the Court determines that, based on the facts of the case, it is not necessary. ( 333). III. Particular Types of Bankruptcy A. Chapter 7 (Liquidation) Chapter 7 liquidation is by far and away the most popular type of bankruptcy. It accounts for more than 70% of all filings. Additionally, many Chapter 11 and 13 filings eventually end up as Chapter 7 cases. In a Chapter 7 case, a trustee is appointed and he or she takes the debtor's nonexempt assets, liquidates them, and to the extent possible, uses the resulting funds to pay the debtor's creditors. A goal of BAPCPA is to get more people into Chapter 13, at least initially. 1. Who May File Chapter 7? a. Any individual, corporation, or partnership except: 13

23 (i) (ii) (iii) a railroad insurance company bank, savings and loan or similar institution. ( 109(b)) b. Each individual, corporation or partnership must file its own separate bankruptcy. The only exception is that an individual and that individual's spouse may file a single bankruptcy under a joint petition. ( 302(a)). Even though the Bankruptcy Code does not mention limited liability companies, such entities have filed bankruptcies and the courts have had no problem recognizing their right to file. c. An individual or family farmer may not file a Chapter 7 petition within 180 days of dismissal of a previous case for willful failure to abide by orders of the court, nor within 180 days of obtaining a voluntary dismissal of a previous case following the filing of a motion for relief from the automatic stay ( 109(g)). 2. Dismissal of Case or Conversion to Chapters 11 or 13 a. Dismissal The court can dismiss a Chapter 7 case after notice and hearing only for cause including: (i) (ii) (iii) (iv) Unreasonable delay that is prejudicial to creditors; Nonpayment of certain fees; Failure to file the schedules and statement of affairs within 15 days of filing the petition for relief; 707(a) Situations where granting relief under Chapter 7 would be an abuse of the provisions of the Bankruptcy Code. 707(b). b. Determining Abuse to Require Dismissal or Conversion The first determination that must be made relates to the debtor s income. In order to file a Chapter 7 the debtor must pass what is called the means test. If the debtor s income is less than the state s median income for a family the size of the debtor s, such a person qualifies for a Chapter 7 and resort to the means test is unnecessary. If the debtor s income is less than the median income for the state, no parties but the judge and the U.S. Trustee can even make a motion on the issue of abuse. If the debtor s income 14

24 exceeds the state median, there is a formula that is used to determine whether there is a presumption of abuse. The U.S. Trustee has the affirmative duty to review each filing to determine if it qualifies for a motion for abuse. 704(b). If the income exceeds the state median, any party in interest can file the motion 707(b)(6). It is calculated as follows: (i) (ii) (iii) (iv) (v) You determine the debtor s current monthly income (based on all income received over the last six months) and reduce it by -- The debtor s monthly expenses (not including accrued debts) based on National and Local Standards and Other Necessary Expenses as specified by the IRS for the area in which the debtor resides, along with certain other specifically allowed expenses under the Bankruptcy Code - - Take the difference of (1) and (2) above and multiply it by Take the lesser of $12,475 or 25% of the debtor s nonpriority unsecured claims, but in no event less than $7,025 (both numbers will increase every three years based on the Consumer Price Index or CPI. The next adjustment will be on 4/1/16) -- If (iii) is greater than (iv) you have a presumption of abuse. The presumption can only be rebutted by establishing that the debtor has additional expenses that should be considered under (ii) above. 707(b)(2)(A) A judge or the U.S. Trustee can still challenge the case for abuse even if the debtor qualifies to file under the means test, but it would then be for some abusive use of the Code beyond just making excess income. ( 707(b)(3)). c. Liability of Attorney for Filing a Case Dismissed or Converted for Abuse. The Bankruptcy Code invites parties in interest to make a motion against the debtor s attorney to pay F.R.B.P sanctions if a case they file is dismissed or converted for abuse. By signing and filing the petition, the attorney is representing to the Court that, to the best of the attorney s knowledge, information and belief after reasonable investigation under the circumstances, the filing is not being made for improper purposes, that it is well grounded in fact, and that the attorney has inquired and determined that the schedules are not incorrect. 707(b)(4). 15

25 3. Conversion As an alternative to dismissing the case for abuse, with the consent of the debtor, the case may be converted to one under Chapter 11 or (b). 4. Administration of a Chapter 7 a. The Estate When a bankruptcy is filed, all of the property owned by the debtor. both real and personal, tangible and intangible, becomes the bankruptcy estate (subject to exemption powers for individuals discussed in VI. below). ( 541). b. The Interim Trustee Immediately following the filing of a Chapter 7 case, an interim trustee is appointed by the U.S. Trustee. ( 701) The trustee has a variety of duties, but the most important is to take control of the estate of the debtor for purposes of liquidation and distribution to creditors. ( 704). c. The Permanent Trustee At the first meeting of creditors, the interim trustee becomes the permanent trustee unless the creditors at the first meeting nominate and elect a different trustee. It is extremely rare for creditors to take such an action. ( 702). d. Creditors' Committee A creditors' committee of unsecured creditors may also be elected at the first meeting of creditors. The committee, if formed, may consult with and advise the trustee or U.S. Trustee or may bring matters regarding administration of the estate before the court. In a Chapter 11 case, the committee can hire professionals to advise it with the expectation of having them reimbursed from the estate. Such reimbursement is apparently not available in a Chapter 7 case. Chapter 7 creditors' committees are very rare. ( 705). e. Operation of Debtor's Business If the debtor in a Chapter 7 case is a business or has a business, the court may authorize its continued operation by the trustee, but only if it is part of an orderly liquidation of the estate. ( 721). 5. Distribution of the Property of the Estate 16

26 Once the trustee has liquidated the estate, the proceeds are distributed to creditors in the order of priority set forth in the Code. a. Secured Claims To the extent of a creditor's security interest, the creditor will receive either a return of the property or its cash equivalent. ( 506). b. Priority Claims Before the general unsecured claims are paid, certain specific unsecured claims are deemed to have a higher priority and are paid in full first. These claims are paid 100% before moving to the next level of priority. The order of priority is as follows: (i) Domestic Support Obligations Those obligations owed as of the filing of the bankruptcy for domestic support obligations. If a trustee has administrative expenses incurred for administering assets available to pay the domestic support obligations, then those trustee administrative expenses are paid even before the domestic support obligations. 507(a)(1). (ii) Administrative Expenses and Fees Those expenses and fees incurred to administer the estate and bankruptcy during the Chapter 7 case. If a case is converted, the administrative expenses of the current bankruptcy chapter are paid in full before the administrative expenses of a prior chapter. See 503 for a more detailed listing of the expenses covered. ( 507(a)(2)). (iii) Gap Creditor Claims If an involuntary bankruptcy was filed, those extending credit to the debtor between the filing of the involuntary petition and the final determination by the court that the involuntary bankruptcy should proceed (order for relief), have a priority right behind the administrative expenses. ( 507(a)(3)). (iv) Wages, Salaries and Commissions Wages, salaries or commissions, (including vacation, sick leave and severance) earned within 180 days of filing of the 17

27 bankruptcy and limited to $12,475 (this amount is subject to adjustment every three years based on the CPI, and the next adjustment is 4/1/16) per individual. ( 507(a)(4)). (v) Employee Benefits Certain employee benefit plan obligations arising within 180 days of filing of the bankruptcy and limited to $12, (this amount is subject to adjustment every three years based on the CPI, and the next adjustment is 4/1/16) times the number of employees qualified under the plan. The amount paid under (iv) above reduces the amount allowed under this provision so the aggregate per employee under (iv) and (v) is $12, (a)(5). (vi) Grain Farmers and Fisherman Special protection for grain farmers and fisherman limited to $6, per each claimant (it pays to have a lobby). (This amount is subject to adjustment every three years based on the CPI, and the next adjustment is 4/1/16) ( 507(a)(6)). (vii) Deposits for Future Purchases or Rentals (viii) Taxes Certain deposits held by the debtor for future purchases or rentals but only to the extent of $2, (subject to adjustment every three years based on the CPI. Next adjustment 4/1/16). 507(a)(7). Certain taxes (a full discussion of this is beyond the scope of this outline). 507(a)(8). (ix) Amounts Owed to FDIC Allowed unsecured claims based on the debtor s commitment to maintain certain capital in an insured depository institution. 507(a)(9). (x) Death and Personal Injury Claims from Intoxication Allowed claims against the debtor arising from death or injury caused by their use of a motor vehicle or vessel while intoxicated. 507(a)(10). 18

28 c. General Unsecured Claims If you have a properly allowed unsecured claim (this would include the unsecured portion of any partially secured claim) and funds remain, you will receive, along with all other general unsecured creditors, a pro rata distribution of up to 100% of your claim. d. Late Filed Claims If you filed your claim beyond the time allowed by the Code and there are still funds available, you will receive, along with all other similarly situated creditors, a pro rata distribution of up to 100% of your claim. ( 502). e. Fines, Penalties, and Forfeitures Actual pecuniary loss is compensated first. If you have a claim based on a fine, penalty or forfeiture (this would include a punitive damage claim) and there are still funds available, you will share with all similarly situated creditors pro rata up to 100% of your claim. f. Payment of Interest g. Residue 6. Fresh Start If there are still funds available, each creditor from (b), (c), (d), and (e) above will then receive, in order, interest at the legal rate from the filing of the bankruptcy until distribution is made (post-petition interest). Any amounts remaining after all claims and interest have been paid are returned to the debtor. ( 726). The debtor files Chapter 7 to get relief from current outstanding obligations. All of the debts owed on the day the bankruptcy was filed are discharged (however, see 523 for a list of particular types of debts that are not discharged). All earnings and debts arising after the filing of the bankruptcy are not subject to the bankruptcy or its discharge. The debtor, if an individual, is usually discharged in about four to six months. A corporation or partnership is not eligible to receive a discharge in Chapter 7. ( 727). A debtor otherwise eligible shall not receive a discharge if the debtor received a previous discharge under Chapter 7 or Chapter 11 commenced within eight years ( 727(a)(8)) or if the debtor previously received a discharge in Chapter 12 or Chapter 13 commenced within six 19

29 years, unless unsecured creditors were paid at least seventy percent of their claims and such payments were the Debtor s best efforts in the prior bankruptcy ( 727(a)(9)). B. Chapter 9 (Municipal Reorganization) This chapter deals with bankruptcy by governmental entities that are subdivisions of states (states cannot file) and is beyond the scope of this outline. While it is a rarely used chapter of the Code, it is becoming more common with the recent financial meltdown which impacted so many governmental entities. Close to home, recently the City of Stockton became the biggest city in the US to file so far. It is most commonly used by public hospitals, though other governmental agencies have taken advantage of its provision (i.e. Orange County). In the current economic climate this might become a much more popular chapter of the Code but would also have to be the subject of an entirely separate class. C. Chapter 11 (Reorganization) A variety of purposes may be served by filing a Chapter 11 case. The reasons most often cited are to develop a plan to financially reorganize the debtor or for orderly liquidation of the debtor. 1. Who May File a Chapter 11? Anyone who may file a Chapter 7 (see III A.1. above) may file a Chapter 11 with two exceptions: a. A railroad may proceed under a Chapter 11. b. Stockbroker and commodity brokers may not file Chapter Administration of a Chapter 11 a. The Estate As in a Chapter 7 case, when a bankruptcy is filed, all the property owned by the debtor, both real and personal, tangible and intangible, becomes the bankruptcy estate (subject to the exemption powers for individuals discussed in VI below). ( 541). b. Debtor-In-Possession One of the major advantages for the debtor in a Chapter 11 case is that the debtor remains in charge of the estate as debtor-inpossession. ( 1101, 1107) No third party trustee is appointed and the debtor-in-possession has duties that basically mirror those of a trustee. ( 1107). In fact, unless specifically limited, any Code 20

30 provision which grants powers or duties to the trustee applies equally to the debtor-in-possession. ( 1107). c. Trustee The court, for cause, may replace the debtor-in-possession with a trustee for certain improper acts of the debtor-in-possession or if it is in the best interest of creditors. The trustee then takes control of the estate, eliminating the debtor-in-possession. Creditors are allowed to elect their own trustee by the same method as the Chapter 7 trustee is elected. The U.S. Trustee is to call a meeting of creditors within 30 days of the order authorizing the appointment of a trustee for the purpose of allowing the creditors to select their own trustee. ( 1104). A trustee can be appointed for either an entity or an individual that has filed a Chapter 11 case. It seems to work okay for the entity, but it puts the individual in a personal no-man s land where control of their life has been turned over to a trustee. While an individual s Chapter 11 is supposed to mirror the Chapter 13 process, it is much more intrusive than that if a Chapter 11 trustee is appointed. Personal experience tells the author to push for a conversion to a Chapter 7 rather than to allow an individual debtor to be subject to a Chapter 11 Trustee. d. Examiner Sometimes, as an interim measure, the court will appoint an examiner rather than a trustee. The examiner does not replace the debtor-in-possession, but rather investigates the debtor to the extent necessary, and reports back to the court. This report is often followed by the appointment of a trustee, but this is not always the case. ( 1104). e. Creditors' Committee This committee is appointed by the U.S. Trustee as soon as practical and is usually made up of the seven largest unsecured creditors willing to serve. The size or constitution of the committee may be altered by the court at the request of any party in interest. (i) A creditor should not serve on the unsecured creditors committee if: (a) It believes its claims are partially or fully secured; 21

31 (b) (c) (d) It has received a potential preference or fraudulent conveyance unless it has already turned such transfer over to the estate; It has a disputed debt; or It is an insider of the debtor. (ii) Powers of the committee. The committee may: (a) (b) (c) (d) (e) (f) With court approval, employ attorneys, accountants and other professionals to aid the committee (costs to be paid from the estate); Consult with the trustee or debtor-in-possession in administering the case; Investigate the debtor's acts, conduct, assets, liabilities and financial condition; Participate in the formulation of the plan: If appropriate, request the appointment of a trustee or receiver; and Perform such other acts as are in the interest of the creditors. ( 1102 and 1103). f. Other Committees The U.S. Trustee may appoint such other committees as the U.S. Trustee deems appropriate. The purpose is to make sure that all significant groups have a voice in the Chapter 11 process. Often, these other committees are made up of equity security holders. These additional committees have the same powers as the unsecured creditors committee. ( 1102). g. Operation of Debtor's Business 3. The Plan The debtor-in-possession or trustee is specifically authorized to continue operating the debtor's business in a Chapter 11 case. ( 1108) Whether it is for financial reorganization or orderly liquidation, the plan is the centerpiece of a successful Chapter 11 case. It tells the creditors and other interested parties how each of their claims will be handled. The 22

32 creditors vote to approve or reject the plan after it is proposed. a. Who May File a Plan? (i) (ii) The debtor may file a plan at any time during the time the Chapter 11 is pending, whether the debtor remains as the debtor-in-possession or not. Any party in interest may file a plan but only if one of the following three conditions has been met: (a) (b) (c) A trustee has been appointed: 120 days has passed since the order for relief (filing of the case) without the debtor filing a plan (these 120 days are known as the debtor's exclusivity period); or If the debtor files a plan within the 120-day exclusivity period, then the debtor has 180 days from the order for relief to obtain acceptance of its plan. If the 180-day period has passed then any party in interest may file its own plan. (iii) The 120- and 180-day time periods (set forth in (ii)(b) and (c) immediately above) can be increased or reduced by the court at the request of a party in interest, but in no event can the exclusivity period be extended beyond 18 months to file a plan and 20 months to obtain its approval. ( 1121). b. Contents of a Plan The plan sets out the means for paying creditors' claims based on the classification and priorities of those claims. There are mandatory rules as well as permissive rules for a plan. The plan shall: (i) (ii) (iii) Set forth the classification of various claims. Claims may only be grouped together if they are substantially similar. Also, claims that are substantially similar shall receive the same treatment. ( 1122). Indicate which classes are being impaired under the plan (having its legal, equitable, or contractual rights altered) and what their treatment will be. Provide an adequate means for the plan s implementation. The plan must explain in some detail how it is to be 23

33 (iv) (v) (vi) executed (more than blue sky is needed here). Provide that the debtor may not issue nonvoting securities or provide for inappropriate distribution of voting power through the plan. In the case of an individual, provide for the payment, through the plan, of all or a portion of earnings from personal services performed after the bankruptcy, as is necessary for execution of the Plan. 1123(a)(8). Beyond these requirements, the plan may: (a) (b) (c) Provide for settlement of any dispute or adjust any claim; ( 1123) Provide for the pursuit of any claims or interest of the debtor or the estate; ( 1123) Provide for the assumption or rejection of executory contracts or unexpired leases that have not been previously rejected; ( 1123) (d) Provide for liquidation of the estate; ( 1123) (e) (f) (g) Cure any default and reinstate any obligation of the debtor without regard to prior defaults; ( 1124) Debtors cannot modify the rights of secured creditors that have only the debtor's principle residence as their collateral ( 1123(b)(5)); Include any other provision not inconsistent with the applicable provisions of the Code. ( 1123). 4. Disclosure Statement No solicitation of acceptances of a plan can be made unless it is accompanied by a court-approved disclosure statement. The main purpose of the disclosure statement is to provide adequate information to those asked to vote on the plan. It sets out how the debtor got into the financial condition necessitating bankruptcy, what the current situation is, and how the debtor will be able to perform under its proposed plan. The requirements of a disclosure statement are: a. Adequate Information. The disclosure statement supports the plan and must contain adequate information to allow the typical holder of a claim in the case to make an informed decision about the proposed plan. ( 1125). 24

34 b. Multiple Disclosure Statements. It is not necessary that each claim holder receive the same disclosure statement as long as the statement provides adequate information to each class receiving it. ( 1125). c. Court Approval. A hearing on the disclosure statement is held before the Court, at which time objections to the disclosure statement are heard. The disclosure statement must be approved by the court before it can be used to solicit acceptance of a Plan. ( 1125). 5. Confirmation of a Plan The plan proponent sends out the plan and disclosure statement to all claimants and solicits their votes for the plan. A hearing will then be held on the plan at which time the court will determine if the plan may be confirmed. a. Acceptance of Plan. A class of claimants has accepted the plan if: (i) (ii) (iii) At least 2/3 in amount and more than ½ in total number of allowed claimants in the class have voted to accept the plan (this includes voting and non-voting class members). ( 1126(c)). An unimpaired class is conclusively presumed to have accepted the plan. A class receiving nothing under the plan is conclusively presumed to have rejected the plan. ( 1126). b. Confirmation Hearing Any party in interest may raise objections to confirmation of the plan at the hearing on confirmation. ( 1128). c. Confirmation A plan will be confirmed only if the following requirements are met (See 1129): (i) (ii) The plan has been proposed in good faith and complies with the Code; All fees and costs to be paid by the debtor or plan proponent for services related to the case have been approved by or are subject to approval by the court as reasonable; 25

35 (iii) (iv) (v) (vi) All affiliations with the debtor, or proponent of any person to serve in a control position after confirmation, have been fully disclosed; Any applicable rate changes proposed by the plan have been approved by applicable government regulatory bodies; Each class of claims is either not impaired or, if impaired, has accepted the plan. An unsecured class that does not receive post-petition interest is impaired; Each impaired class has either accepted the plan or will receive at least as much as that class would receive under Chapter 7 if the debtor was liquidated on the effective date of the plan; (vii) Unless agreed otherwise, priority claim holders ( 507(a)(7)) must receive priority as to payments as set forth in the Code; (viii) If there are impaired classes under the plan, at least one impaired class must have accepted the plan; (ix) (x) (xi) (xii) The court must determine that the plan is not likely to be followed by further financial reorganization or subsequent liquidation unless otherwise set forth in the plan; Priority tax claims, secured or unsecured, are paid in regular installments over not more than five years from the filing of the case; 1129(a)(9)(C) The debtor has paid all domestic support obligations, if any, coming due since the filing of the bankruptcy; 1129(a)(14) If the debtor is an individual and an unsecured creditor objects, then either the creditor must receive the full value of its claim or the value of the property to be distributed under the plan is not less than the projected disposable income of the debtor over the longer of the next five years or the period over which the plan will make payments; 1129(a)(15) (xiii) All fees payable to the court or U.S. Trustee must have been made; (xiv) The Plan contains appropriate treatment of retirement benefits, if applicable. ( 1129(a)). 26

36 d. Alternate Confirmation: CRAMDOWN A plan not meeting all the requirements of c. above may be confirmed if it meets all requirements of c. other than (v). In such cases, if the plan is fair and equitable to the dissenting impaired class, it may still be confirmed over that class objection if: (i) As to secured claims: (a) (b) (c) (d) The claim holder retains a lien equal to the value of its claim; and, The claim holder receives deferred cash payments equal to the amount of such claims with a present value at least equal to the secured interest; or The property securing the claim will be sold with the claim to attach to the proceeds of sale; or The claim holder realizes the indubitable equivalent of the claim. Although indubitable equivalent is often hard to define, as a practical matter many courts consider payment in full in cash as the only form of indubitable equivalent for payment of a secured creditor's claim. Any other proposal is likely to lead to protracted and expensive litigation. (ii) As to unsecured claims: (a) (b) (c) Either the claim holder receives property equal to the amount of such claim; or No junior claim holder shall receive anything on account of its claim if the senior claims are not paid in full first (absolute priority rule). ( 1129 (b). If the debtor is an individual then the debtor is obligated to make payments of all projected disposable income of the debtor over the longer of the next five years or the period over which the plan will make payments. 1129(b)(2)(B). 6. Effect of Confirmation A confirmed Chapter 11 plan acts as a new contract between the debtor and all of its creditors (including those who did not consent to the plan). Any creditor violating the plan will be in breach. ( 1141(a).) 27

37 a. Confirmation also re-vests in the debtor all property of the estate free and clear of all liens and other interests except as provided for by the plan. ( 1141(d)(1).) b. Confirmation also acts to discharge all debts arising before confirmation except as provided in the plan. ( 1141(d)(1).) If the debtor is an individual, then unless the Court, for good cause, orders otherwise, discharge does not occur until the debtor has completed all plan payments. 1141(d)(5). c. A Chapter 11 discharge is virtually identical to a Chapter 7 discharge except that all Chapter 11 debtors receive a discharge, including corporate and partnership debtors. (Only in Chapter 11 may a corporation or partnership receive a discharge.) d. In certain instances, a Chapter 11 debtor will not be entitled to a discharge. A debtor liquidating assets through a Chapter 11 plan that does not intend to remain in business and would not be entitled to a discharge if the proceeding were a Chapter 7, will not be discharged by confirmation of a Chapter 11 Plan. ( 1141(d)(3).) e. Thus, a corporation or partnership debtor with a liquidating Chapter 11 plan will not receive a discharge because a corporation or partnership is not entitled to a Chapter 7 discharge. On the other hand, an individual is entitled to receive a discharge through a liquidating Chapter 11 plan because an individual may receive a Chapter 7 discharge. 7. Post Confirmation Modification Under normal circumstances a confirmed plan can only be modified before substantial consummation. In the case of an individual debtor, the plan can be modified at any time until completion of all payments. The modification can increase or decrease payments or the time for such payments. 1127(e). 8. Conversion or Dismissal A debtor who remains a debtor-in-possession may unilaterally convert a voluntary petition under Chapter 11 to a case under Chapter 7 of the Bankruptcy Code in most instances. Any party may seek to have a case under Chapter 11 converted to Chapter 7 or dismissed for cause shown, unless the debtor is a farmer, in which case dismissal is the only option (unless the debtor requests the conversion). 9. Small Business Chapter 11's The 1994 amendments allowed for special treatment for what the Code 28

38 defines as Small Business Chapter 11. The debtor must request treatment as a small business. A small business is engaged in commercial or business activities (other than a business that has as its primary activity owning or operating real property) and has less than $2,490, total debts (this amount is adjusted every three years based on the CPI, and the next adjustment is 4/1/16) that are non-contingent and liquidated, excluding debts owed to affiliates of the debtor. A case cannot be a small business case if a creditors committee has been appointed unless the Court determines that the committee is not sufficiently active or effective. Also you cannot be a small business debtor if you are affiliated with other debtors that have total non-contingent liquidated debt of more than $2,490, ( 101(51) (C) & (D)). If you qualify as a small business, you can request that the court dispense with a creditors committee ( 1102(a)(3)). You also have a 180-day exclusivity period, with an outside limit of 300 days to confirm your plan ( 1121(e)). You can get a conditional approval of a disclosure statement and you can combine your hearing on the disclosure statement and plan. The Court also has the authority to determine that the plan provides sufficient information and can dispense completely with the disclosure statement. ( 1125(f)). There are special relief from stay provisions regarding these cases. The automatic stay does not apply in the following circumstances: a. The debtor is already involved in another small business case that is pending; b. The debtor was involved in another case that was dismissed within two years of the filing of the current case; c. The debtor was involved in another case with a confirmed plan within two years of the filing of the current case; d. The debtor is a new entity that has acquired the assets of a small business that otherwise would fall under the three conditions (a, b & c) above unless they can prove such acquisition was not for the purpose of evading this paragraph. The debtor can move the court to have the automatic stay imposed if it can prove that the filing was from circumstances unforeseeable when the prior case was pending and that a feasible plan will be confirmed within a reasonable period of time. ( 362(n)). 10. Single Asset Real Estate Cases The 1994 amendments also define a type of case known as the single asset real estate case and imposes limitations on these cases. Single asset cases are those where you have a single property or project (other than a residential project with fewer than four units) where there is no substantial 29

39 business of the debtor beyond operating the real property. The 2005 Act eliminated the debt limitation of no more than $4,000, of liquidated, non-contingent, aggregate secured debt completely ( 101 (51)(B)). These provisions do not apply to family farmers. ( 101 (51)(B)) In these cases, relief from the automatic stay shall be granted by motion of an interested party unless a feasible plan is filed and payments to secured creditors commenced within 90 days of the case commencing or 30 days after determining that the case qualifies as a single asset case whichever is later. Further once a determination is made that the real property has been part of scheme to hinder, delay or defraud creditors, limitations can be placed on filing additional bankruptcies for a two year period. ( 362 (d)(3)). 11. Individual Chapter 11 Cases An individual debtor (or an individual and spouse), even one not engaged in business, is eligible to file a Chapter 11 proceeding. Individual debtors not engaged in business who are not eligible for Chapter 7 relief (due to high income) and who are also not eligible for Chapter 13 relief (i.e. because they have debts exceeding the limits for Chapter 13 eligibility currently set at less than $383, for noncontigent, liquidated, unsecured debt and less than $1,149, for noncontigent, liquidated, secured debt) may find that this is their only option with respect to filing a bankruptcy. BAPCPA made numerous changes to the provisions governing individual Chapter 11 cases, making them more closely resemble Chapter 13 cases. However, there are still a number of differences between individual Chapter 11 cases and Chapter 13 cases. For example, although an individual cannot be subjected to an involuntary Chapter 13 case, an individual may be subjected to an involuntary Chapter 11 case. In addition, an individual Chapter 11 debtor may not include a provision in a plan which modifies the right of the holder of a claim secured only by a home mortgage on the debtor s residence. Some of the differences between a regular Chapter 11 case and an individual Chapter 11 case are: a. In an individual Chapter 11 case, the definition of property of the estate is expanded beyond the definition in 541 to include property acquired by the debtor after the commencement of the case, including income from salary and earnings ( 1115). b. The individual Chapter 11 debtor is subject to a different confirmation standard than regular Chapter 11 debtors. If an unsecured creditor objects to the plan, the debtor must either (i) devote all projected disposable income for the longer of five years or the plan s term or (ii) pay 100% of all claims. This means that the cramdown provision that applies in regular Chapter 11 cases is hamstrung, and an individual dissenting creditor can object to the 30

40 plan even if his or her class has accepted the plan. ( 1129(a)(15)). c. Following the end of the exclusivity period, third parties may propose plans, but that plan cannot provide for the sale, use, or lease of exempt property without the debtor s consent. ( 1123(c)). d. An individual Chapter 11 debtor may be granted a hardship discharge, similar to a Chapter 13 debtor. ( 1141(d)(5)). A discharge is ordinarily granted to a Chapter 11 debtor upon completion of plan payments, an individual Chapter 11 debtor may receive a hardship discharge where prior to the completion of the plan (i) the court finds the debtor s unsecured creditors have received as much as they would in a Chapter 7 case, (ii) modification is not practicable, (iii) and the debtor does not have any debts listed under 522(q) arising from felony convictions, securities violations, and personal injuries caused to others. D. Chapter 12 (Family Farmer/Fisherman Bankruptcy) Until BAPCPA, this was the only Bankruptcy Chapter added after adoption of the Code. Chapter 12 became effective November 26, 1986, and provides special and powerful remedies for those who qualify. Unfortunately, the original law contained a sunset provision which ran out in Congress extended Chapter 12 a couple of times thereafter, but it was allowed to lapse on July 1, Since then, it has been resurrected several times. BAPCPA does two important things; it keeps Chapter 12 from lapsing again and makes it a permanent part of the Bankruptcy Code. BAPCPA also expands the coverage of Chapter 12 to include a definition for family fisherman who can also file under Chapter Who May File Chapter 12? a. Any individual or individual and spouse engaged in a farming operation: (i) (ii) (iii) Who have $4,031, (the amount will adjust every three years based on the CPI, with the next adjustment set for 4/1/16) or less of non-contingent, liquidated debt; At least 50% of whose non-contingent liquidated debts arise out of a farming operation owned or operated by the debtor. (The 50% test does not include debt on the principal family residence unless the debt arose in the farming operation.); and, Who earned at least 50% of gross taxable income from farming operations in the tax year just preceding filing or in each of the 2nd and 3rd years preceding the filing. ( 101(18) (A)); or, 31

41 b. Any individual or individual and spouse engaged in a commercial fishing operation ( 101(7A): (i) (ii) (iii) Who have $1,868, (amount will adjust every three years based on the CPI with the next adjustment set for 4/1/16) or less of non-contingent, liquidated debt; At least 80% of whose non-contingent, liquidated debts arise out of a farming operation owned or operated by the debtor (The 80% test does not include debt on the principal family residence unless the debt arose in the fishing operation.); and, Who earned at least 50% of gross taxable income from fishing operations in the tax year just preceding filing. 101(19A) (A)). c. Any corporation or partnership which conducts farming operations in which: (i) (ii) (iii) (iv) More than 50% of the outstanding stock or equity is held by one family or by related family members. (Stock cannot be publicly traded); More than 80% of the assets (by value) are related to the farming operation; There is $4,031, (amount will adjust every three years based on the CPI with the next adjustment set for 4/1/16) or less of all non-contingent, liquidated debt; and At least 50% of the non-contingent liquidated debts arise out of a farming operation owned or operated by the corporation or partnership (excluding debt for one residence owned or operated by the debtor which a shareholder or partner maintains as his principal residence, unless the debt arose in the farming operation). ( 101(18)(B)). d. Any corporation or partnership which conducts commercial fishing operations in which: (i) (ii) More than 50% of the outstanding stock or equity is held by one family or by related family members. (Stock cannot be publicly traded); More than 80% of the assets (by value) are related to the commercial fishing operation; 32

42 (iii) (iv) There is $1,868, (amount will adjust every three years based on the CPI, with the next adjustment set for 4/1/16) or less of all non-contingent, liquidated debt; and At least 80% of the non-contingent liquidated debts arise out of a fishing operation owned or operated by the corporation or partnership (excluding debt for one residence owned or operated by the debtor which a shareholder or partner maintains as his principal residence, unless the debt arose in the farming operation). ( 101(19A)(B)). e. The debtor must have annual income sufficiently regular to enable the making of payments under this Chapter. ( 109(f)). 2. Administration of Chapter 12 a. The debtor becomes a debtor-in-possession with powers and duties very similar to a Chapter 11 debtor-in-possession. ( 1203). b. A trustee who has duties and powers very similar to a Chapter 13 trustee is also appointed. Standing Chapter 12 trustees are appointed for the Eastern District of California: Sacramento, Modesto, Fresno. ( 1202). The Chapter 12 Trustee: (i) (ii) (iii) Administers the plan and distributes income received from the debtor; Investigates the acts, conduct, assets, liabilities and financial condition of the debtor and reports to the court on the feasibility of the plan and the desirability of continuing the operation; and Takes over the duties of the debtor if he fails to perform them. 3. The Debtor's Plan a. Within 90 days of filing bankruptcy, the debtor should file a plan. (i) (ii) Only the debtor may file a plan. The Court may allow the debtor additional time in which to file a plan. ( 1221). b. The plan must provide for the following: 33

43 (i) (ii) (iii) Submission of all or a portion of future income to the trustee; One hundred percent payment to 507 priority claims. There are certain amounts that do not have to be paid in full, provided it involves an amount owed to a governmental unit arising from the sale of a farm asset OR is a domestic support reimbursement owed to a governmental entity, provided all the debtor s disposable income for a five year period is dedicated to plan payments; ( 1222(a)) Similar treatment of similar claims. ( 1222(a)). c. The plan may: (i) (ii) (iii) (iv) (v) (vi) (vii) Treat co-debtor consumer claims differently from other secured and unsecured claims; Modify the rights of holders of secured or unsecured claims (removes the Chapter 13 rule that prohibits modifying the rights of secured creditors on the principal residence); Provide for the curing or waving of any default; Provide for payment on unsecured claims concurrent with payments on secured claims; Provide for curing and maintaining payments on secured or unsecured claims which have payment terms that by contract extend beyond the term of the plan; Provide for the assumption, assumption and assignment, or rejection of leases or executory contracts under 365; Provide for payment of all or a portion of a claim from property of the estate or property of the debtor (Dirt for debt); (viii) Provide for the sale of any property and the distribution of proceeds to those with an interest in the property; (ix) (x) Provide for payment of secured claims over a period beyond the term of the plan (Stretch out); Provide for the vesting of title to property in the debtor or any other entity upon confirmation of the plan; or 34

44 (xi) Provide for anything else not otherwise inconsistent with bankruptcy law. ( 1222(b)). d. The plan is to be no longer than three (3) years, but the court, for cause, may allow a five (5) year plan. ( 1222(c)). e. A hearing on the plan is to be held no later than 45 days after filing of the plan. ( 1224). (i) (ii) Creditors will be notified of the hearing. Creditors may object to the plan if: (a) (b) The plan does not comply with the Bankruptcy Code; or They want to require payment of 100% of the debtor's disposable income over the term of the plan. ( 1225(b)(1)) (iii) If the plan is objected to by a secured creditor due to the treatment of his interest, the debtor must either return the collateral to the secured creditor or cram down the interest of the secured creditor. ( 1225(a)(5)). f. The plan will be confirmed if: (i) (ii) (iii) (iv) (v) (vi) The plan complies with the applicable provisions of the Bankruptcy Code; All court fees and costs are paid; The plan is proposed in good faith; The creditors are getting at least what they would under a Chapter 7 liquidation; The debtor has made all payments required under any domestic support obligation since the filing of the bankruptcy ( 1225(a)(7)); and The plan is feasible ( 1225(a)). g. Alternate confirmation: Cramdown (i) If a secured claimant objects to the plan, the plan must provide that: (a) The secured creditor retains its lien; and 35

45 (b) (c) The secured creditor receives payments through the plan with a present value of not less than the allowed amount of its claim (the value of its collateral if undersecured) on the day the plan is confirmed; or The debtor returns the collateral. ( 1225(a)(5)). (ii) If an unsecured claimant objects to the plan, the plan must provide that: (a) (b) The objecting claimant receives property at least equal in value to the value of the claim, or 100% of the debtor's projected disposable income is used to make payments over the period of the plan. ( 1225(b)(1)). h. Once confirmed, the plan is binding on all parties whether or not their claims or interests were addressed in the plan. (i) (ii) Confirmation vests all property of the estate in the debtor free of any claim or interest of any party except as provided in the plan. Secured creditors should ensure they are properly provided for in the plan. The vesting of property in the debtor free of claims or interests is to facilitate the obtaining of credit postconfirmation. ( 1227). 4. Special Treatment of Secured Creditors Under Chapter 12 a. Normal adequate protection provisions that apply to all other Chapters of bankruptcy ( 361) do not apply to Chapter 12. Adequate protection under Chapter 12 may include: (i) (ii) (iii) Periodic payments covering any decrease in the value of the collateral; Providing additional or replacement liens to the extent the value of collateral is being decreased; Payment of rent for farmland in an amount which is customary and reasonable for the community (This could be troublesome for junior lienholders since the payment of reasonable rent to a senior lienholder may result in no payment to the juniors); or 36

46 (iv) Granting such other relief (except administrative priority) as will adequately protect the secured creditor's interest in the collateral (Not the indubitable equivalent standard). ( 1205). b. The trustee has the right to sell farmland or farm equipment free and clear of any lien after notice and a hearing: (i) (ii) (iii) (iv) Any lien attaches to the proceeds of the sale; Consent of the lien holder is not necessary; and The sale price need not be sufficient to cover all liens. Creditors can object to price. (v) Creditors can credit bid. ( 1206) c. The debtor may cram down the interests of secured creditors and extend the payments beyond the term of the plan. (i) (ii) (iii) The debtor need only provide a stream of payments which has a present value equal to the value of the collateral when the plan is confirmed. Payments can extend beyond the term of the plan. The Code makes no indication as to a proper interest rate or maximum term over which payments can be spread. ( 1225(a) (5)). 5. Conversion or Dismissal of Cases a. Conversion From Chapter 12 (i) Debtor has the absolute discretionary right to convert from Chapter 12 to 7 (but not to 13 or 11). ( 1208(a)). (ii) Any party can move the Court for conversion to Chapter 7 if the debtor has committed fraud in connection with the case. ( 1208(d)). b. Conversion to Chapter 12 (i) infra, the debtor can convert from Chapter 11 to 12 if: (a) He has not been discharged in the Chapter 11; 37

47 (b) (c) The conversion is equitable; and He qualifies under Chapter 12. ( 1112(d)). (ii) The debtor can move to convert from Chapter 7 to 12 if: (a) He has not previously converted; and, (b) He qualifies under Chapter 12. ( 706). (iii) The debtor can move to convert from Chapter 13 to 12 if: (a) (b) Such request is made before confirmation of the Chapter 13 plan; After notice and hearing; and (c) The debtor otherwise qualifies for Chapter 12. ( 1307 (d)) and (e). c. Dismissal of a Chapter 12 Case (i) (ii) The debtor may dismiss a Chapter 12 case unless it has previously been converted from Chapter 7 or 11; then such dismissal is at the discretion of the court. ( 1208(b)). Any party in interest may move to dismiss the case for cause including: (a) (b) (c) (d) (e) (f) (g) (h) Unreasonable delay or gross mismanagement by the debtor; Nonpayment of court costs or fees; Failure to timely file a plan; Failure to make payments under a confirmed plan; Denial of confirmation of a plan coupled with a denial of an extension of time to amend the plan; Material default by debtor of a plan obligation; Revocation of confirmation coupled with the denial of the right to modify a plan; Termination of a plan, prior to completion, by the happening of a condition set forth in the plan; 38

48 (i) (j) (k) Continuing loss or diminution of the estate coupled with an absence of reasonable likelihood of reorganization; The debtor's committing fraud in connection with the case. ( 1208(c) and (d)); Failure by the debtor to make any domestic support obligation that comes due after the filing of the bankruptcy 1208(c)(10). 6. Discharge in a Chapter 12 ( 1228) a. Upon completion of the plan, including certifying that all domestic support obligations have been paid since the bankruptcy was filed, the Court shall grant a discharge of all debts provided for in the plan except: (i) Debts to be paid for a term beyond the term of the plan such as: (a) (b) Crammed down secured debts; or, Secured and unsecured debts which have a normal stated term beyond the plan; (ii) (iii) Debts for which the debtor has executed a written waiver of discharge approved by the court; or, Debts specifically nondischargeable. ( 523(a))( 1228(a)) b. The debtor may obtain a hardship discharge, which is the same discharge as the debtor would receive under a completed plan, after confirmation but before completion of the plan, if: (i) (ii) The debtor's failure to complete the plan is due to circumstances for which the debtor is not justifiably responsible; Creditors have received at least what they would have received if the debtor had liquidated under Chapter 7 on the date the plan was confirmed; and, (iii) Modification of the plan is not practical. ( 1228(a)). E. Chapter 13 (Individual Wage Earner Plan) Provides individuals with a limited amount of debt a means of proposing a 39

49 repayment plan without the complexity of Chapter Who May File Chapter 13? a. Only an individual (or individual and spouse) may file Chapter 13. Partnerships and corporations cannot file, but an individual with a sole proprietorship can. b. The individual must have regular income (this has been broadly defined). c. The individual (or in the case of joint petition, individual and spouse) must have less than $383, (there will be automatic adjustments to this number every three years, with the next adjustment on 4/1/16 based on the CPI) of non-contingent liquidated unsecured debt and less than $1,149, (also with automatic adjustments every three years with the next adjustment on 4/1/16 based on the CPI) of non-contingent liquidated secured debt. ( 109(e)). 2. Administration of a Chapter 13 a. The Estate All the property owned by the debtor, both real and personal, tangible and intangible, becomes the bankruptcy estate (subject to the exemption powers for individuals discussed in VI below) ( 541). Additionally, in Chapter 13, the estate includes: (i) (ii) All property acquired after commencement of the case that would otherwise be property of the estate if acquired during the time the Chapter 13 is pending. All wages earned by the debtor after commencement of the case during the time the Chapter 13 is pending. ( 1306) b. Possession of the Estate Except as specifically provided in the plan, the debtor retains possession and control of the estate during the Chapter 13 case. ( 1306(b) and 1303). c. The Trustee Chapter 13 cases have a standing trustee (in Fresno/Bakersfield it is Michael Meyer, and in Modesto it is Russell Greer). He is the trustee of every Chapter 13 that is filed. The trustee's basic duties 40

50 are to review and administer the debtor's plan. The debtor pays funds to the trustee, who then distributes them to creditors under the terms of the debtor's plan. ( 1302). d. Operation of Debtor's Business 3. Chapter 13 Plan The debtor may continue to operate any trade or business in which the debtor is engaged. ( 1304). The plan must be filed by the debtor within 15 days of the filing of the bankruptcy. The debtor must commence making payments within 30 days of the filing of the bankruptcy. Only the debtor can file the plan. As long as the plan meets the Code requirements, it will be confirmed; creditors have no vote. a. Plan Requirements Creditors should carefully read the plan to ensure they are treated properly. Once the plan is confirmed, all creditors are bound by it. Only if the debtor defaults on the plan will a creditor be able to raise objections after confirmation. The plan will normally specify: (i) (ii) A term of 36 to 60 months (terms over 36 months must be approved by the court). If the debtor(s) income is greater than the median income for a family of their size, the plan will be five years; if it is less, the plan will be three years, unless the court for good cause approves a longer time (but in no event longer than five years). 1322(d). Secured arrearages and priority claims be paid before unsecured claims. The Supreme Court in Rake v. Wade, 113 S.Ct (1993) ruled that arrearages on mortgages (deeds of trust) would have to be repaid with interest regardless of what the underlying agreement or state law might allow. The 1994 amendments overrule this case to the extent that the underlying note was entered into after the 1994 amendments became effective. To the extent that the note post-dates the act, interest will only be allowed if called for in the note and allowed by state law. ( 1322(e)). (iii) (iv) Regular payments on long term secured debt will normally be paid by the debtor outside the plan. The amount to be paid to the trustee (usually monthly). 41

51 (v) (vi) (vii) The amount to be shared by unsecured creditors (may be 0% to 100% of claim). Debtor's intention as to leases and executory contracts. ( 1322 and 1325). The debtor cannot materially alter a pension loan obligation in the plan and such payment amounts will not constitute disposable income. 1322(f). b. Confirmation of the Plan The plan will be confirmed provided it complies with the provisions of Chapter 13 and is proposed in good faith. The value of property to be distributed under the plan on behalf of each unsecured creditor is at least what they would get in a Chapter 7 case. As to secured creditors, they will retain their lien and be paid in full, receive their collateral, or be crammed down (see below). The debtor must have paid all domestic support obligations coming due since the filing of the case. If a creditor objects to confirmation of the plan, it shall only be confirmed if the creditor is paid in full or the debtor s disposable income is all dedicated to the plan for the term of the plan. The plan is a three-year plan if the debtor s current monthly income is less than the state median for a similarsized family and five years if it is greater c. Cram-down of Secured Debt Under the Plan The cram-down provisions allow a Chapter 13 debtor to retain collateral by paying the present fair value of the collateral to the secured creditor through the plan and leaving the rest of the creditor's claim as unsecured. With respect to each secured claim provided for in the plan, the plan can be confirmed if: (i) (ii) (iii) The creditor has accepted the plan; The debtor returns the collateral to the creditor; or, The creditor retains its lien and receives an amount through the plan, the value of which, as of the effective date of the plan, is not less than the value of the collateral. This involves: (a) (b) Determining current market value. Determining a fair interest rate to calculate present 42

52 value (Courts tend to use from 8 to 10%). (iv) Payments can be spread over time but must conclude no later than the end of the plan. ( 1325(a)(5)). d. Confirmation Hearing As soon as practical after the filing of the bankruptcy, a hearing on confirmation of the plan will be set. The hearing shall not be earlier than 20 day or later than 45 days after the date for the first meeting of creditors. The Court, for good cause, can order a hearing earlier than 20 days if it is in the best interest of creditors and the estate, provided there is no objection. While no vote on the plan is taken, creditors can raise objections at this time to the terms of the plan if they are not in compliance with the requirements of the Code. ( 1324). F. Chapter 15 (Ancillary and Cross Border Cases) This Chapter deals with the method for the getting the U.S. Bankruptcy Court involved in insolvency cases that have been filed in non-u.s. jurisdiction. The case is commenced when a representative from the foreign insolvency case files a petition in a U.S. Bankruptcy Court. The purpose is to seek protection for and administration of the debtor s assets in the U.S. The Chapter is designed to have the U.S. court cooperate to the greatest extent possible with the foreign court. Further discussion of this Chapter is beyond the scope of this outline. G. Credit Counseling Requirements for All Chapters for Individuals 1. Counseling Requirement An individual that wants to file a bankruptcy under any Chapter must have received appropriate credit counseling not earlier than 180 days prior to filing the bankruptcy. This counseling must provide an outline of the available opportunities for credit counseling and perform a budget analysis. This counseling can take place by phone or over the internet. This requirement will not apply in the following situations: a. The U.S. Trustee has determined that no credit counseling agency exists in the district that can adequately provide services. The U.S. Trustee shall re-examine this determination on an annual basis. b. The debtor can request a waiver based on exigent circumstances acceptable to the Court provided the debtor requested credit counseling but was unable to obtain such services for a five day period beginning on the date the first request was made. Even in this situation, the debtor must receive counseling within 30 days of filing. 43

53 c. The debtor has a mental or physical disability that prevents them from participating in such counseling. d. The debtor is unable to complete the requirements because they are on active military duty in a combat zone. 109(h). 2. Qualified Non Profit Credit Counseling Agencies The clerk of the Court shall maintain a list of U.S. Trustee-approved budget and credit counseling agencies within the district. They shall also maintain a list of the available approved instructional courses. It is the responsibility of the U.S. Trustee to review the agencies and the instructional materials and to confirm that the agency qualifies. In order to qualify, the agency must: a. Have a board of directors, the majority of which are not employees of the agency and will not benefit financially from the services offered; b. Offer services for a reasonable fee and be willing to provide services without regard to ability to pay; c. Provide for safekeeping and accounting of client funds; d. Provide full disclosure to clients of funding sources, counselor qualifications, possible impact on credit reports, fees to be charged and how they will be paid; e. Provide adequate counseling with respect to each client s credit problems, including an analysis of the client s current situation, how it occurred, and a plan to respond to the situation; f. Provide experienced, trained counselors who receive no commissions or bonuses based on the outcome of the counseling; g. Demonstrate adequate experience and background in providing credit counseling services; and h. Have sufficient financial resources to provide continuing support to those using the counseling services IV. Involuntary Bankruptcy A. What is Involuntary Bankruptcy? An involuntary petition is one in which someone other than the debtor brings the petition before the court. (See, generally, 303). 44

54 B. Limitation on Chapters Only Chapters 7 or 11 may be used with involuntary petitions. C. Who May Be an Involuntary Debtor? Any person or entity that can file a Chapter 7 or 11 can be an involuntary debtor except: 1. A farmer or family farmer; or 2. A corporation which is neither moneyed, business nor commercial. D. How is an Involuntary Bankruptcy Commenced? In order to file an involuntary bankruptcy you must have one of the following: 1. Three or more creditors of the debtor with undisputed, (as to both liability and amount) noncontingent unsecured claims totaling at least $15, (this number adjusts every three years based on CPI, with the next adjustment on 4/1/16) who are willing to sign the petition; ( 303(b)(1)). 2. If there are fewer than 12 creditors in all (excluding insiders, employees and certain other claimants) then one or more creditors with undisputed, noncontingent unsecured claims of at least $15, (this number adjusts every three years based on CPI, with the next adjustment on 4/1/16) can sign the petition ( 303(b)(2)); or 3. Any general partner of a partnership. ( 303(b)(3)(A)). 4. Subsequent to the filing of the involuntary bankruptcy, other creditors may join the petition with the same effect as if they were an original petitioning creditor (This may be important if they are needed to meet the requirement set forth above). ( 303(c)). E. Preliminaries to and Hearing on Involuntary Petition 1. Debtor's Response 2. Bond The debtor or a non-petitioning general partner may contest the filing of an involuntary bankruptcy by answer or motion. ( 303(d)). The court, after notice and hearing, may require the petitioning creditors to post a bond to indemnify the debtor against possible damages. ( 303(e)). 45

55 3. Trustee The creditors may petition the court to appoint an interim trustee even before a determination is made on the involuntary bankruptcy if it is necessary to preserve the property of the estate. ( 303(g)). 4. The Order for Relief If no response is received from the debtor, the court will enter the order for relief and the debtor will be in bankruptcy. ( 303(h)). If an answer is received, the creditors must show: a. The debtor is generally not paying undisputed debts as they come due, or b. Within 120 days of the filing of the involuntary bankruptcy, the debtor made a general assignment for the benefit of creditors or a receiver, or a custodian as defined by 101(10) was appointed to take charge of all or substantially all of the debtor s property. Section 303(h)(2) does not contemplate an involuntary case upon the appointment of a state court receiver to foreclose on less than substantially all of a debtor's real estate. ( 303(h)(2)). 5. Failure to Establish Involuntary Bankruptcy If the court does not find for the creditors who filed the petition, it may dismiss the involuntary bankruptcy and: a. Award the debtor its costs and reasonable attorney s fees; and b. If the court finds that the creditors filed the involuntary petition in bad faith, the Court may award: (i) (ii) Any damages proximately caused by such filing; and Punitive damages. ( 303(i)). 6. Dismissal The creditors who commence the involuntary petition have a fiduciary duty to other creditors. They cannot simply obtain what they want from the debtor and then dismiss the case. Only after notice to all creditors and a hearing will a case be dismissed: a. On the motion of a petitioner; b. On consent of all petitioners and the debtor; or c. For lack of prosecution. ( 303(j)). 46

56 7. Miscellaneous Rules for Involuntary Bankruptcies V. Property of the Estate ( 541) a. The time period for commencing an avoidance action begins to run from the date of the entry of the order for relief on the involuntary petition. However, the date the involuntary petition was filed marks the point in time for determining preferences and fraudulent transfers. b. The automatic stay is in effect from the time the involuntary petition is filed. ( 362(a)). c. Creditors who deal with the debtor from the day the involuntary bankruptcy is filed until the order for relief is entered by the court are called gap creditors and are given priority second only to administrative claims in any Chapter 7 or 11. ( 507(a)(2) and 502(f)). d. The debtor continues to operate the business between the filing of the involuntary petition and the order for relief being entered by the court as if no involuntary petition had been filed. ( 303(f)). Once a bankruptcy is filed, all the property of the debtor becomes property of the bankruptcy estate. It is out of this estate that creditors will be paid. The estate is defined very broadly, and includes any and all interests held by the debtor. It is specifically made up of the following: A. Legal and Equitable Interests All interests of the debtor as of the commencement of the bankruptcy become property of the estate, whether legal or equitable in nature (note that state law defines whether the debtor has an interest in property). B. Community Property All interests of the debtor and the debtor's spouse as of the commencement of the bankruptcy in community property, whether both spouses file the bankruptcy or only one does, provided that the community property is: 1. In the sole, equal or joint management and control of the debtor; or 2. Subject to an allowable claim against the debtor or both the debtor and the debtor's spouse. C. Recovered Property After a bankruptcy is filed, the Trustee may recover certain property that the 47

57 debtor transferred voluntarily or involuntarily, such as: 1. Excessive payments to attorneys for handling the bankruptcy; ( 329(b)). 2. Property that was involved in a collusive sale among bidders; ( 363(n)). 3. Property held by a custodian (most often this involves a court-appointed receiver); ( 543). 4. Property recovered as a voidable transfer under 544, which includes state law causes of action for recovery of property; ( 544). 5. Property recovered in a preference action; ( 547). 6. Property recovered in a fraudulent conveyance action; ( 548). 7. Property transferred without appropriate court approval after the filing of the bankruptcy. ( 549). 8. In a Chapter 7 case, any property recovered from general partners of a partnership debtor. ( 723). D. Preserved Transfers When a transfer of property or a lien against the debtor is set aside under one of the bankruptcy avoidance provisions ( 506(d), 522, 544, 545, 547, 548, 549, or 724(a)), its priority position is retained by the trustee vis-à-vis all other creditors with claims. All creditors therefore benefit from the avoidance, as opposed to any particular creditor benefiting. The most common example is when a senior lien is set aside. Rather than have the benefit flow to junior lienholders by moving up in priority, the lien position is preserved for the benefit of all general creditors. The amount covered by the avoided lien then becomes available for distribution to the general creditors based on priorities. E. Certain Property Acquired within 180 Days after Filing There are certain types of property that the debtor may receive after the filing of bankruptcy that are still treated as if they were received prior to the bankruptcy filing and thus are part of the estate. This keeps debtors from timing their bankruptcies to occur right before they are anticipating a large windfall. Any of the following occurring within 180 days of the filing of the bankruptcy will be considered part of the bankruptcy estate: 1. Receiving a bequest, devise or inheritance. 2. Receiving property as part of a property settlement, interlocutory or final divorce decree. 48

58 3. Receiving property as beneficiary of a life insurance policy or a death benefit plan. F. Proceeds, Product, Offspring, Rents or Profits Property of the estate will often produce proceeds, product, offspring, rents or profits, all of which become property of the estate. This does not include earnings for services performed by an individual debtor after commencement of the case. G. After Acquired and Earned Property in a Chapter 11 If the debtor in a Chapter 11 is an individual, then in addition to the items listed in 541, any property acquired of the type listed in 541, or earnings from service that become the debtor s after filing but prior to the case being closed, dismissed or converted is property of the estate H. Exceptions to Property of the Estate There are certain items that are not included in property of the estate. In almost every case, it appears to be the result of some special interest group getting legislation to provide some protection for them. The following are excluded from property of the estate: 1. Powers to be exercised solely for the benefit of an entity other than the debtor; 541(b)(1) 2. Interests in nonresidential real property leases that expired under their own terms prior to the filing of the bankruptcy; 541(b)(2) 3. State and federal educational accreditations; 541(b)(3) 4. Interests in liquid and gaseous hydrocarbons that have already been transferred or agreed to be transferred in a farmout agreement; 541(b)(4) 5. In certain situations, proceeds from the sale by the debtor of a money order sold within 14 days of filing. 541(b)(9) 6. Educational IRAs Tuition Credits or Certificates (to the extent such amounts are allowed under the IRC) created more than 365 days before the filing of the bankruptcy (there is a limitation for funds placed in the account for the same beneficiary more than 365 and less than 720 days of $6, subjected to adjustment every three years based on CPI, with the next adjustment on 4/1/16) provided the beneficiary was a child, stepchild, grandchild or step-grandchild of the debtor. 541(b)(5) & (6) 7. Certain employee benefits withheld from the debtor s paycheck 541(b)(7). 49

59 Property of the estate remains property of the estate until it is transferred ( 363), exempted ( 522), abandoned ( 554) or a plan is confirmed ( 1141, 1227 or 1327). VI. Exemptions A. Purpose of Exemptions Individuals are allowed to retain certain basic necessities of life after filing a bankruptcy. Not everything owned by an individual is subject to being sold and paid out to creditors. A fresh start would be meaningless if the debtor was thrown out naked onto the street. It should be noted that exemptions apply in all Chapters, but only as to individuals, and not corporations, partnerships, or limited liability companies. B. Federal Exemptions The Code provides a list of federal exemptions that can be applied by debtors but also allows individual states to opt out of the Code exemptions and create their own. ( 522(b)). California has elected to opt-out of the federal exemptions and created a special exemption scheme that can only be used by bankruptcy debtors. CCP C. Election Under California Law California allows debtors in bankruptcy to use the normal state exemptions allowed for judgment debtors CCP , et seq. or to use the special set of exemptions available only to bankruptcy debtors as set out in CCP (b) (it should be noted that these are very similar to the federal exemptions under 522). The decision as to whether to use these special exemptions or the regular state exempting laws normally revolves around equity in a residence. Normal state law allows anywhere from $75,000 to $175,000 for a homestead exemption (CCP Subject to increase every three years based on the California CPI, with the next increase on 4/1/16) while these state special bankruptcy rules allow only $25, For this reason, the set of exemptions found at CCP (b) are commonly referred to as the grub stake or renters exemptions. The set of exemptions available for judgment debtors as well as bankruptcy debtors is commonly referred to as the homeowner's exemptions in reference to the available homestead exemption. It greatly depends on the nature and value of a debtor's assets as to which exemption scheme he or she will choose to elect. With the drastic reduction in home values, many homeowners find that there may be no equity in their homes and so, more and more we are seeing homeowners opting for the grub stake exemptions under 703 rather than the traditional exemptions under 704. In order to choose the CCP 703 exemptions when only one spouse files, the nonfiling spouse must specifically provide a written waiver of their right to the CCP 704 exemptions. If this is not obtained, the filing spouse cannot choose the CCP 50

60 703 exemptions and is left with only the 704 exemptions. This can be especially significant when the spouses are in dispute and the filing spouse does not have substantial equity in real property. See Appendix III for the tables showing the 703 and 704 exemptions. D. Special Homestead Rules For purposes of determining the state of domicile for homestead exemptions, you must be a resident of the state for 730 days. If you have not been a resident for 730 days at the time of filing, then you determine the state you were the resident of for the 180 days immediately preceding the 730-day period. If more than one state is involved it would be the state in which the debtor was a resident for the longest period of time. Debtors are limited to $155, (amount will adjust every three years based on the CPI, with the next adjustment set for 4/1/16) for their homestead exemption if they acquired the property within 1215 days prior to filing the bankruptcy (does not apply to a family farmer). Therefore, even in California, if you acquired the property within 1215 days of the filing of the bankruptcy, $155, represents an absolute ceiling. If the equity is due to rolling over the value of prior homestead within the same state that was owned more than 1215 days, then the limitation does not apply to the equity rolled over from the previous homestead. The limitation also applies to a debtor guilty of certain criminal conduct no matter when they acquired the homestead. 522(p) & (q). E. No Stacking of Exemptions Husbands and wives are allowed only one set of exemptions. They cannot increase their exemptions in California by filing separate petitions. F. California CCP (b) Exemptions For purposes of showing one of the exemption schemes, what follows are the exemptions allowed by California only for bankruptcy debtors. It is interesting to note that California has its own automatic CPI increase which follows the consumer price index for California rather than the general CPI, so while the amounts increase every three years, they do not follow the along with the numbers found in the Bankruptcy Code. Additionally the increases are not automatic and must be approved by the California Legislature. The following are the figures that took effect on April 1, The next adjustment will not occur until April 1, CCP (b). 1. The debtor's aggregate interest, not to exceed $25, in value, in real property or personal property that the debtor or a dependent of the debtor uses as a residence, in a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence, or in a burial plot for the debtor or a dependent of the debtor. 51

61 2. The debtor's interest, not to exceed $5, in value, in motor vehicles (a recent change allows you to keep more than one vehicle as long as you do not exceed the total exemption). 3. The debtor's interest, not to exceed $ in value in any particular item, in household furnishings, household goods, wearing apparel, appliances, books, animals, crops, or musical instruments that are held primarily for the personal, family, or household use of the debtor or a dependent of the debtor. 4. The debtor's aggregate interest, not to exceed $1,525 in value, in jewelry held primarily for the personal, family, or household use of the debtor or a dependent of the debtor. 5. The debtor's aggregate interest, not to exceed in value $1, plus any unused amount of the exemption provided under paragraph (1), in any property. Commonly referred to as the Wildcard/Grubstake exemption. This is a very flexible exemption that allows you to cover any property not already covered by another exemption. 6. The debtor's aggregate interest, not to exceed $7, in value, in any implements, professional books, or tools of the trade of the debtor or the trade of a dependent of the debtor. 7. The debtor's aggregate interest, not to exceed in value $13,675.00, and any accrued dividend or interest under, or loan value of, any unmatured life insurance contract owned by the debtor under which the insured is the debtor or an individual of whom the debtor is a dependent. 8. Professionally prescribed health aids for the debtor or a dependent of the debtor. 9. The debtor's right to receive any of the following: a. A social security benefit, unemployment compensation, or a local public assistance benefit; b. A veteran's benefit; c. A disability, illness, or unemployment benefit; d. Alimony, support or separate maintenance, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor; e. A payment under a stock bonus, pension, profit-sharing, annuity, or similar plan or contract on account of illness, disability, death, age, 52

62 or length of service to the extent reasonably necessary for the support of the debtor and any dependent of the debtor, unless all of the following apply: (i) (ii) (iii) That plan or contract was established by or under the auspices of an insider that employed the debtor at the time the debtor's rights under the plan or contract arose. The payment is based on age or length of service. That plan or contract does not qualify under 401(a), 403(a), 403(b), 408, or 409 of the Internal Revenue Code of f. Individual retirement accounts (IRAs) are now included in property that can be exempted. There is a ceiling of $1,245, (subject to adjustment every three years based on the CPI under the Bankruptcy Code, with the next adjustment on 4/1/16). The Court, in the interest of justice, can increase the ceiling above $1,245, (n). 10. The debtor's right to receive, or property that is traceable to, any of the following: a. An award under a crime victim's reparation law; b. A payment on account of the wrongful death of an individual of whom the debtor was a dependent, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor; c. A payment under a life insurance contract that insured the life of an individual of whom the debtor was a dependent on the date of such individual's death, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor; d. A payment, not to exceed $25,575.00, on account of personal bodily injury, not including pain and suffering or compensation for actual pecuniary loss, of the debtor or an individual of whom the debtor is a dependent; or e. A payment in compensation of loss of future earnings of the debtor or an individual of whom the debtor is or was a dependent, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor. 53

63 The above amounts for exemptions are to be adjusted every three (3) years based on the California Consumer Price Index for all Urban Consumers. The next adjustment will be on April 1, (CCP ). G. Avoidance of Liens Impairing Exemptions The Code allows for the avoidance of certain creditors' liens if they impact the debtor's rights to an exemption. ( 522(f)). The following liens can be avoided if they impact an exemption stated right above: 1. Judicial liens (e.g., abstracts of judgments). Except for certain types of spousal and child support liens. 2. Non-possessory (creditor does not have possession of collateral), nonpurchase money security interest (the security interest was not granted to secure the purchase of the collateral) in: a. Household goods, furnishings, wearing apparel and similar household items held for household use of the debtor or a dependent of the debtor; b. Tools of the debtor's trade or by the trade of a dependent of the debtor; c. Professionally prescribed health aids of the debtor or a dependent of the debtor. ( 522(f)). d. There is a limitation imposed by the Bankruptcy Code 522(f)(3) which puts a ceiling of an aggregate of $6,225 (amount will adjust every three years based on the CPI, with the next adjustment set for 4/1/16) on lien avoidance for tools of the trade, animals and crops. e. There is a limitation imposed by the Bankruptcy Code regarding what qualifies as household goods for lien avoidance. There is a laundry list of items that are included and not included as household goods. 522(f)(4). VII. Conversion of a Case to Another Chapter A. Generally A bankruptcy case, once filed, does not always stay in the same Chapter. The debtor may voluntarily convert the case to a different Chapter (as long as the debtor can be a debtor in the new Chapter) or the creditors may move to convert the debtor to a different Chapter (as long as the debtor can involuntarily be placed in that Chapter). ( 348). 54

64 B. Effect of Conversion Conversion does not create a new case; it does create a new order for relief in the Chapter into which the case has been converted. ( 348(b)). Conversion terminates the services of a trustee or examiner serving before the case was converted. ( 348)(e)). C. Pre-Conversion, Post-Filing Claims In general, claims that arise after a Chapter 11, 12, or 13 bankruptcy case is filed, but before conversion, are treated as if they arose just prior to the original filing of the bankruptcy. In a Chapter 7, the claims are treated as if they arose whenever they actually arose. ( 348(d)). D. Chapter 7 A debtor has the right, at any time, to convert a Chapter 7 case to a Chapter 11, 12 or 13 case if the debtor has not previously converted from a Chapter 11, 12 or 13 case to the Chapter 7 case. The court, upon the request of a party in interest, and after notice and a hearing, may convert the debtor's Chapter 7 case to one under Chapter 11 at any time. ( 706(b)). E. Chapter The Debtor has the right to convert to Chapter 7 at any time unless: a. The debtor is not a debtor-in-possession; b. The case was commenced as an involuntary petition; and c. The case was previously converted to Chapter 11 at other than the debtor's request. ( 1112(a)) 2. Any party in interest can request conversion of the case to Chapter 7 for cause and if it is in the best interest of creditors. ( 1112(b)). 3. The court may convert a Chapter 11 case to a case under Chapters 12 or 13 only if: a. The debtor requests such conversion; b. The debtor has not already received a Chapter 11 discharge; and c. As to Chapter 12, the conversion is equitable. ( 1112(d)). F. Chapter 12 (See III.D.5) 55

65 G. Chapter The debtor can convert to Chapter 7 at any time without a hearing or court approval. ( 1307(a)). As long as the Chapter 13 case was not previously converted, a Chapter 13 debtor can dismiss a case at any time without a hearing or court approval. 2. Any party in interest can request conversion of the case to Chapter 7 if it is in the best interest of creditors and for cause as defined in the Bankruptcy Code. ( 1307(c)). 3. Any party, before confirmation of the plan, may request that the court convert the case to one under Chapters 11 or The court may not convert the case to a Chapter 7, 11, or 12 case if the debtor is a farmer, unless the debtor requests the conversion. 5. When a Chapter 13 case is converted to a different Chapter, the property of the estate in the converted case consists of the property of the estate as of the date the original bankruptcy petition was filed that remained in the possession of, and under the control of, the debtor on the date the Chapter 13 case is converted. The value of property and of allowed secured claims as determined in the Chapter 13 case shall also apply in the converted case, except in a case converted to Chapter 7; however, allowed secured claims will be reduced to the extent they had been paid in accordance with the Chapter 13 plan. ( 348(f)). If a debtor converts a Chapter 13 case to a different Chapter in bad faith, the property in the converted case consists of the property of the estate as of the date of conversion. 6. Unless a pre-bankruptcy default has been cured during the pending Chapter 13, when a Chapter 13 case is converted to another Chapter then the default continues to be given the effect applicable under nonbankruptcy law. In the past, the position was taken that a Chapter 13 plan confirmation terminates any foreclosure process. Now, in the event of conversion, the foreclosure process is still in place. 348 (f)(1)(c)(ii). VIII. The Automatic Stay A. Scope of the Automatic Stay The Automatic Stay: 1. Arises upon the filing of bankruptcy in all Chapters and does not require any notice to be effective against any person or entity. Actions in violation of the automatic stay are void. 2. Section 362(a) of the Code provides that the following actions are stayed: 56

66 a. The commencement or continuation of any judicial or non-judicial proceeding against the debtor that was or could have been commenced before the bankruptcy petition was filed to recover on a claim against the debtor that arose before the bankruptcy case was filed; b. The enforcement of a pre-petition judgment against the debtor or against property of the estate; c. Any act to obtain possession of property of the estate or to exercise control over property of the estate; d. Any act to create, perfect, or enforce any lien against property of the estate; e. Any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a pre-petition claim; f. Any act to collect, assess, or recover a pre-petition claim against the debtor; g. The setoff of any debt owing to the debtor that arose pre-petition against any claim against the debtor; and h. The commencement or continuation of a proceeding before the United States Tax Court concerning the debtor. 3. As can be seen, the automatic stay is extremely broad and it is always prudent to err on the side of caution. In other words, unless you are certain that the automatic stay does not apply, you should act as if it does. 4. The Code does provide certain exceptions to the automatic stay. The most significant are: a. Criminal proceedings against the debtor. b. Civil proceedings regarding the following domestic matters: (i) (ii) (iii) (iv) Establishment of paternity. Establishment or modification of domestic support obligations. Collection of domestic support obligations from property that is not property of the estate. Child custody or visitation. 57

67 (v) (vi) (vii) Dissolution of a marriage, except to the extent it attempts to make determinations regarding property of the estate. Withholding of income or interception of a tax refund that is property of the estate for domestic support obligations. Withholding or suspension of a driver s or professional license by the state for failure to meet domestic support obligations. (viii) Enforcement of certain medical support obligations. ( 362(b)(2)) c. The right under 546(b) to perfect certain security interests after the filing of the bankruptcy or under 547(e)(2)(A) within 10 days of filing. ( 362(b)(3)). Pursuant to Bebensee-Wong v. Federal National Mortgage Association (9th Cir BAP 2000) California Civil Code 2924h(c) allows 15 days after a trustee's sale to record a trustee's deed, which will then relate back to the day of the trustee's sale even if the recordation occurs after the bankruptcy was filed. d. Proceedings by a governmental unit to enforce police or regulatory powers and enforcement of any non-monetary judgments. ( 362(b)(4), (5)). e. The right of a landlord to proceed against the debtor for possession of non-residential real property when the lease was terminated by the expiration of the stated term prior to the filing of the bankruptcy or during the bankruptcy case. ( 362(b)(10). f. The right of a governmental unit to issue to the debtor a notice of tax deficiency. g. Presentment of a negotiable instrument and giving notice of and protesting dishonor of such instrument. ( 362(b)(11)). h. Actions by accrediting agencies regarding the accreditation of a debtor as an educational institution at either the federal or state level. This includes the rights of the federal government to take actions to remove educational institutions from participation in various financial aid programs. ( 362(b)(14-16)). i. The right to perfect liens to secure ad valorem property taxes that arise after the filing of the bankruptcy. ( 362(b)(18)). j. Withholding from debtor s income to make certain qualified pension loan payments. 362(b)(19). 58

68 k. If relief from the automatic stay has been obtained in a prior case within two years against real property, then there is no automatic stay. The debtor may petition the Court to reinstate the stay for good cause shown. 362(b)(20). l. If the debtor filing the bankruptcy is not qualified to be a debtor or the filing is in violation of a prior Bankruptcy Court order against filing the current case. 362(b)(21). m. If a landlord has a judgment for possession of property prior to the filing of the bankruptcy, then the landlord may proceed with eviction. Debtor can delay the impact of this provision by 30 days by (i) filing with their bankruptcy petition a statement that they still have rights under state law to cure the default and (ii) posting 30 days rent with the Court. The debtor must then cure the default within 30 days. 362(b)(22) & 362(l). n. There are also exceptions for situations where a landlord is removing a debtor due to endangerment of the property or the illegal use of drugs on the property. The landlord must file an appropriate certification under penalty of perjury. If the debtor does not challenge the certification, then the automatic stay is removed 15 days after filing the certification. 362(b)(23) &362(m). o. The completion of transfers that are not avoidable by the trustee whether those transfers are pre- or post-petition. 362(b)(24). p. The investigation or enforcement by a securities self-regulatory organization to enforce such organization s power other than monetary sanctions. 362(b)(25). q. The ability to set off an income tax refund for a pre-petition period against an income tax liability that ended before the filing of the petition. 362(b)(26). B. Duration of the Automatic Stay The Automatic Stay: 1. Continues as to actions regarding property of the estate until such property is no longer part of the estate. ( 362(c)(1)). 2. Any other act is stayed until ( 362(c)(2)): a. The stay is lifted by court order; b. The case is closed; 59

69 c. The case is dismissed; or, d. The debtor's discharge is granted or denied. (i) (ii) (iii) Chapter 7. Discharge is usually granted within four to six months of filing. Chapter 11. Discharge occurs when the plan is confirmed. However, for individuals, it occurs when payments are completed. Chapters 12 and 13. Discharge occurs when the plan is completed. 3. The automatic stay for an individual or joint case ends 30 days after the case is filed if another case was dismissed within one year of the current filing. This provision does not apply if the prior case was dismissed pursuant to 707(b) and the new case is not a Chapter 7. The debtor can for cause petition the Court within the 30 day period to continue the stay. If there have been two or more prior cases as defined above within the prior 12 months, then there is no automatic stay and the 30 day delay is not applicable. Under this circumstance, the Debtor can also petition the Court to impose a stay. 362(c)(3)&(4). C. Relief from the Automatic Stay 1. Relief by Abandonment a. The trustee, on its own motion or on the motion of a party in interest, may abandon property of the estate. ( 554). b. Abandonment requires notice (often to all creditors). c. Abandoned property re-vests in the debtor. While the automatic stay is lifted as to the estate's interest in the abandoned property, the stay remains as to the debtor if he or she has not been discharged. ( 362(c)). 2. Relief by Stipulation Relief may also be obtained by agreement with the debtor (if the debtor has not been discharged)or the trustee, and approved by the court. A Chapter 11 or 7 case may require notice to certain creditors. F.R.B.P Relief by Motion Relief from the automatic stay is most often sought by motion to the court 60

70 with notice to the debtor and certain creditors. While the Code provides for specific time restraints regarding relief from the automatic stay of any act against property of the bankruptcy estate, a creditor must always consult the local bankruptcy rules and the particular judge's requirements for any motion for relief from the automatic stay. Thirty days after the request for relief from the stay, the stay is lifted, unless the Court specifically directs that the stay is to remain in place. A final hearing must be held on the motion within 30 days of the preliminary hearing, unless the court finds compelling circumstances for additional time. ( 362(e)(1)). In an individual or joint case under Chapters 7, 11 or 13, the automatic stay is terminated 60 days after a motion for relief has been filed unless a final decision is made by the court, a stipulation of the parties extending the time has been signed, or the Court has extended it for good cause for a specific amount of time. 362(e)(2). The F.R.B.P. provides that an order granting a motion for relief from the stay is not effective for a 10-day period after it is entered unless the court orders otherwise. Often, the motion for relief will specifically request that the 10-day period be waived in the order. (FBR 4001(a)(3)). 4. Grounds for Relief From the Stay a. Cause (i) (ii) General. This usually relates to debtor's inequitable conduct or the debtor's failure to comply with bankruptcy rules. It is very broad, varies from case to case, and cause can include bad faith filing, failure to follow orders of the court, fraudulent conduct, or because the case has been pending for a considerable period of time without real progress. ( 362(d)(1)). Lack of adequate protection of an interest in property. According to 361, the creditor can be adequately protected by: (a) (b) (c) An equity cushion (the value of collateral is greater than the total debt and/or all debt senior to the creditor); Periodic payments equal to the creditor's loss of collateral value; Replacement liens or additional liens ( 361); or 61

71 (d) In Chapter 12, adequate protection can be payment of the reasonable rental value of the farmland. ( 1205). b. No equity; property not necessary to an effective reorganization. With respect to property, relief will be granted if there is no equity in the debtor's interest in the property and if the property is not necessary to the debtor's effective reorganization. ( 362(d)(2). (i) (ii) Equity is determined by comparing all valid debt against the property to the fair market value of the property. Whether the property is necessary to an effective reorganization may depend on whether a reorganization in a reasonable period of time is possible at all. ( 362(d)(2)). c. Single asset cases. (See III. C. 9., above). (i) In a single asset real estate case, a secured creditor secured by an interest in the real estate may obtain relief from the automatic stay if the debtor has not, within 90 days of the order for relief, or 30 days after the Court has determined that the debtor qualifies for treatment under this provision, whichever is later, done one of the following: (a) (b) filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time; or commenced monthly payments to each creditor secured by the real estate, which payments are in an amount equal to the interest, at current fair market value, on the value of the creditor's interest. D. Scope of Relief The Order or Agreement for Relief May: 1. Terminate or lift the stay, effective on some specified date; 2. Annul the stay, effectively validating certain actions which may have been technical violations of the stay taken by a creditor after the filing of the bankruptcy; 3. Modify the stay in some manner (e.g. allow the creditor to record a notice of default but not publish the notice of trustee's sale); or 62

72 4. Condition the stay on the debtor's future performance of certain obligations, i.e., adequate protection order. E. Effect of Conversion or Dismissal on Relief from the Automatic Stay 1. Obtaining relief in one bankruptcy case will not grant relief in a subsequent bankruptcy case affecting the same property. 2. Relief from the automatic stay previously granted in one Chapter will not be affected when a case is converted to another Chapter. F. Violation of the Automatic Stay 1. The stay arises whether a creditor has notice of the bankruptcy or not. Any action taken against the debtor or property of the estate violates the stay and is void. 2. Any willful violations of the stay may result in the assessment of damages, costs and attorneys' fees (costs and attorneys fees are only available where the debtor is an individual), and, in appropriate cases, punitive damages may be assessed against the violating party (punitive damages are only available where the debtor is an individual). ( 362(h)). 3. Creditors must deal cautiously with the stay. The debtor's mere possession of property can make it property of the estate. G. Effect of the Stay on Co-debtors (Chapters 12 and 13) The automatic stay only applies to the named debtor and assets of that debtor's estate. However, there is an additional stay which protects a co-debtor under certain, specific circumstances. 1. Co-debtors are only protected when: a. Chapter 12 or 13 is filed; b. The underlying debt is a consumer debt; and c. The obligation of the co-debtor did not arise in the ordinary course of his business. 2. Relief from the co-debtor stay is obtained by motion to the court or by stipulation. ( 1201 and 1301). 3. Though not a co-debtor stay per se, a creditor may not pursue a non-filing spouse for community debts, except as the non-filing spouse may have separate property liable for community debts. 63

73 IX. Proofs of Claim ( ) A. When to File 1. Chapter 7, 12 and 13 Must be filed within 90 days of the first date set for the first meeting of creditors. (Rule 3002). In a no asset case, the notice will often inform the creditors that no claims need to be filed unless assets are subsequently discovered, in which case all creditors will be notified. 2. Chapter 11 Must be filed by a date fixed by the Court. In the Eastern District of California, it must be filed within 90 days of the first date set for the first meeting of creditors. (Local Rule ). a. A claim is deemed filed if it is scheduled by the debtor and not listed as contingent, unliquidated or disputed; otherwise a proof of claim must be filed. b. It is a good practice to file a proof of claim whether the debt is scheduled or not. ( 1111(a)). 3. Filing a Claim as a Grant of Jurisdiction B. Where to File It should be noted that the filing of a claim subjects the claimant to the jurisdiction of the Bankruptcy Court not only on the filed claim, but also on any related or unrelated claims existing against the claimant. Due to this, some caution should be taken before filing a claim, especially when the creditor may have a legitimate objection to the Bankruptcy Court's jurisdiction and there is some fear that the debtor may have some claims against the creditor. If in doubt, file in several places. 1. The Court An original proof of claim must be filed with the court in which the bankruptcy case is pending and should substantially conform to official form The Trustee In Chapters 7, 12, and 13, a proof of claim should be sent to the trustee. A proof of claim should also be sent to the trustee in Chapter 11 if one is 64

74 appointed. 3. The Debtor's Attorney In a Chapter 11 case, a proof of claim should be sent to the debtor's attorney when the debtor is a debtor-in-possession. 4. The U.S. Trustee C. Amount of Claim If you want to make a clean sweep, a claim could also be sent to the U.S. Trustee, but this is unnecessary. The proof of claim should generally show the amount owing on the day the bankruptcy is filed. 1. Unsecured Claims These should include the full payoff amount as of the day the bankruptcy is filed. a. Post-petition interest is not allowed on unsecured or undersecured claims; in a rare case, a plan may provide for it. b. Post-petition costs and fees on unsecured claims are not allowed by most courts because the court feels it is unreasonable to incur postpetition costs and fees on an unsecured claim. These fees and costs are not specifically disallowed by the Code; the contract may allow them even though the court does not. c. Include copies of all documentation that supports the claim. (F.R.B.P. 3001) 2. Secured Claims Should include the full payoff amount as of the day the bankruptcy is filed. a. Post-petition interest is allowed only if the collateral is worth more than the debt (the creditor is oversecured). Otherwise, it is disallowed. b. Post-petition costs and fees should be allowed if the creditor is oversecured. Otherwise, it should be part of an unsecured claim and may be disallowed. c. Pre-petition arrearages. Unless the obligation is all due, the proof 65

75 of claim should show both the amount necessary to reinstate the debt and the amount to pay it off. d. Copies of all documentation establishing the claim and security interest should be attached. e. If the value of the collateral is equal to or less than the amount owed on senior liens, all junior lienholders have unsecured claims despite the security documents. 3. Ordinary Leases (claims on financing leases should be filed like any secured claim) a. Pre-petition arrearages are considered unsecured for amounts owing at the time the bankruptcy is filed. The claim should indicate the amount necessary to fully reinstate the lease. b. Post-petition payments should be claimed as an administrative (first priority) claim until the leased property is surrendered. If the debtor makes use of the leased property after filing, the creditor is entitled to the fair market value of the use. c. With respect to a claim after leased property is returned, except as to any priority amounts in paragraph (b) above, if the debtor rejects the lease and returns the property, the claim for damages due under the lease will be unsecured. d. If the lease is assumed by the debtor, all arrearages must be brought current within a reasonable time from assumption and there must be adequate assurance of future payments. All subsequent payments will be priority claims if not paid. ( 365 and 502). D. Claims Arising After the Filing of Bankruptcy 1. Chapter 7 Debts incurred after filing are not part of the bankruptcy and are not subject to discharge or the automatic stay. 2. Chapter 11 Debts incurred after filing the petition and before confirmation of a plan are generally administrative claims and subject to discharge. In order to get a plan confirmed, however, they must be paid or provided for in full. 3. Chapter 12 The Code is not clear on the effect of post-petition debt. The debtor can 66

76 apparently incur debt in the ordinary course of business and also apparently grant a security interest. However a good practice would be to obtain court approval for any large credit transaction. 4. Chapter 13 X. Payment of Claims Consumer debts, if approved by the court, may be included and paid through the plan. Other debts are not includable and would appear not to be discharged. However, since the debtor's earnings would have to pay the plan first, there may be nothing with which to pay the debts until the plan is completed. These debts could be discharged if the debtor converts to another chapter. ( 1305). Once you have a claim filed, the goal (of course) is to get it paid. The reality is that only a small percentage of claims ever see any payment and then it is usually only cents on the dollar. To complicate things, certain claims are given priority over other claims. The higher up in the priority scheme you are, the more likely it is that your claim may see some payment. It is important to determine whether, for any reason, you have a claim of higher priority. You want to be sure to include that in filing your proof of claim. A. Allowance of Claims Once you file a claim, it is deemed allowed unless an objection is filed to it. ( 502(a)). Any interested party can file an objection, but most often it is filed by the debtor or the Trustee. There are a variety of rules relating to limitations on certain types of claims (i.e. rent on defaulted long term leases, employment termination claims, etc.) which are beyond the scope of this outline and can be reviewed at 502. B. Secured Claims The first thing you want to know is whether your claim is secured. That is normally the best type of claim to have. Fully secured claims have the best chance of any claim of being paid and, in fact, of being paid in full with interest and with contractually provided-for costs being covered. You are secured to the extent you have a lien on an asset of the estate where the value of the asset is greater than the amount of your lien and all senior liens on the property. While it may not guarantee payment right away, as long as your collateral position remains positive, at some point you will either get paid or receive the collateral. ( 506.) BAPCPA has made changes in the priority scheme. The biggest change is that domestic support obligations moved from a seventh priority to the first priority. Below is a listing of priorities. 67

77 C. Unsecured Claims If you have no collateral for your claim, you are unsecured. There are a wide variety of unsecured claims and the treatment of these claims depends on how they are classified. There are also mixed secured and unsecured claims. This is referred to as being an undersecured creditor. This happens when you have collateral but its value is less than the amount of your claim and any senior liens on the property. In these cases, you are treated as a secured creditor for up to the amount of your collateral and as an unsecured creditor for all amounts above your collateral. 506(a). D. Priority of Claims Not all unsecured claims are created equal in bankruptcy. Some are much better than others. There is a series of priorities set out in the Code at 507. The higher the priority, the better the chance of seeing some payment. All claims in higher priorities must be paid in full before even one cent goes to the next priority in line. Thus, you can see why establishing a claim with a high priority is important, though most claims end up simply being general unsecured claims. 1. Domestic Support Obligations (1st Priority Claim) These are for claims for unpaid alimony and child support and the like. This is actually a benefit to the debtor since these claims are not dischargeable in bankruptcy and this allows the debtor to use the first dollars available from the estate to get them paid. This continues a trend in legislation over the last 10+ years to try to make bankruptcy less attractive to ex-spouses. 507(a)(1). 2. Administrative Claims (2nd Priority Claim) These are claims that arose after the bankruptcy was filed and are services or goods that provided some benefit to the bankruptcy estate. The biggest cost is usually in the area of professional fees, though taxes, salaries and ongoing costs of operation can all be large administrative items. Usually administrative expense claims need court approval. See 503 for more information on administrative expense claims. The amount owed for all goods received by a debtor within 20 days of the filing of a bankruptcy if such goods were sold to the debtor in the ordinary course of that debtor s business are also within this priority group. 503(b)(9). 507(a)(2). 3. Gap Creditor Claims (3rd Priority Claim) These are claims that arise in an involuntary bankruptcy case after the case is filed but prior to a finding by the Bankruptcy Court that the case is properly in bankruptcy. Claims that arise during this gap period are given this priority. 507(a)(3). 68

78 4. Wages, Salaries or Commissions Claims (4th Priority Claim) These are for claims up to $12, (This figure is adjusted every three years, with the next adjustment based on CPI to be made 4/1/16) earned but unpaid wages, and salaries or commissions (including sick leave and vacation), if they were earned within 180 days prior to the filing of the bankruptcy. This is on an employee-by-employee basis. 507(a)(4). 5. Employee Benefit Plan Claims (5th Priority Claim) These are for claims up to $12, (This figure is adjusted every three years, with the next adjustment based on CPI to be made 4/1/16) for payments owed to employee benefit plans, if such payments became due within 180 days of the filing of the bankruptcy or the cessation of business, whichever came first. This is on an employee-by-employee basis. The amount of this claim is reduced by the amount of any qualifying claim under the 4th priority above. 507(a)(5). 6. Grain Producers and Fisherman Claims (6th Priority Claim) This is where it pays to have a lobby that can get you special interest legislation. The first $6, (this figure is adjusted every three years, with the next adjustment based on CPI to be made 4/1/16) owed to a grain producer or fisherman from a storage or processing facility is included in this priority group. 507(a)(6). 7. Deposit for Goods or Service Claims (7th Priority Claim) These are for claims where you paid a deposit for goods or services that were not delivered. The ceiling on the claim is $2, (This figure is adjusted every three years, with the next adjustment based on CPI to be made 4/1/16). 507(a)(7). 8. Tax Claims (8 th Priority Claim) This covers a variety of federal, state and local taxes. For the most part, these taxes would have become due within three years prior to the filing of the case. A full discussion of the tax provisions is beyond the scope of this outline. 507(a)(8). 9. Obligations to Maintain Capital in a Federally Insured Financial Institution (9 th Priority Claim) This is a seldom-used priority based on the debtor having a specific obligation to maintain a certain capital balance in a federally insured financial institution. If the balance has not been maintained, the deficiency will become a priority claim. 507(a)(9). 69

79 10. General Unsecured Claims If you have no priority, then your claim is simply one of the general unsecured claims. If there is money left over after all priority claims are paid in full, then the unsecured creditors receive something. E. Payments Made Under the Doctrine of Necessity Courts sometimes will allow certain unsecured claims to be paid very early in the bankruptcy case. If the court determines that a vendor is critical to the ongoing operation of a debtor and if the vendor will not continue to provide services or products unless they are paid for some or all of the pre-petition debt, then courts have shown a willingness to approve these payments. These types of payments started with wage earners who were necessary to the ongoing operations of the debtor and have now expanded to various types of creditors. It is hard to find statutory support for these payments, though most courts point to their equitable powers under 105. F. Reduction of Claim Amount for Failure to Cooperate with Debtor Before Bankruptcy The Court, on a motion by the debtor, can reduce unsecured consumer debt by up to 20% if the debtor can show: 1. The claim was filed by a creditor who unreasonably refused to negotiate with an approved nonprofit budgeting and credit counseling agency; 2. The offer was made at least 60 days prior to the filing of the bankruptcy; 3. The offer was to pay at least 60% of the claim over a period not to exceed the repayment period of the loan or a reasonable extension of it; and, 4. No part of the debt is non-dischargeable. 502(k). G. Miscellaneous Comments on Claim Payments Claim payments are usually the last thing that occurs in a bankruptcy case and often don't occur for several years after the case is filed. All claims of the same priority are paid pro rata based on the amount of the claimant s claim as a percentage of all claims of the same priority. If an entity is subrogated to the rights of a priority claimholder under priorities three through nine, that entity does not get the same priority but rather is simply a general unsecured creditor for that amount. 507(d). XI. Statement of Intention This is a statement filed by the Chapter 7 individual or joint debtor listing all secured 70

80 debts and their intention relative to the disposition of the collateral. (F.R.B.P. 1007; See Official Form No.8.) A. Time for Filing 1. Within 30 days of filing of a Chapter 7; or 2. Before the first meeting of creditors, whichever is earlier, unless the court, for cause, grants additional time. ( 521(2)). B. The Debtor's Options The debtor must specify what will be done with the collateral. The debtor may: 1. Retain the Collateral If the debtor is current on secured obligations or will be current before discharge, the choice will likely be to retain the collateral. If the debtor is not current and is unable to become current, the creditor may seek to obtain relief from the stay and to repossess the collateral prior to discharge or repossess the collateral after discharge if the collateral has been exempted by the debtor. 2. Surrender the Collateral The debtor may choose to return the collateral to the secured creditor. 3. Redeem the Collateral If the collateral has been exempted by the debtor or abandoned by the trustee, the debtor may retain the property free of the lien by paying the secured creditor the fair market value of the collateral. (This requires a single lump sum payment.) The debtor then retains the property and the creditor has an unsecured claim for any deficiency. ( 722). 4. Reaffirmation Agreements The debtor may reaffirm the obligation with a creditor. This creates a formal obligation that will survive the bankruptcy discharge. ( 524(c) & (k)). a. A formal reaffirmation agreement must be executed by the creditor, the debtor, and if the debtor was represented by an attorney, you must have the attorney certify that the debtor has been given certain disclosures and that it does not impose an undue hardship on the debtor or a dependent of the debtor. b. The agreement may conform to the original pre-bankruptcy 71

81 agreement or may be modified. c. The full amount of any reaffirmed debt is not discharged by the bankruptcy. The debtor may be sued personally for any deficiency under such an agreement. d. To be valid, a reaffirmation agreement: (i) (ii) (iii) (iv) (v) (vi) Must have been made before the discharge is granted. Must contain a clear and conspicuous statement which advises the debtor that the agreement may be rescinded at any time prior to discharge or within 60 days after such agreement is filed with the court, whichever occurs later, by giving notice of rescission. It further must state that the debtor is not required to sign the agreement under any law, bankruptcy or otherwise. BAPCPA creates very specific and detailed disclosures that must be made in any reaffirmation agreement and those should be reviewed before entering any such agreement; 524(k) Must be filed with the court; and The debtor must not have rescinded such agreement at any time prior to discharge or within 60 days after the agreement is filed with the court, whichever occurs later. That a hearing has been held by the court at which the debtor was cautioned about the effect of the agreement. No hearing is necessary if the reaffirmation is for consumer debt secured by the debtor s real property. The court must find the reaffirmation is consistent with the best interests of the debtor. No hearing is needed if the debtor is represented by counsel and the debtor's attorney signs a statement in the agreement that it is in the debtor's best interest, does not pose an undue hardship, and that the debtor has been advised of the legal consequences. e. If a discharge has been granted and the debtor subsequently wishes to enter into a reaffirmation agreement, then court involvement is required if the debtor was not represented by an attorney in the negotiations. The court must hold a hearing at which the debtor must appear in person. The court shall inform the debtor (i) that the agreement is not required under the law; (ii) of the legal effect and consequences of such an agreement; and, (iii) if the consideration 72

82 C. Performance of Intentions for the agreement is based in whole or in part on a consumer debt that is not secured by real property of the debtor, determine that the agreement does not impose an undue hardship on the debtor or dependent of the debtor. The debtor has 30 days after the first date set for the meeting of creditors to perform the stated intentions. Additional time can only be obtained by court order. D. Trustee Duty The trustee has a duty to see that the debtor performs the stated intentions. This obligation is usually ignored by trustees. ( 704(3)). E. Debtor's Performance The debtor's failure to timely file the Statement of Intention or perform those intentions regarding leases and secured properties will result in the automatic stay being lifted. The trustee can petition to the court to continue the automatic stay. Performance of his intentions does not lift the automatic stay. Surrender of collateral alone will not allow the secured creditor to proceed to sale without lifting the automatic stay. The automatic stay is not necessarily affected by performance under the Statement of Intention( 362(h)), except that if the debtor has not performed as required within 45 days after the first meeting of creditors regarding purchase money collateral, then the stay is terminated and the creditor can proceed to exercise their rights under both state and federal law. The trustee can move within the 45 days to protect property that has consequential value to the estate. 521(b)(6). F. Trustee Rights The trustee's rights are not waived by the debtor's filing of the statement. Any interest the trustee feels he has in the collateral will supersede the debtor's Statement of Intentions. (But see 521(b)(6) as stated in E. above. XII. Use, Sale or Lease of Property Including Cash Collateral Once a bankruptcy is filed, one of the first questions is what can be done with the estate property. Whether you are the debtor in possession or trustee, there are limitations. The Code provides a series of requirements for use, sale or lease of such property. These provisions apply whether the bankruptcy is a reorganization or a liquidation. ( 363). A. Cash Collateral Cash collateral is a term of art under the Bankruptcy Code. It means cash and cash equivalents (negotiable instruments, documents of title, securities, deposit accounts) owned by the estate in which a third party claims some secured 73

83 position. It also includes proceeds, product offspring, rents or profits received from any property of the estate if a third party has some secured position in the proceeds, etc. This means that property can be converted to cash collateral after the filing of a bankruptcy. Use of cash collateral has special restrictions that apply to it which do not apply to other types of estate property. ( 363(a)). B. Use, Sale or Lease in the Ordinary Course of Business If the use, sale or lease of the property is part of the ordinary course of the debtor's business, no notice or further court approval is needed. This is provided that a business is authorized to be operated by the trustee or the debtor in possession. By way of example, a retail store can continue to sell its merchandise to customers since that is ordinary for a retail store. However, the retail store could not sell the entire inventory in bulk since that is not ordinary for that business. ( 363(c)). C. Use, Sale or Lease not in the Ordinary Course If the trustee or debtor in possession wants to make some use of estate property not in the ordinary course of business, there must be an appropriate notice and a hearing in order to seek approval for such use. ( 363(b)). D. Use of Cash Collateral Cash collateral is treated differently from other assets of the estate. Neither the trustee nor the debtor-in-possession may make any use of cash collateral unless they receive the consent of each creditor that has a secured interest in the cash collateral or they have obtained consent of the court after notice and hearing. Often the first action taken after a bankruptcy is filed is to obtain, by stipulation or motion, permission to use cash collateral. The court normally will grant at least a preliminary hearing on short notice to determine whether to allow at least some use of cash collateral. Without the use of cash collateral, most bankruptcy cases have no chance of surviving. ( 363(c)(2)). E. Provision of Adequate Protection Use of cash collateral or other property is often conditioned on providing adequate protection to the party who is at risk of damage due to the use proposed. For example, it is important with cash collateral that the creditor with the secured interest has something to protect it from the potential diminution of its secured position as the cash collateral is used. Often this involves providing replacement liens in other collateral or new collateral generated by the use of current cash collateral. ( 363 (e)). F. Sales of Estate Property Free and Clear of Others Interest The Bankruptcy Code provides substantial power to sell estate property free and clear of the interest of others even when those with the interests do not consent to 74

84 such sales. In order to sell free and clear, one of the following must be true: 1. Applicable non-bankruptcy allows such sale free and clear of the interest; 2. The entity who has an interest in the property consents to the sale; 3. The interest is a lien and the sales price is greater than the aggregate value of all liens on the property; 4. The interest is in bona fide dispute; or, 5. The entity with the interest could be compelled in a legal proceeding to accept a money satisfaction of its interest. ( 363(f)). The non-debtor party with a lien against the property to be sold retains the right to purchase the property at the time of sale by matching the proposed purchase price. The non-debtor party is allowed to use the secured amount it is owed as part of the purchase price. ( 363(k)). G. Sale of Co-Owner Interest in Estate Property Among the more extraordinary rights that exist in bankruptcy is the ability to not only sell the estate interest in property, but also the interest of other parties in the property. In a bankruptcy you can sell a co-tenant's interest, along with the estate's interests, if all of the following are true: 1. Partition of the property is impractical; 2. Sale of the estate's undivided portion of the property would result in a price substantially below the amount the estate would receive in a sale of the entire property, including the interests of the co-owners; 3. The benefit to the estate outweighs the detriment to the co-owners; and, 4. The property is not used for the production, transmission or distribution for electric or gas power. ( 363 (h)). The co-owner of the property retains the right to purchase the property at the time of the sale by matching the price for which the property is proposed to be sold. ( 363 (i)). Each of the co-owners will share the net proceeds of the sale based on their individual interests in the property. ( 363 (j). H. Sale or Lease Good Despite Appeal The buyer or lessee of property from the estate cannot be changed by appeal of the court's decision allowing the sale or lease unless there is a stay of the sale or lease pending appeal. This allows sales or leases to close in a timely manner. If 75

85 you wish to block a sale or lease pending appeal, you need to move the issue of a stay before the court prior to the closing of the lease or sale. ( 363 (m)). I. Bid Fixing Will Allow a Sale to be Unwound The trustee or debtor in possession has the power to unwind any sale where it is shown that the eventual sales price was controlled by any agreement between the potential bidders. As an alternative, the trustee or debtor in possession can recover the additional amount that would have been received had the bidding not been fixed. The trustee or debtor in possession may also recover attorney s fees and costs as well as punitive damages against the parties fixing the bidding. ( 363 (n)). XIII. Use of Cash Collateral and Debtor-In-Possession ( DIP ) Financing A. Conceptual Overview The Bankruptcy Code allows the debtor to use, sell or lease estate property-- except for cash collateral --in the ordinary course of the debtor's business without notice, a hearing, or the consent of creditors. Assets which are not cash collateral would include equipment, goods, inventory, farm products, and real property, etc. This creates a smoother transition at the filing and allows continued operation of the debtor's business without interruption. However, cash and cashlike assets (such as negotiable instruments, deposit accounts, rents, cash proceeds from collateral, etc.) present unique problems for the bankruptcy system, since they are usually consumed quickly in the debtor's business. Creditors cannot readily obtain or maintain perfection of their liens on such assets without taking possession of them, which would violate the automatic stay. Therefore, there are special rules for the debtor's use of cash assets --termed cash collateral under the Bankruptcy Code--in order to protect creditors interests. If these rules operate to prevent the debtor from using cash collateral, then the debtor will have to seek a third party lender to meet the cash needs of its business. B. Use of Cash Collateral - Chapters 7, 11, 12, and 13 If the debtor wishes to use property of the estate that meets the definition of cash collateral, the debtor must either (1) obtain the consent of all creditor(s) having a security interest in the cash collateral, or (2) obtain an order from the Bankruptcy Court authorizing the use of cash collateral. 11 U.S.C. 363(c)(2). 1. Definition of Cash Collateral: 11 U.S.C. 363(a) Cash collateral is generally defined in 363(a) as cash, negotiable instruments, documents of title, securities, deposit accounts or other cash equivalents, in which a creditor has a security interest. All proceeds of collateral, including rents, issues, and profits from a deed of trust on real property, are also cash collateral. 76

86 2. Applicable Bankruptcy Code Sections and Rules The debtor's use of a creditor's cash collateral is governed by 363(c)(2), (3) and (4), and F.R.B.P. 4001(b) and (d). a. Use of Cash Collateral via Creditor Consent Although 363(c)(2)(A) allows use of cash collateral upon creditor consent, creditors ordinarily have little incentive to consent to use of its cash collateral by the debtor, particularly where the debtor has little or no equity in the cash collateral. Where consent of creditors is not attainable, the debtor's only choice is to seek an order of the court authorizing use of cash collateral over creditors' objections. b. Use of Cash Collateral Without Creditor Consent A motion for use of cash collateral is only granted if the debtor establishes that the interests of creditors having an interest in the cash collateral are adequately protected. 11 U.S.C. 363(e). (i) Requirement of Adequate Protection Creditors whose collateral has a value that exceeds the amount of that creditor's secured claim are oversecured. Oversecured creditors may be found to be adequately protected by virtue of the equity cushion they enjoy in their cash collateral. In other cases, adequate protection may be achieved by giving the secured creditor a new lien on unencumbered or under-encumbered property of the debtor. An undersecured creditor, on the other hand, is only entitled to have the value of its collateral maintained. In all cases, the debtor bears the burden of proof on the issue of adequate protection. 363(o). (ii) Nature of Cash Collateral Motions Motions for use of cash collateral are often brought very early in the case since the debtor usually has an urgent need for use of cash collateral and debtors often enter bankruptcy with serious cash flow problems. F.R.B.P. 4001(b)(2) requires a minimum of 15 days notice for a hearing on use of cash collateral, but provides that the court may conduct a preliminary hearing before that time in order to authorize the use of only that amount of cash collateral as is necessary to avoid immediate and irreparable harm to the estate pending a final hearing. In most cases, motions for use of cash collateral are brought on an ex parte basis to 77

87 C. DIP Financing - Chapters 7, 11, 12, and 13 obtain an emergency interim order allowing the use of cash collateral until a final, regularly-noticed hearing may be held on the motion. F.R.B.P. 4001(b)(2). The outcome of a motion for use of cash collateral in a Chapter 11 case is often the determining factor as to whether the debtor will reorganize or liquidate. Where use of a secured creditor's cash collateral is not available, whether as a result of the fact that either creditor consent and court authorization is denied, or there is simply no cash collateral in the estate, a debtor in possession may meet its cash flow needs by borrowing cash from a third party. Motions to borrow are governed by 364 and F.R.B.P. 4001(c). 1. Debt Incurred in Ordinary Course of Business Section 364(a) provides that the trustee or debtor in possession may obtain unsecured credit or incur unsecured debt in the ordinary course of the debtor's business. No court approval is required. This allows the debtor to incur ordinary trade debt if suppliers are willing to work under these terms. Such debt is allowed as an administrative expense under 503(b)(1) and given second priority under 507(a). 2. Debt Incurred in Other than Ordinary Course of Business Sections 364(b), (c) and (d) provide that borrowing outside of the ordinary course of the debtor's business requires a court order after a hearing with notice to all parties in interest. Service of the motion must be made in accordance with F.R.B.P. 4001(c), which provides for service on all parties in interest and any creditors committee or special service list. A copy of the lending agreement must accompany service of the motion. Like motions for use of cash collateral, F.R.B.P. 4001(c)(2) requires 15 days notice on a motion to borrow, but the court may hold a preliminary hearing for interim borrowing to the extent necessary to avoid irreparable harm until a final hearing can be held. The required showing by the debtor to obtain such relief is similar to that required for use of cash collateral. a. Unsecured Borrowing If the debtor is unable to find financing by offering prospective lenders administrative expense priority, the debtor may offer such lenders super-priority status (i.e., the loan is paid before all other administrative expenses). 364(c). The giving of super-priority status requires a court order after notice to all parties in interest. 78

88 b. Secured Borrowing Section 364(c) provides that, where the debtor is unable to obtain unsecured credit through the giving of administrative expense priority or super-priority as outlined above, the debtor may give a lien on unencumbered or a junior lien on under encumbered property. 364(c)(2) and (3). Often, the debtor may obtain more favorable lending terms by borrowing on a secured basis. c. Priming Existing Liens XIV. Leases & Executory Contracts ( 365) A. Definitions 1. Executory Contract If the debtor can neither obtain unsecured financing through the giving of administrative or super-priority status, nor secured financing through the giving of a lien as described above, then the court, after notice and a hearing, may authorize the debtor to give a lien that is senior to existing liens (known as priming ). In order to give such a lien the debtor must show that the secured creditor who is being primed is adequately protected and no other borrowing terms are available. ( 364(d)). A contract under which the obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either party to complete performance would constitute a material breach excusing the performance of the other. Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L. Rev. 439 (1973). The Bankruptcy Code contains specific provisions for certain types of contracts that do not fall under the general rules set forth in 365. Special consultation to those sections are necessary for contracts involving: securities, commodities, repo, swap, aircraft and vessels, collective bargaining agreements, retirement benefits, and railroads. 2. Unexpired Lease The Bankruptcy Code does not define an unexpired lease, so a number of factors must be examined to determine whether the agreement is a true lease. One cannot simply assume that any lease for personal or real property that has time remaining on its term is an unexpired lease. Many contracts that are titled leases are not really true leases as the term is used in bankruptcy. For example, many leases are actually financing agreements and cannot be rejected, assumed, or assigned under 365 of the Bankruptcy Code. 79

89 a. Financing Leases Versus True Leases The Bankruptcy Court will treat a lessor under a financing lease the same as a secured creditor. The court will look to the following factors to determine whether a lease is a financing lease: (i) (ii) (iii) (iv) (v) (vi) (vii) Is the lessee required to insure the items on behalf of the lessor in an amount equal to the total rental payments? Is the risk of loss or damage on the lessee? Is the lessee to pay for taxes, repairs, damage and maintenance? Do default provisions govern the acceleration and resale of the item? Is a substantial non-refundable deposit required? Is the object leased to be selected from a third party by the lessee? Are rental payments a reasonable equivalent of the cost of the item plus interest? (viii) Is the lease to be discounted with a bank? (ix) Are warranties generally found in a lease excluded by the agreement? B. Assumption, Assignment, or Rejection of a Lease or Executory Contract The trustee or debtor in possession, subject to the court's approval, can choose to assume or reject an unexpired true lease or executory contract. An executory contract is defined as a contract under which the obligation of the bankrupt and other party are so far unperformed that failure of either party to complete performance would constitute a material breach. 1. Assumption To assume an executory contract or lease the debtor or trustee must cure any arrearage and provide adequate assurance of the ability to perform in the future. The lease or executory contract must be performed according to its original terms. If the debtor is in default (other than for a bankruptcy termination, insolvency clause, or for a non-monetary default that cannot be cured), the trustee cannot assume the lease or demand that the lessor comply with any 80

90 obligation to provide services or supplies incidental to the lease without first curing the default. The business judgment test is applied by the courts in determining whether to allow assumption. Under this test, the debtor must be able to articulate a sound business reason for assuming the lease or contract. ( 365(b)). 2. Assignment Any lease or executory contract that is assumed can be assigned to any party capable of performance unless state law allows the lessor or other party to reject a new assignee. Once a lease is properly assigned, neither the trustee nor the debtor have any further obligation under the lease or contract and are not liable for any future breaches--the assignee becomes fully responsible. ( 365(k)). 3. Rejection The trustee or debtor may reject any executory contract or lease. If the debtor or trustee fails to act within a certain time period as described below, the lease may be deemed rejected. If rejected, the non-debtor party will be entitled to a damage claim. ( 365(a)). C. Time in Which to Assume or Reject Lease 1. Chapter 7 The trustee has 60 days to assume or reject a lease of residential real property or personal property. If the trustee does not assume the lease or obtain an extension, the lease is deemed to be rejected. ( 365 (d)) 2. Chapters 11, 12 or 13 The trustee or debtor may assume or reject any lease, other than nonresidential real property leases, up until confirmation of the plan. Any party in interest may request an earlier determination. ( 365 (d)) 3. Nonresidential Real Property Leases Under all Chapters, unless the court grants additional time, the trustee has the earlier of plan confirmation or 120 days from the day the bankruptcy is filed to assume or reject a lease of nonresidential real property. If the trustee fails to assume or reject the lease within the time limits allowed, it is deemed rejected and the trustee is to surrender possession. The court may for good cause extend the time, but only for an additional 90 days. 81

91 Any additional extensions can only be obtained with the consent of the landlord. ( 365(d)) D. Termination or Modification of the Lease or Executory Contract The Bankruptcy Code invalidates any termination clause based on bankruptcy or insolvency. The exceptions to this general rule are personal service contracts, contracts to make loans, and contracts to issue securities. ( 365 (c)). E. When is a Breach Deemed to Have Occurred on a Rejected Lease and What Claim Will Result? 1. Rejected Leases If a lease is rejected and has not previously been assumed it is treated, for purposes of a claim, as if the breach had occurred immediately before the bankruptcy was filed and the claim is usually unsecured. ( 502(g)). 2. Lease Assumed Then Rejected If the lease is assumed and then rejected with no intervening conversion from Chapters 11, 12 or 13, for purposes of a claim, the breach is treated as occurring at the time of rejection and the claim is administrative for the next two years of lease payments due, without offset. After that, the remainder of the claim is an unsecured claim based on the limitations found in 502(b)(6). 503(b)(7). 3. Lease Assumed Before Conversion Then Rejected If a lease is initially assumed and not rejected until the debtor converts from Chapters 11, 12 or 13, for purposes of the claim, the breach is treated as occurring immediately before the conversion and is an administrative claim from the prior Chapter. All remaining amounts recoverable under the lease are treated as an unsecured claim arising just prior to the conversion. ( 365 (g)). 4. Administrative Claim If the estate or debtor continues to use the leased property after filing the bankruptcy, the lessor can claim a priority administrative expense at least to the extent such use benefits the bankruptcy estate. The claim would include the monthly rental on the property from the date of filing until use ceases. This claim should be filed separate from any other claim on the lease.( 503) F. Effect of Rejection on the Automatic Stay Rejection by the debtor or trustee terminates the lease and requires the trustee to 82

92 turn over the property to the lessor. While this does not technically lift the automatic stay for all intents and purposes, it does put the burden on the trustee to act. However, if the trustee does not act to turn over before repossessing leased property, the creditor should obtain relief from the stay. G. The Debtor as Lessee of Shopping Center Property The Bankruptcy Code recognizes that special consideration must be given to leases involving shopping centers because of the impact one tenant can have on all the other merchants. Accordingly, the Code is designed to maintain the financial stability of the lessor and avoid disrupting the other businesses in the shopping center. In general, the requirements for assumption and assignment of shopping center leases are: 1. The proposed assumption or assignment will result in an entity with a similar financial condition and operating performance; 2. The rent due must not decline substantially; 3. The assumption or assignment is subject to all provisions of the original lease; and 4. The assumption or assignment will not disrupt the tenant mix or balance in the shopping center. ( 365(b)(3)). H. The Debtor as the Lessee of Aircraft Terminal or Gates The debtor, if a lessee to multiple gate leases in the same airport, must assume all the gate/terminal leases in that airport unless the airport operator consents otherwise. If the trustee intends to assume and assign those leases, it must assign all to the same person unless the airport operator otherwise agrees. ( 365(c)(4)). I. Debtor as the Lessor of Real Property If trustee rejects a lease for real property, the tenant can treat such lease as terminating under its own terms or the tenant may remain in possession for the balance of the term and for any renewal or extension that is enforceable under non-bankruptcy law. The tenant may also offset, against any rent, the amount of any damages the tenant suffers that are caused by the nonperformance of any obligation of the debtor. ( 365(h)). The same rules apply when the debtor is a time share interest seller. J. Other Restrictions on the Assumption and Assignment of Unexpired Leases or Executory Contracts 1. A lease or executory contract cannot be assumed or assigned if, under applicable law a party, other than the debtor, is excused from performing 83

93 its side of the contract and that party does not consent to the assumption or assignment. 2. The trustee may not assume or assign a contract to make a loan to the debtor, extend debt financing to the debtor, or issue a security of the debtor. 3. If a lease for nonresidential real property has terminated under nonbankruptcy law prior to the order for relief, then it cannot be assumed. If it cannot be assumed, then it cannot be assigned. ( 365(l)). K. The Debtor as the Seller of Real Property If the trustee rejects a debtor's sales contract for real property (or the sale of a time share interest in a time share plan) and the buyer is in possession of the property, the buyer may treat the contract as terminated or remain in possession. If the buyer remains in possession, she must continue to make the payments subject to any offset for damages occurring after the date of rejection. The trustee will deliver title in accordance with the original terms of the contract. A buyer who treats the contract as terminated or who was not in possession at the time of rejection will have a lien on the debtor's interest in the property equal to the amount the buyer has paid towards the purchase price. ( 365(i)). L. The Debtor as Licensor of Intellectual Property Intellectual property includes trade secrets, inventions, processes, designs, plant varieties, patent applications, and trademark work. If the trustee rejects an executory contract under which the debtor is the licensor, the licensee may either terminate the contract or retain their rights under it, including any exclusivity rights. Like leases above, the licensee must make all royalty payments due under the contract, but a licensee is not entitled to a set off for damages or an administrative claim. If the licensee elects to retain its rights under the contract, the trustee cannot interfere with those rights and must perform under the contract, including providing the licensee with the intellectual property. ( 365(n)). M. FDIC and other Financial Institutions If the debtor has made a commitment to maintain the capital of an insured depository institution such as the Federal Deposit Insurance Corporation, the Resolution Trust Corporation, the Director of the Office of Thrift Supervision, the Comptroller of the Currency, or the Board of Governors of the Federal Reserve System, the trustee is deemed to have automatically assumed that contract and must immediately cure any default. Any claim arising under an agreement of this sort is granted administrative priority. ( 365(o)). 84

94 N. New Provisions for Non Consumer Personal Property Leases after the 1994 Act The 1994 amendments also effect the leasing area. New provisions effect only leases of personal property not leased for consumer purposes. First, if a lease provides for a penalty default rate, the lease can be cured at a non-penalty rate, provided the default is non-monetary in nature. In a Chapter 11 case, the lease must be performed under its terms beginning not later than 60 days after the Chapter 11 commenced, unless the court for good cause orders otherwise. O. Debtor s Ability to Personally Assume a Personal Property Lease that has been Rejected Once a personal property lease has been rejected, it is no longer property of the estate and any ongoing automatic stay is lifted. The debtor, if the debtor is an individual, can then personally assume the lease with the consent of the lessor and with no further obligation of the estate. 365(p). XV. Preferences A guiding principal of bankruptcy law is equal distribution to all creditors that are similarly situated. What happens when near the filing of a bankruptcy the debtor decides to favor certain of its creditors with substantial payments while completely ignoring other creditors? The Bankruptcy Code defines these types of payments as Preferences and sets out a process for recovering such payments for the benefit of all creditors. The threat of a preference action against creditors can also keep them from being overly aggressive in their debt collection efforts against a debtor that is sliding towards bankruptcy. ( 547(b)). While the concept of preference recovery seems fair, it is often seen as very unfair by the creditors who get sued. For most creditors that get sued they did nothing wrong at all. They simply got paid on an invoice that was legitimately owed (albeit usually delinquent). Most of the creditors were not even aware that the debtor was near bankruptcy at the time of payment. Also, often instead of the recoveries going to other unsecured creditors, the recoveries get absorbed by administrative and other priority claims. A. What is a Preference? A preference is any transfer, voluntary or involuntary, of any interest of the debtor in property (cash, securities or other) which has all of the elements set forth below. It is important to note that in order to maintain a preference action the party bringing it (debtor or trustee) has the burden of proving each element in order to establish a preference. ( 547(g)). If any element is not proved then no preference exists. The elements of a preference are: 1. To or for the benefit of a creditor. The party sued must be a creditor (must have had a claim against the debtor when the payment was made) of the debtor and the transfer sought to be recovered must have been either 85

95 made directly to the creditor or to a third party that resulted in some direct benefit to the party being sued. ( 547(b)(1)). 2. For an antecedent debt owed by the debtor. An antecedent debt is one that was existing prior to the alleged preferential transfer. Was the transfer to the preference defendant made based on an obligation owed before the transfer? For example, a loan of money is not a preference because it wasn't payment of a debt owing. ( 547(b)(2)). 3. Made while the debtor was insolvent. If the debtor was not insolvent when the transfer was made, it is not a preference. However, the debtor is rebuttably presumed to be insolvent within 90 days of filing. ( 547(f)) This means that, on this issue, the burden shifts to the defendant. If you are dealing with an insider preference transfer that was made more than 90 days before the filing, the presumption does not apply and the burden remains with the debtor/trustee. ( 547(b)(3)). 4. Made within 90 days of filing of the petition. To simplify the issues on preferences, a bright line test was established. If the transfer occurs within 90 days of the bankruptcy filing, it is a preference if the other elements are established. Count back 90 days from the date of the filing and determine what transfers occurred within that time and they are the potential preferences. Those falling outside of the 90-day period are protected. A payment made by check is deemed transferred when the check clears not when it is written or delivered for purposes of preference calculations. ( 547(b)(4)(A)). 5. Made within one year of filing the petition if the transferee was an insider at the time of the transfer. The exception to the 90-day rule is when the transferee of the preference is deemed to be an insider of the debtor. In such cases transfers occurring up to one year prior to the bankruptcy filing can be recovered. ( 547(b)(4)(B)) The insider definitions are contained in 101(31) of the Bankruptcy Code. These definitions should be studied very carefully whenever a party is alleged to be an insider. The recovery for an insider preference can only be from the insider and not from some third party that received a transfer that benefited the insider. 547(i). 6. Which allows the creditor to receive more than it would receive under a Chapter 7 liquidation. Would the creditors in the same priority as the preference defendant receive anything from the bankruptcy if the debtor was liquidated? If it is clear that the answer is no, then this should be a pretty easy element to prove. A number of courts make short order of this issue by saying that by getting payment early they received more than a similarly situated creditor who did not get paid so that the transfer is recoverable. ( 547(b)(5)). 86

96 B. Exceptions to Preferences After the trustee or debtor has proved all the elements of a preference, there are still a number of defenses available to a preference defendant. The defendant has the burden on the defenses but all they have to show is that any one of the defenses apply. Here is the list of potential defenses: 1. Contemporaneous Exchange. A transfer which was intended by the debtor and creditor to be a substantially contemporaneous exchange and was, in fact, substantially contemporaneous is not a preference. The key is show two things: a. That the parties intended the exchange to be contemporaneous. If the parties intended the transaction to be a type of credit transaction, you will never prevail on this issue. If the parties intended it to be cash and carry, you are in good shape. In between those two extremes, you have a lot of grey area. How much time between delivery of goods and services and payment can vary depending on the circumstances. If a crop is delivered to be cleaned and weighed before payment is made but payment is processed as soon as practical then that is going to be seen as contemporaneous. b. That the exchange was actually contemporaneous. Only part of the issue is the parties intent. The other question is did they perform according to their intentions in how the transfers occurred? ( 547(c)(1)). 2. Ordinary Course of Business. A transfer on account of a debt incurred in the ordinary course of the debtor's business or financial affairs is not a preference. This means that the debt must have arisen in the ordinary course of both the creditors and debtors business. If that is true, then there are two tests,one of which must be met in order to prevail on this defense: a. The transfer itself must be made according to the customary business terms in the subject industry. This is the objective test. Are the terms under which the payment made normal in the industry? (This does not require that they be the most common terms, only that it not be outside the normal type of transactions that occur); or, b. The transfer must be in the ordinary course of the business or financial affairs of both debtor and transferee. This is the more subjective test. In looking at the business dealings between the debtor and creditor historically, does this transaction fall outside the norm? ( 547(c)(2)). 87

97 3. Creation of a security interest within 30 days of new value being given. A transfer which created a security interest in property of the debtor will not create a preference provided that two things are proven: a. The creditor gave new value to the debtor which was secured by the property given as collateral. Often when an account becomes delinquent, a creditor may seek collateral to secure the debt. This exception does not allow old debt to protect the security interest. The creditor must give new value at or after the time the security interest is granted. b. The security interest must have been perfected within 30 days of the debtor receiving the new value. This means that recording, filing or whatever other perfection mechanism is provided by law on security interests must be completed within 30 days of the new value being received by the debtor ( 547(e)(1)). ( 547(c)(3)). 4. New Value. If, subsequent to the preferential transfer, the creditor receiving the preference gave new value to or for the benefit of the debtor that is not otherwise secured or otherwise the subject of an avoidable transfer, it provides a defense to the preference to the extent of the new value given. In its simplest terms, the following must be shown: a. The new value was given after the preference payment. This usually involves providing additional goods or services on credit after the purported preference payment. b. The new value must be unsecured. c. The new value remains unpaid. There are a number of courts that now say that it is not necessary for the new value to remain unpaid if the payment on the new value is also subject to preference challenge. In such cases the defense is still allowed. ( 547(c)(4)). 5. Perfection in Inventory, Receivables or their Proceeds. A transfer which created a perfected security interest in inventory or receivables, or the proceeds of either, is not a preference, except to the extent that the aggregate of all such transfers to the creditor caused a reduction, as of the date of filing the petition, of any amount by which the debt secured by such security interest exceeded the value of all security interests for such debt on the later of 90 days before the bankruptcy was filed or the date new value was first given under the agreement creating the security interest (extended to one year for insiders). This is designed to protect those that do normal financing on inventory or receivables. Provided they do not improve their position during the preference period, they can be 88

98 secured in new inventory or receivables that came into existence during that time period. ( 547(c)(5)). 6. Statutory Liens. A statutory lien which is not otherwise voidable under Bankruptcy Code 545 is not a preference. There are a lot of liens that arise by the operation of law. A lien that arises by operation of law will not be set aside simply because it arises for the first time during the preference period. ( 547(c)(6)). 7. Alimony, Maintenance or Child Support. The Bankruptcy Code favors these types of payments and they are protected throughout the Code. These are payments made on a debt to a spouse, former spouse or child in connection with alimony, maintenance or child support provided that the obligation truly is in the nature of alimony, maintenance or child support and is paid in accordance with a separation agreement, divorce decree, or other court order. Assignees of these payments are not so lucky and are not protected. ( 547(c)(7)). 8. De Minimus Payments. Preferences to any creditor which are of an aggregate amount less than $6, (amount will adjust every three years based on the CPI, with the next adjustment set for 4/1/16) on consumer debt are not actionable. Most trustees and debtors do not pursue the small amounts in any event. The cost to pursue these make it prohibitive. ( 547(c)(8)). 9. Negotiated Repayment Schedule. If payments are made pursuant to a repayment schedule arranged by an approved nonprofit budgeting and credit counseling agency, those payments will not be recoverable as preferences. 547(h). C. Action on a Preference The debtor or trustee has two years to bring preference actions from the time the case is commenced or one year from when the first trustee is appointed in the case. ( 546(a)). The action is commenced by the filing of an adversary proceeding. Normally, however, efforts are made to settle the matter prior to the filing of a legal proceeding. Failure to repay a preference after demand is made can result in the creditor being denied any claim in the bankruptcy case, including any claim for any preference that is repaid. According to the Supreme Court in Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989), a defendant in a preference action has the right to request a jury trial provided that the a proof of claim has not been filed in the case. See also Langenkamp v. Culp 498 U.S. 42 (1990) which confirmed that Granfinanciera also applied to preference actions. 89

99 XVI. Fraudulent Transfers The Bankruptcy Code is intended to prevent a debtor from depleting the bankruptcy estate by transferring assets for less than fair value or incurring debt in anticipation of filing bankruptcy. Under certain conditions, such transfers may be rescinded to prevent the debtor from perpetrating fraud, whether intentionally or not, or hindering or delaying creditors. There is a special focus on transfers to insider employees outside the ordinary course of business during the relevant fraudulent conveyance period. A. What is a Fraudulent Transfer? A Fraudulent Transfer is any transfer of an interest of the debtor in property (assets of any kind), or any obligation incurred by the debtor, during the two year period prior to filing bankruptcy, if the debtor, voluntarily or involuntarily: 1. made the transfer or incurred the obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was indebted or became indebted on or after the date of the transfer or when the obligation was incurred; OR 2. received less than a reasonably equivalent value in exchange for the transfer or obligation; AND 3. the debtor was insolvent on the date of the transfer or creation of the obligation, or became insolvent as a result; or 4. the debtor was engaged or about to become engaged in business or a transaction for which the property remaining with the debtor was unreasonably small capital; or 5. the debtor intended to incur, or believed she would incur, debts that would be beyond the debtor's ability to pay as such debts matured. (11 U.S.C. 548). B. Constructive Fraud Because only rarely will evidence of actual intent be found, a trustee may avoid a transfer regardless of intent, under three circumstances, indicating a constructively fraudulent transfer. Constructive fraud is present when the debtor receives less than reasonably equivalent value in exchange for the transfer and, as of the transfer, the debtor suffered from at least one of three financial difficulties: 90

100 1. the debtor was insolvent; or 2. the debtor was in business and as a result of the transfer had unreasonably small capital remaining to continue business; or 3. the debtor intended to, or believed he would incur, debts beyond his ability to repay when the debts became due. C. Reasonably Equivalent Value One of the major fraudulent transfer issues is whether the debtor received reasonably equivalent value for the transfer. To the extent that the transferee did not give reasonably equivalent value, the transfer is avoidable. In other words, if the recipient of the debtor's transfer obtains a windfall by the transfer, the debtor did not receive reasonably equivalent value in exchange. For example, if the debtor sold a car worth $10, for only $2,000.00, the buyer received an $8, windfall, and the bankruptcy trustee can avoid the sale of the car. Furthermore, the reasonably equivalent value must have been received by or benefited the debtor. If not, then the transfer may be avoided. For example, a debtor gives a $5,000 diamond to transferee, who in turn gives a $5,000 payment to the debtor's friend. The exchange is avoidable because the debtor did not receive reasonably equivalent value for the diamond despite the payment to the debtor's friend. D. Religious and Other Charitable Giving In 1998, the Code was amended to create certain safe harbors for religious and charitable giving from challenges as fraudulent conveyances. If the organization receiving the donation is a qualified religious or charitable organization as defined by the Internal Revenue Code, giving is protected provided: 1. The giving does not exceed 15% of the gross income for the year; or 2. The giving exceeds 15% but is consistent with the donor's historical giving pattern. E. Foreclosure Sales The issue of a fraudulent transfer often arises in the context of a foreclosure sale. As long as the foreclosure sale was regularly conducted and there was no collusion, the purchase price will be, as a matter of law, reasonably equivalent value. F. Reach-back Period The reach-back period for avoiding fraudulent transfers is two years prior to the date of filing of the bankruptcy petition. The two-year period may be extended if, 91

101 for example, a transfer occurs more than two years prior to filing, but perfection of the transfer occurs within the two-year period. For example, the debtor might incur a debt, then, to secure the debt, later creates a security interest that is perfected by filing a UCC-1 within the two year period. Furthermore, the bankruptcy trustee might be able to use 544(b) of the Bankruptcy Code to invoke the California State Uniform Fraudulent Transfer Act, which provides for a longer statute of limitation, to avoid a transfer that occurred beyond the two-year period prior to the bankruptcy petition. G. Extended Reach-back Period for Self-Settled Trusts There is a ten-year reach back period on transfers of any property to transfer to a self-settled trust or similar device if the following are all true: 1. The transfer was by the debtor; 2. The beneficiary of the trust is the debtor; and 3. The transfer was made with the actual intent to hinder, delay or defraud any entity to which the debtor was or became indebted on or after the transfer was made -- Effective immediately for cases filed after 4/20/ (e). H. Statute of Limitations The debtor or trustee generally has two years to bring a fraudulent transfer action from the date the petition is filed. ( 546(a)). I. Safe Harbor Against Avoidance There is a limited safe harbor under 548(c) for innocent transferees who acted in good faith and gave some value for the transfer. A transferee that returns fraudulently transferred property to the bankruptcy estate holds a lien on the property to the extent of the fair consideration paid in the exchange. In other words, the transferee will not be harmed by avoidance of the transfer, but is not entitled to keep the benefit of a favorable transaction. For example, a transferee that paid $750 for debtor's $1000 gold bar has a $750 lien against the gold bar upon its return to the bankruptcy estate. When the gold bar is sold, the transferee will receive $750 of the sale proceeds. The 548(c) protection is available to innocent recipients of transfers actually intended by the debtor to be fraudulent, and also to innocent recipients who, in hindsight, are later found to have not given reasonably equivalent value. 92

102 XVII. Effect of Discharge 524 A. Chapter 7 Under bankruptcy law, the honest debtor is entitled to a Fresh Start and the presumptions are generally in favor of granting the discharge. The court is required to grant the discharge unless an exception applies. Discharge usually occurs approximately four to six months after filing (however, this timing can vary greatly). Except as to the items listed in XVIII Exceptions to Discharge, below, the debtor is discharged from: 1. All debts that arose before the date on which the order for relief was entered (affects post filing, pre-conversion debts); and, 2. All obligations specified in 502 whether or not a claim was filed, including: B. Chapter 11 a. Claims arising from the rejection of leases after filing, and executory contracts that existed prior to the order for relief; b. Claims arising from the recovery of property by the estate or debtor after the order for relief; c. In an involuntary case, claims arising from the operation of the debtor's business between the filing of the involuntary petition and entry of the order for relief; d. Claims for reimbursement or contribution which become fixed after the order for relief if the underlying obligation arose prior to the order for relief; e. Claims that were unliquidated or contingent at the time of the order for relief. ( 727) Discharge of the debtor occurs when the plan is confirmed unless the debtor is an individual, in which case the discharge occurs when the plan payments are completed, unless the plan provides otherwise. Except as to exceptions listed in XVIII, Exceptions to Discharge, below, the debtor is discharged from: 1. All debts that arose before confirmation of the plan (including debts incurred after filing) (Note: All pre-confirmation debts are presumptively provided for in the plan which becomes a new contractual obligation of the debtor); 2. Claims arising from the rejection of executory contracts or unexpired leases by the plan; and, 93

103 3. Claims arising from the recovery of property by the debtor in possession or trustee even after confirmation of the plan. ( 1141). C. Chapter 12 (Discussed Earlier in Outline) D. Chapter 13 Super Discharge (Not so super anymore) Discharge of the debtor occurs when the plan is completed. In order to get a discharge, the debtor must certify that they are current on all domestic support obligations. The exceptions in XVIII, Exceptions to Discharge, below do not apply to Chapter 13 if the plan is completed except as set forth below. With the 2005 Act the Chapter 13 Super Discharge has become the less than Super Discharge. If the plan is completed, the debtor is discharged from all debts provided for in the plan except: 1. Debts which, under their normal terms, will not be paid off during the term of the plan (long term obligations); 2. Claims for domestic support obligations as set forth under 523(a)(5). ( 1328(a)); 3. Claims for repayment of educational loans which first came due less than seven years prior to the filing (unless the debtor can show undue hardship) as set forth in 523(a)(8) ( 1328(a)(2)); 4. Claims for death or personal injury caused by driving under the influence of alcohol, drug or other substance as set forth in 1523(a)(9) ( 1328(a)(2)); 5. Claims for restitution included in the sentence for criminal conviction ( 1328(a)(3)); 6. Debts for taxes for non-filed or late filed returns filed within two years of the bankruptcy or for willfully fraudulent returns ( 523(a)(1)(B) & (C)); 7. For money, property or services obtained through fraud or false pretenses ( 523(a)(2)); 8. For claims where the debtor failed to list or provide adequate notice to the claimant in time to allow them to participate in the bankruptcy ( 523(a)(3)); 9. For debts that are the result of fraud or defalcation while acting in a fiduciary capacity ( 523(a)(4)); and 10. For restitution or damages awarded in a civil action against the debtor as a result of willful or malicious injury by the debtor causing death or 94

104 personal injury. ( 1328(a)(4)). 11. The debtor will not receive a discharge if the debtor received a discharge under a prior Chapter 7, 11 or 12, within four years of the current Chapter 13, and the debtor will not receive a discharge if the debtor received a discharge under a prior Chapter 13 within two years of the filing of the current Chapter 13. ( 1328(f)). 12. The debtor will not receive a discharge unless they have completed an instructional course concerning personal financial management, unless they are physical or mentally incapable of taking the course or no such approved course exists within the district. ( 1328(g)). 13. A debt does not have to be paid in full to be provided for under a Chapter 13 plan and subject to discharge. E. Chapter 13 Hardship Discharge At any time after confirmation of the plan and despite failure to complete the plan, the court may grant a hardship discharge to the debtor under Chapter Requirements for Hardship Discharge a. Notice and hearing; b. The debtor should not justly be held accountable for his failure to complete the plan; c. Creditors have received at least what they would have received had the debtor been liquidated under Chapter 7 on the day the plan was confirmed; and, d. Modification of the Chapter 13 plan is not practical. ( 1328(b)). 2. Scope of Hardship Discharge. Except as to the exceptions listed in XVIII, Exceptions to Discharge, below, the debtor will be discharged: a. From all unsecured debts provided for by the plan except those which, under their normal terms, would not have been paid off during the term of the plan; and, b. From all claims which were disallowed under the Bankruptcy Code. ( 1328(c)) 95

105 F. Effect of Discharge (applicable to all Chapters) 1. A discharge voids any judgment which relates to the personal liability of a debtor to any discharged debt. 2. A discharge creates a permanent injunction against any and all acts to collect any discharged obligation. 3. A discharge prohibits recovering any community debts discharged from the community property (whenever the property was acquired) even if only one spouse filed the bankruptcy. ( 524). 4. Violations of the discharge injunction can subject the violator to liability for damages to the debtor including punitive damages. G. Revocation and Reaffirmation 1. Within one year, the court may revoke a discharge if the discharge was obtained by fraud and the requesting party did not know of the fraud until after the discharge was granted. 727(d). 2. A debtor may voluntarily reaffirm any debt by written agreement, whether secured or unsecured debts (See XI B. 4. above for discussion of the procedure for reaffirmation). 3. A discharge does not prevent any debtor from voluntarily repaying any debt. XVIII. Exceptions to Discharge The goal of most debtors in filing bankruptcy is to ultimately get a discharge of all of their unsecured obligations. Unless specifically excepted, all personal debts and obligations of the debtor are discharged by the bankruptcy. The Bankruptcy Code provides a listing of types of debts that are not discharged by a debtor s bankruptcy. The debtor still gets a discharge, there is simply specific debt or debts that are not discharged. These exceptions to discharge are discussed immediately below (Section A). There are also circumstances where the debtor goes through bankruptcy and at the end they do not get any discharge. These circumstances are discussed further below (section B). A. Exception to Discharge of Specific Debts The Bankruptcy Code favors giving debtors their discharge but at the same time, there are certain types of debts for which the Code feels discharge is not appropriate. A debtor goes through the process and gets a discharge but a particular debt is excepted from that discharge. A denial of discharge of any one of these individual debts does not affect the debtor's right to discharge in general. 96

106 A specific debt owed by the debtor will not be discharged if: 1. The debtor is an individual (does not apply to other entities); 2. The debtor seeks a discharge under Chapters 7, 11, 12 or a hardship discharge under 13. (A regular Chapter 13 discharge, unless otherwise qualified, discharges even these debts listed below as nondischargeablesee XVII D. above); and, 3. The debts are for: a. Taxes No discharge for certain taxes or customs duties or for money borrowed to pay any of these taxes. ( 523(a)(1) & (14), (14A)); b. Money, Property, or Services Obtained by False or Fraudulent Activities No discharge for money, property, services or an extension, renewal or refinancing of credit obtained by: (i) (ii) False pretenses, false representations, or actual fraud (other than involving financial condition); or The use of a materially false statement in writing regarding the financial condition of the debtor or its insiders which the debtor caused to be published and on which the creditor reasonably relied. ( 523(a)(2)(A) & (B)). c. Luxury Goods No discharge for consumer debts aggregating $ (this figure is adjusted every three years with the next adjustment based on the CPI to be made 4/1/16) or more for the purchase of luxury goods or services owed to a single creditor and incurred within 90 days of filing of the bankruptcy. (Luxury items are not necessary for support or maintenance.) ( 523(a)(2)(C)). d. Cash Advances No discharge for cash advances aggregating $ (this figure is adjusted every three years with the next adjustment based on the CPI to be made on 4/1/16) or more under an open-end consumer credit plan obtained from a single creditor within 70 days of filing. ( 523(a)(2)(C)). 97

107 e. Failure to Properly Schedule Debts No discharge for debts which are neither listed nor scheduled in the bankruptcy petition with the name of the creditor, if known, in time to allow: (i) The creditor to timely file a proof of claim; or, (ii) If the claim is of the type specified under a XVIII A.3.b), f) or h) in time for a timely objection to discharge. ( 523(a)(3)). (iii) (iv) If the creditor had notice or actual knowledge of the bankruptcy, this provision will not apply. Note: Unless the failure to list was deliberate and there were assets in the estate, courts tend to treat debtors leniently under this exception. f. Fraud or Defalcation While Acting as a Fiduciary No discharge for obligations which arose by fraud or defalcation while acting in a fiduciary capacity (must be a real, as opposed to at law, trust relationship), or by embezzlement or larceny. ( 523(a)(4)). g. Domestic Support Obligations No discharge for domestic support obligations (nondischargeable even under a regular Chapter 13 bankruptcy). ( 523(a)(5)). h. Willful and Malicious Injuries No discharge for obligations which arose by willful and malicious injury caused by the debtor to another entity or the property of another entity. ( 523(a)(6)). i. Fines, Penalties and Forfeitures No discharge for obligations which involve certain fines, penalties and forfeitures payable to the government. ( 523(a)(7)). j. Educational Loan Obligations No discharge for obligations which involve an educational loan or similar obligations unless undue hardship is established. (Nondischargeable even under a regular Chapter 13 bankruptcy absent a showing of undue hardship. ( 523(a)(8)). 98

108 k. Death or Injury Caused While Intoxicated No discharge for obligations which arose from the debtor operating a vehicle, vessel or aircraft while under the influence, causing death or personal injury. (Non-dischargeable even under a regular Chapter 13 bankruptcy. ( 523(a)(9)). l. Debts From a Prior Bankruptcy Where Discharge was Denied No discharge for obligations which were or could have been listed in a prior bankruptcy in which the debtor waived or was denied their discharge on any of the grounds listed in XVIII B., below. ( 523(a)(10)). m. Federal Restitution Orders No discharge of federal criminal restitution orders, ( 523(a)(13)). n. Property Equalization Obligations In addition to obligations for alimony maintenance and child support, if there are additional obligations taken on by one of the divorcing spouses which are beyond the scope of alimony, maintenance, or support (i.e. agreeing to pay certain of the predivorce community debts), they are also not dischargeable ( 523(a)(15)). o. Condo Fees Coming Due After the Bankruptcy Filing Fees and assessments for condominiums and cooperative associations that become due and payable after the filing of the bankruptcy are nondischargeable but only to the extent that the period of the assessment is after the filing. The other limitation is that the debtor either physically occupied the unit or rented the unit and received rents during the period. ( 523(a)(16)). p. Filing Fees for Prisoner Litigation In 1996, Congress added a new exception to discharge for a fee imposed by a court for the filing of a case, motion, complaint, or appeal, or for other costs and expenses assessed with respect to such filing. This was supposed to deal with frivolous litigation by prisoners (It was passed in the Prison Litigation Reform Act ). Unfortunately, it does not contain limiting language and may take in any cost or expense imposed by a court in litigation. ( 523(a)(17)). 99

109 q. Amounts Owed on Pension Loans If amounts are owed on pension loans they are not dischargeable in bankruptcy. ( 523(a)(18)). 1. In order for a debt specified under XVIII A.3.b., f., or h., above, to be nondischargeable, a timely complaint must be filed in the Bankruptcy Court and the court must specifically find the debt nondischargeable. All other debts listed above are nondischargeable without court action. Unless the court extends the time, a discharge action must be filed not later than 60 days after the 341(a) meeting of creditors. 2. If a creditor files an action for nondischargeability against a debtor on a consumer debt and the creditor loses, he must pay the debtor's attorneys fees and costs if the court determines the suit was not substantially justified. 3. Just to make matters more complicated in the area of nondischargeable debts, in 1996 Congress added two more provisions denying discharge that can't even be found in the Bankruptcy Code. They are as follows: a. The Anti-Terrorism and Effective Death Penalty Act of 1996 had a buried provision that makes a whole new area of debts nondischargeable. Title 18 (Criminal and Penal Code) of the United States Code, 3613 now contains a provision which make fines and orders of restitution owing to the United States nondischargeable and liens supporting those fines and restitution orders enforceable. b. The other new nondischargeability provision is even more convoluted in its application but fortunately has a much more limited scope. Section 302g of Title 37 of the United States Code has been amended to add new subsections (d) and (e). It makes nondischargeable any reimbursement due for special pay received by a health care professional acting in the military reserves who prematurely voluntarily terminates services in the reserve. B. Exceptions Denying Discharge Of The Debtor In General In addition to denying discharge on a particular debt, there is also the ability in the appropriate circumstances to object to the entire discharge of a debtor. These 100

110 objections may be filed by a creditor or by a Trustee. The debtor may be denied a discharge of all its debts if any of the following is true: 1. Chapter 7 (These provisions also apply to a Chapter 11 when a liquidating plan is involved. ( 1141(d)(3)) Discharge denied if any of these are true: a. The debtor is not an individual. b. With intent to hinder, delay or defraud, the debtor has transferred, removed, destroyed or concealed property of the debtor or the estate at any time within one year before the bankruptcy was filed. c. The debtor has concealed, destroyed, falsified or failed to keep or preserve any record or information from which debtor's financial condition or business transactions could be ascertained (unless otherwise justified). d. In connection with the case, the debtor knowingly and fraudulently made some false oath, account or claim or withheld information from an officer of the court entitled to such information. e. The debtor has failed to satisfactorily explain the loss of assets. f. The debtor has refused to obey a lawful order of the court. g. The debtor has committed any act described in (b) through (f) in another bankruptcy concerning an insider within one year of the filing of his bankruptcy or during its pendency. h. The debtor has been discharged under Chapters 7 or 11 within eight years of filing his bankruptcy petition. i. The debtor has been discharged under Chapters 12 or 13 within six years of filing his bankruptcy unless: (i) (ii) 100% of all unsecured claims were paid; or, 70% of all unsecured claims were paid and the plan was proposed in good faith and was debtor's best effort. j. The court has approved a written waiver of discharge signed by the debtor after filing the bankruptcy. ( 727(a)). k. The debtor failed to complete an approved instructional course on 101

111 2. Chapter 11 personal financial management, unless the U.S. Trustee has determined that no acceptable course exists in the district or that the debtor is physically or mentally unable to take the course. 727(a)(11). If the order confirming the plan was obtained by fraud, the court may revoke the order confirming the plan and discharging the debtor. ( 1144) (See Chapter 7 rules for liquidating Chapter 11 plans when the debtor does not conduct business after filing.) 3. Chapters 12 and 13 If the debtor's discharge was obtained by fraud, the court may then revoke the discharge by request of a party in interest if the party in interest was unaware of the fraud prior to discharge. ( 1228, 1328). 4. Chapter 13 (Super Discharge) XIX. Setoff Rights Under Bankruptcy Chapter 13 offers the fullest discharge to a debtor. A creditor may have a debt declared nondischargeable only to have the debtor either convert to a Chapter 13 or to file a Chapter 13 immediately after discharge. Such a strategy may allow the debtor to discharge an otherwise nondischargeable debt. A. Setoff Rights Of Creditor A setoff exists when the debtor and a creditor owe a debt to each other. The debtor's obligation to the creditor may be set-off or applied to reduce the creditor's obligation to the debtor. Property of the debtor which has been properly set-off prior to the bankruptcy does not become property of the estate upon filing under 506(a). A creditor's claim is a secured claim to the extent of the amount subject to set-off at the time of filing. (This does not affect the priority of other secured creditors under the U.C.C.) Whatever set-off rights a creditor had prior to the filing of a bankruptcy are not voided by the filing of the bankruptcy except: 1. The automatic stay prevents the actual set-off from occurring before the stay is lifted. ( 362(a)(7)). 2. If the claim of the creditor is voidable under bankruptcy law, the right to set-off is destroyed. 102

112 3. A set-off is not allowed if the debt that the creditor wants to set-off was transferred to the creditor by other than the debtor: a. After commencement of the case or within 90 days of its commencement; b. While the debtor was insolvent; and c. For the purpose of creating a set-off. 4. A set-off is not allowed if the debt owed to the debtor was incurred by the creditor: a. Within 90 days of the filing of the bankruptcy; b. While the debtor was insolvent; and c. With the purpose of creating a set-off. ( 553). B. Set-off of Post-Petition Debts Against Pre-Petition Debts Debts must be mutual to be set-off. The set-off of a Pre-petition debt and a Postpetition debt is recoverable by the trustee. C. Preference Rules for Set-off Except as provided below, a lawful set-off may not be avoided as a preference because the creditor's claim was secured to the extent of the set-off and the creditor received at least what it would have received under Chapter 7. The following rules pertain to any set-off made within 90 days of the filing of the bankruptcy: 1. The trustee may recover from the off-setting creditor the amount so offset to the extent that: a. An insufficiency on the date of set-off is less than the insufficiency would have been the later of; (i) (ii) 90 days before filing the petition; or The first date an insufficiency occurred. b. This is to prevent the creditor from improving his position within the 90 days prior to filing. 2. Insufficiency means the amount, if any, that the creditor's claim against the debtor exceeds the debtor's claim against the creditor. 103

113 D. Bank Accounts, Security Interests, and Bankruptcy Set-Off 1. Banker's Lien a. Under both common law and statute, banks and savings and loans have a lien on all property in their possession owing to a customer (not including special accounts, such as funds held in trust for another). b. The right to exercise the lien is recognized under the Bankruptcy Code subject to the restrictions set forth above. c. Under Bankruptcy Code 506, an allowed claim subject to set-off in favor of the creditor is a secured claim to the extent of the set-off. 2. Administrative Freeze The automatic stay must be lifted before the actual set-off may be made. However, the Supreme Court in Citizen's Bank of Maryland v. Stumpf, 116 S.Ct. 286 (1995) found that the administrative freeze of an account is not a set-off or violation of the automatic stay. Once an account is frozen the creditor should immediately make a motion for relief from the stay in order to proceed with set-off. 3. Cash Collateral Any funds in the hands of a bank or savings and loan upon which a banker's lien can be claimed would be defined as cash collateral. If the bank objects, a debtor is not allowed to use cash collateral without an order of the Bankruptcy Court. Permission to use cash collateral generally requires a showing of adequate protection. ( 363). This is another reason for freezing funds pending a determination by the Bankruptcy Court. In the case of set-off, both the creditor and debtor should request relief immediately. 4. Recoupment In certain situations, you are allowed to do a type of set-off called a recoupment which is much more powerful for the creditor. Recoupment is like a set-off due to the fact that you are dealing with mutual debts. However, it involves a more limited situation where the debts that are to be set off arise out of the same transaction or contract. To exercise recoupment is not a violation of the stay nor is it improper to exercise recoupment when both pre- and post-petition obligations are involved. 104

114 XX. Miscellaneous Bankruptcy Provisions and Issues A. Debt Relief Agency Regulations 526 A debt relief agency ( 101(12A)) is any person (attorney or non-attorney) that provides bankruptcy assistance (providing information, advice, counsel, document preparation, filing, attendance at creditor meetings or hearings) to an assisted person. An assisted person is anyone with primarily consumer debts and with less than $186, (amount adjusted every three years based on CPI, with the next adjustment on 4/1/16) of non-exempt property. This provision casts a wide net and sets out a series of disclosures that must be made to debtors ( 527), at the risk of being subject to loss of fees and other liabilities. Each representation of an assisted person requires a very specific written agreement ( 528). It even sets out requirements for any advertisement of bankruptcy services ( 528). This will impact practitioners in most consumer bankruptcy representation. The Supreme Court in Milaveetz, Gallop & Milavetz P.A v. United States, 559 U.S. (2010) confirmed that consumer bankruptcy attorneys were covered by the requirements for a Debt Relief Agency. B. The First Meeting of Creditors 1. Scheduled in the first notice of bankruptcy sent to creditors (usually set about 45 days after the notice is sent). 2. Is a time at which the debtor must make himself available to answer creditors questions, under oath. a. The debtor and his attorney will appear. b. If the debtor is not an individual, then an officer of the debtor will appear. c. Generally the first meeting will last only a short time (15 minutes or less). d. The debtor is only expected to answer general questions about his bankruptcy. (This is not a deposition.) e. The judge is not present but the U.S. Trustee s Office runs the meeting. f. A trustee, if appointed, will also attend and ask questions. g. Creditors are not required to attend and waive no rights by not attending. The creditor can appear at the first meeting by a representative other than an attorney. 3. If a creditor has a substantial number of questions to ask the debtor, he 105

115 may schedule an examination of the debtor. The court will order the debtor to appear and to produce whatever documents the creditor requires. This examination is very similar to a deposition. (F.R.B.P ) Under F.R.B.P. 2004, the debtor or any other person with information about the debtor may be examined and required to produce documents. The scope of the examination is limited to matters regarding the debtor's financial conditions. (Note - Generally an 2004 examination does not have the same evidentiary value as a formal deposition. If the examination is being conducted in connection with an adversary proceeding or a contested matter, the creditor should notice a formal deposition. 4. Several time limits begin to run as of the first meeting of creditors: a. As a general rule, a proof of claim in all bankruptcy proceedings must be filed within 90 days after the first date set for the first meeting of creditors. b. Usually, any objection to discharge must be filed within 60 days after the first date set for a first meeting of creditors. c. Any objections to the debtor's claimed exemptions must be made within 30 days after the conclusion of the first meeting of creditors. d. Note that a) and b) refer to the date first set for the first meeting of creditors. It does not matter whether the meeting is continued or not. The time runs from the date on which the meeting is first scheduled. ( 341) e. The court may extend any of the above time limits for cause, so long as a request is made by motion or ex parte application before the expiration of the time to be extended. 5. If the debtor has filed a plan and has, prior to filing the petition, solicited and received approval of the plan, the Court, on the debtor s motion, may waive the need for a first meeting of creditors. 341(c). C. Status Conferences Under 105, bankruptcy judges, on their own motion or at the request of any party in interest, shall hold status conferences in their cases to make sure that cases move forward expeditiously and economically. While this can occur in any Chapter, it will in all likelihood only occur in Chapter 11 cases with any regularity. At these conferences, the court may issue appropriate orders that: 1. Set a date by which assumption or rejection of executory contracts and 106

116 leases must have occurred. 2. Set dates for the filing of a disclosure statement and plan in a Chapter 11 case and the solicitation of acceptances. ( 105). 3. While 1. & 2. above are explicit, many judges use this status conference to obtain more information on the case and grant a wide variety of relief as they deem appropriate. D. The Avoiding Power As of the filing of the bankruptcy, the trustee or debtor-in-possession has special powers to set aside certain transfers of assets to third parties which, if not transferred, could be used to help pay all creditors. This power is usually used to void liens unperfected prior to the filing of bankruptcy. The trustee or debtor in possession is given the power to set aside any transfer that could be set aside by: 1. A hypothetical judicial lien holder; 2. A hypothetical creditor with an unsatisfied execution; 3. As to real property, a hypothetical bona fide purchaser for value who has no knowledge of any other transfer; or, 4. Any actual creditor of the debtor under the Bankruptcy Code or under any applicable state or federal law. (This includes rights under state fraudulent conveyance laws, among others.) ( 544) 5. The Trustee may also set aside any transfer which would constitute a fraudulent conveyance (transfer without reasonably equivalent value) and any post-petition transfer of property outside the ordinary course of business, made without court approval. 6. Generally, an action to enforce the bankruptcy avoiding powers may not be commenced after: a. two years from the appointment of a trustee, or b. the case is closed or dismissed. ( 546(a)). 7. The avoiding powers are also limited by numerous specific exceptions listed in 546. E. Return of Goods The trustee (or DIP) in a Chapter 11 case has the right to move the court (such motion must be brought within 120 days of the filing of the Chapter 11 case) for 107

117 the right to return pre-petition delivered goods to the seller if such return is in the best interests of the estate. The seller may then offset its pre-petition claim for the purchase price of the goods returned. 546 (h). F. Reclamation If, in the ordinary course of a seller s business, goods were delivered to an insolvent debtor, then they are subject to reclamation under the following rules: 1. Goods were delivered 45 days prior to the bankruptcy filing. 2. The seller has made written demand for reclamation within 45 days of receipt of the goods or 20 days after the filing of the bankruptcy, whichever is later. 3. This right may not trump a secured creditor who has a valid, perfected lien on the goods, once delivered to the debtor. Even if the creditor fails to provide notice, it still has the right, provided under 503(b)(9), to have an administrative claim for goods delivered within 20 days of the bankruptcy filing. 543(c). G. Loss of Certain Collateral After the Filing of Bankruptcy 1. After Acquired Property Any after-acquired property clause contained in a security agreement is cut off by the filing of a bankruptcy. Assets or interests acquired by the debtor or the estate after the filing are free of any lien. Most often this affects: a. Crop Liens Crop liens are cut off for all crops not in existence when the bankruptcy is filed. There can be substantial controversy over the meaning of the term in existence. b. Inventory Inventory which is purchased or created after filing. Any work-inprocess inventory is usually prorated among the debtor's and creditors' interests. c. Accounts Accounts which are earned after filing are not covered by the lien. ( 552(a)). 108

118 2. Exception to Loss of After Acquired Property Collateral H. Local Practice If the security agreement identifies specific collateral and the products, proceeds, offspring, rents or profits of that collateral, then the interest continues in those particular products, proceeds, offspring, rents or profits. This will generally create tracing problems. ( 552(b)). (Note: If new collateral is about to come into existence, i.e. the budding of a new crop, the timing of the bankruptcy may be crucial to assure that the old lien does not attach to the new collateral. Matters are seldom handled in the same fashion from one Bankruptcy Court to another. Each judge exercises considerable latitude in establishing his court's procedures and rules. The court clerk can answer any procedural questions. I. When to Call an Attorney In most cases, it is not cost effective to retain an attorney to handle most bankruptcy matters (especially filing proofs of claim), especially if there is no possibility for recovery. An attorney may be helpful if: 1. A secured contract is in default. 2. A debt may be nondischargeable. 3. The case is relatively complex or the claim is large. 4. The debtor wants to reaffirm its obligation. 5. Loan documentation is at issue. 6. A lessor has not been receiving payment. 7. An extensive examination of the debtor is necessary. J. Lack of Settled Law The established bankruptcy rules and practice today may change substantially in the future. Courts are not unanimous in their approach to similar problems. Conflicting, published bankruptcy opinions are available to support nearly every proposition. BAPCPA has, and will continue to, create as many questions as it will answer. Key to Effective Bankruptcy Administration For most creditors, a successful approach to administering bankruptcy matters will combine flexibility and common sense. While no approach will work every time, a consistent, hard line approach will be successful less often than an 109

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