Dynamic business law 4e kubasek 4e CH32

Chapter 32
Bankruptcy and Reorganization

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Overview

• LO32-1: What are the goals of the Bankruptcy Act?
• LO32-2: What is the basic set of procedures for bankruptcy cases?
• LO32-3: What specific types of relief are available through bankruptcy?

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Chapter 32 Hypothetical Case 1
•

Julius Talbert owes Tom Finnegan $10,000 on an unsecured promissory note. The note became due and payable
three months ago. Last week, Finnegan received notice from federal bankruptcy court that Talbert had filed for
Chapter 7 bankruptcy. Finnegan would like to forego participation in the bankruptcy proceedings and instead file a
civil lawsuit against Talbert for the $10,000 owed (plus associated interest, court costs, and attorney's fees). Once
Finnegan secures a civil judgment against Talbert, he plans to execute on the judgment by seizing any nonexempt
property Talbert owns in satisfaction of the debt.

•

Does Tom Finnegan have the legal right to pursue civil litigation against Julius Talbert for the $10,000 owed on the
promissory note?

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Chapter 32 Hypothetical Case 2
•

Go to Bankruptcy Exemptions—What Do I Keep When I File for Bankruptcy? and research the Chapter 7 bankruptcy exemptions allowed in your particular
state ("exemptions" represent property the debtor is allowed to keep, even though he/she is filing for Chapter 7 liquidation bankruptcy). Based on your
research, are your state's Chapter 7 exemptions more or less generous than the federal bankruptcy exemptions outlined in Exhibit 32-4 of the textbook?

Although bankruptcy is primarily a matter of federal jurisdiction (delegated to the federal government in Article I, Section 8 of the United States constitution),
the federal government does allow the individual states to craft their own Chapter 7 exemptions for individuals filing in their particular state. If the state
chooses to enact its own Chapter 7 exemptions, the state can then require those filing in its jurisdiction to use the state exemptions, or it can allow the
bankrupt debtor to choose the federal exemptions outlined in Exhibit 32-4 of the textbook. If the state chooses not to enact its own Chapter 7 exemptions,
the federal exemptions apply by default.

•

In your reasoned opinion, should Chapter 7 bankruptcy exemptions be uniformly applied in all states (by applying the federal bankruptcy exemptions in every
state), or do you favor the idea of allowing the individual states to craft their own Chapter 7 exemptions?

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Bankruptcy Law

• Bankruptcy Act: Purpose is to provide debtors with opportunity to realize a
fresh financial start

• Offers protection to creditors

• A matter of federal jurisdiction

• United States Constitution Article I, Section 8: "Congress shall have the power . . .
To establish . . . uniform laws on the subject of bankruptcies throughout the
United States"

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Bankruptcy Abuse Prevention and Consumer Protection Act of
2005

• Most comprehensive change to bankruptcy law in over 25 years
• Effect: More difficult for individual debtor to qualify for Chapter 7 (liquidation)
bankruptcy

• Reasons for its passage:
•
•
•
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Increased number of bankruptcy filings
Significant creditor losses associated with bankruptcy filings
Debtor abuse of bankruptcy protection rights
Debtor ability to repay

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Types of Bankruptcy
Relief by Chapter

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•
•
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Chapter 7: Sale of nonexempt assets, and distribution of money to creditors
Chapter 9: Adjustment of municipalities' debts
Chapter 11: Reorganization of debtor's financial affairs under supervision of bankruptcy court
Chapter 12: Reorganization of family farmers' debts
Chapter 13: Reorganization of individual's debts
Chapter 15: Recognition of insolvency proceedings pending in foreign country, and relief for
foreign debtors

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Attributes of Bankruptcy Cases
•
•
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Procedural rules for bankruptcy cases set forth in federal bankruptcy rules

•

Bankruptcy appeals proceed to federal district court judge

Cases filed in federal district courts and referred to bankruptcy judges
Bankruptcy judges appointed and serve 14-year terms; judges make decisions regarding
administration of bankruptcy proceedings

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Bankruptcy Procedures
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•
•
•
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Bankruptcy petition filed
Court grants automatic stay, freezing creditor actions outside bankruptcy court against debtor's estate
Court determines whether order of relief should be granted
Creditors meet with debtor
Payment plan created and approved, usually by creditors and court
Payment plan carried out through actions of trustee and debtor
Debts remaining after plan executed usually discharged

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Chapter 7: Voluntary Versus Involuntary Petition

• Voluntary petition: Debtor files
• Involuntary petition: Creditor(s) file, forcing debtor into bankruptcy
•
•

12 or more creditors: Three or more creditors with unsecured claims totaling at least
$14,425 must sign involuntary petition
Less than 12 creditors: Single creditor with claim totaling at least $14,425 can file
involuntary petition

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Required Schedules for
Chapter 7 Liquidation
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•
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Schedule A: All real property
Schedule B: All personal property
Schedule C: Exempt property listed in Schedules A and B

Schedule D: Secured creditors and their addresses
Schedule E: Unsecured priority claims
Schedule F: Unsecured nonpriority claims
Schedule G: Executory contracts and expired leases
Schedule H. List of co-debtors
Schedule I: Statement of debtor's current income
Schedule J: Statement of current expenditures

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Federal Bankruptcy Exemptions

• Up to $22,975 for residence (homestead exemption)
• Interest in motor vehicle up to $3,675
• Interest in jewelry up to $1,550
• $1,225 of any property debtor chooses (wild-card exemption)

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Federal Bankruptcy Exemptions (cont'd)

• Up to $2,300 in tools of trade and professional books
• Any unmatured life insurance contract owned by debtor
• Professionally prescribed health aids
• Right to receive certain personal injury awards up to $22,975
• Retirement funds in IRA/SEP up to $1,245,475 per person

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Voidable Transfers
•

Preferential payments: Trustee can recover (and include in bankruptcy estate) payments made by insolvent
debtor that give preferential treatment to one creditor over another, if debtor made such payments within
90 days of bankruptcy filing

•

Fraudulent transfers: Trustee can recover (and include in bankruptcy estate) transfers made with intent to
defraud creditors, if debtor made such transfers within two years of bankruptcy filing

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Classes of Priority Claims Among Unsecured Creditors
•
•

Class 1: Alimony/child support

•

Class 3: Unsecured claims in involuntary bankruptcy that arise through debtor's ordinary business expenses,
from date of filing petition to date of trustee appointment

•
•

Class 2: Court costs, trustee fees, attorney, fees, other costs associated with administration of bankruptcy
estate

Class 4: Unsecured claims for unpaid wages, salaries, and commissions earned within 180 days of filing of
petition
Class 5: Unsecured claims for contributions to employee retirement plans

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Classes of Priority Claims Among Unsecured Creditors (cont'd)
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•
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Class 6: Unsecured claims by farmers and fishers against grain operators of grain storage facilities /fish
storage/processing facilities
Class 7: Claims for deposits given to debtor in connection with property/services never given
Class 8: Certain taxes and penalties due government
Class 9: Claims in bankruptcies related to federal depository institutions
Class 10: Unsecured claims for personal injuries and deaths caused by debtor's operation of motor vehicle
under influence of alcohol/drugs

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Nondischargeable Debts Under Bankruptcy Code

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Claims for back taxes/government fines within three years of bankruptcy filing

•
•
•

Claims by creditors not listed on schedule and who did not have notification of bankruptcy proceedings

Claims for liabilities against debtor for his/her obtaining money/property under false pretenses, false
representation, or fraud
Claims based on fraud, embezzlement, and larceny by debtor while he/she acting in fiduciary capacity
Alimony, child support, and certain property settlements

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Nondischargeable Debts Under Bankruptcy Code (cont'd)
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Claims of willful/malicious conduct by debtor that caused injury to another person/property
Specific student loans, unless payment of loans would impose undue hardship on debtor
Judgments against debtor for claims resulting from debtor's driving under the influence

Debts not discharged in previous bankruptcies
Claims for money borrowed to pay tax to federal government that would be nondischargeable
Cash advances on credit card

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Chapter 32 Hypothetical Case 3
•

Effective October 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) represents the most sweeping
change to the United States Bankruptcy Code in almost 40 years. Applauded by the credit card industry, which had lobbied the United
States Congress for several years before its enactment, BAPCPA makes it extremely difficult, if not impossible, for middle income Americans
to file for Chapter 7 (liquidation) bankruptcy. (Traditionally, the United States Bankruptcy Court used Chapter 7 for debtor rehabilitation,
allowing the debtor to discharge preexisting debts in return for his/her relinquishment of nonexempt property, and the nonexempt
property was used to partially satisfy creditor claims.) Instead, BAPCPA channels bankrupt debtors into Chapter 13 (reorganization)
bankruptcy, with strict restrictions against debt forgiveness.

BAPCPA has come under criticism, in part because it allows no exceptions for unanticipated medical expenses (a Harvard University study
concluded that more than 50 percent of bankruptcies are attributable to unpaid medical bills), loss of employment, or financial difficulties
resulting from dissolution of marriage.

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Chapter 32 Hypothetical Case 3 (cont'd)
•

BAPCPA critics argue that individuals so affected should be allowed to file Chapter 7 (liquidation) bankruptcy protection. Critics
further contend that without such a change in BAPCPA, the only real discharge for many debtors will be death.

•

From a legal standpoint, should the United States Congress rewrite BAPCA and create exceptions for unanticipated medical
expenses, loss of employment, or financial difficulties resulting from dissolution of marriage (and allow the bankrupt debtor to file
for Chapter 7 bankruptcy protection)?

•

From an ethical standpoint, should not our society give these people a break? Are not such people, and their financial situations,
substantially different from consumers who max out their credit cards on mad shopping sprees?

For reference, see Bankruptcy Overhaul Enacted—New Rules for Bankruptcy Implemented.

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Chapter 32 Hypothetical Case 4
•

Foster Williams, a 43-year-old California resident, lost his job two years ago and has not been able to find work since. He was diagnosed
with colon cancer one year ago, and his medical bills have piled up. Williams has more than $75,000 in credit card debt, a $450,000
mortgage, $275,000 in medical bills, and $50,000 in back child support and alimony payments to his ex-wife, Karina Chatsworth.

Last month, Williams filed for bankruptcy under Chapter 7. He has never filed for bankruptcy before.

Chatsworth filed suit last week to try to get the child support and alimony payments she is owed before Williams's bankruptcy proceedings
are complete.

•

Is it permissible under bankruptcy law for Chatsworth to pursue the back child support and alimony payments while Williams's bankruptcy
proceedings are ongoing? Explain your answer.

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