Bankruptcy: Chapter 7 Liquidations

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   NY FarmNet                              1-800-547-3276
   Department of Applied Economics and Management, Cornell University

                Overview of Bankruptcy Chapter 7
A Chapter 7 bankruptcy is a liquidation proceeding, and is the most logical choice for
farmers who must terminate their farming operation. Under Chapter 7, a trustee is
appointed to liquidate all nonexempt assets and distribute the proceeds to creditors.
Secured creditors receive either the value of their collateral or the collateral itself. The
proceeds of the debtor's nonexempt assets are used to satisfy claims according to the
priorities established by the Bankruptcy Code. The farmer debtor can retain property
claimed exempt, although it may be subject to pre-bankruptcy liens.

The Trustee
Once a debtor files a voluntary Chapter 7 petition with the clerk of bankruptcy court, a
trustee is appointed to wind up the debtor’s business affairs. The trustee, who is
generally an attorney or someone familiar with bankruptcy laws and the courts, has a
number of responsibilities and powers that enable the person to deal with the debtor's
property, debts, and creditors.

The trustee:
 Conducts a meeting of creditors usually within 40 days after the filing date. The
   debtor must appear at this meeting and submit to an examination under oath by
   both the trustee and interested creditors. Generally, the examination is limited to
   questions concerning the extent and whereabouts of the debtor's assets.
 Liquidates all property of the estate, created at the initiation of bankruptcy case. The
   bankruptcy estate consists of all the debtor’s legal or equitable interests in property
   as of the filing date. This includes all real property, crops, livestock, machinery and
   equipment, interests in cooperatives, farm program entitlements, contract rights,
   and leases. The estate also includes:
   - Property recovered by the trustee from creditors or other third parties.
   - Property that the debtor is entitled to acquire by inheritance, divorce decree,
       property settlement, life insurance policy, or death benefit plan within 180 days
       of filing the bankruptcy petition.
   - Income from other assets that are the property of the estate.

   -    A debtor's earnings from services performed after the filing of a Chapter 7
        petition but before the termination of the case are not included in the estate. So
        creditors cannot look to income a debtor earns from off-farm employment once
        the bankruptcy petition has been filed.
 A trustee can use, sell, or lease property in the debtor's estate in the ordinary course
   of business.
 A trustee may be authorized by the bankruptcy court to operate the debtor's
   business for a limited time if it’s in the best interest of the estate and the creditors.
   For example, if a farm debtor is in the hog business and the estate has hogs of
   varying sizes, the trustee may be authorized to feed the hogs until they reach market
   weight. This will maximize the amount recovered by the estate.
   If livestock owned by a farm debtor is subject to a valid, perfected security interest,
however, the trustee will not, in most cases, continue care and feed of it. Instead the
trustee will likely abandon the property so as to limit the estate's continued
 A trustee will avoid, or set aside, certain of the debtor's transactions that were
   entered into prior to the filing of the bankruptcy case. The laws governing these
   avoidance powers are complex, but the following details can clarify the issue:
   - The trustee may avoid any transfers of property to a creditor to repay a pre-
        existing debt made by the debtor within 90 days before filing the bankruptcy
        petition. This occurs, particularly, if the transfer would allow a creditor to receive
        more than entitled to. These transfers, which include transferring ownership or
        possession of property or granting a security interest in property, are called
        "preferences" under the Bankruptcy Code.
        A trustee can use this avoidance power to set aside any 11th hour security
        interests that were obtained by zealous unsecured creditors. The 90-day period
        may be extended to one year for transfers made to insiders of the debtor.
        (Insiders are relatives of an individual debtor, partners in a partnership and
        shareholders of a corporation.)
   - A trustee can review all payments made to creditors within 90 days of the filing
        date and recover payments made out of the ordinary course of business. Not all
        transfers made by the debtor within 90 days of filing are avoidable. The
        following do not constitute preferential transfers: Transfers made for new value,
        payments for debts incurred in the ordinary course of business, and the
        perfection of purchase money security interests within the time period required
        by the Uniform Commercial Code (UCC).
        In regards to preferential transfers, the law, in general, takes away from a
        creditor any transactions that might improve a creditor’s position on the eve of
        bankruptcy. This is in line with the underlying Bankruptcy Code policy:
        Creditors should receive equal treatment.
   - The bankruptcy trustee also may avoid fraudulent transfers made within one
        year before the filing. The Bankruptcy Code defines fraudulent transfers as
        though made with the intent to hinder, delay or defraud a creditor. It also

       includes transfers for which the debtor received less than a reasonably equivalent
       value in exchange for the transfer. This means a trustee can avoid gifts,
       assignments or other transfers made to relatives to shelter assets from the claims
       of creditors.
   - A trustee may also avoid transfers under the New York Fraudulent Conveyance
       Law, which has six-year statute of limitations.
   - The trustee may reject or continue a debtor’s executory contracts and
       leases. These are agreements, such as equipment leases and real property leases,
       under which the obligations of both parties to the contract are unperformed.
       Certain farm program contracts, such as Conservation Reserve Program
       contracts, are also executory (executed) contracts.
       A trustee who elects to assume an executory contract must either cure any
   defaults in the contract or provide the other party to the contract with adequate
   assurances that the defaults will be cured. In a Chapter 7 case, the trustee has 60
   days from the filing of the bankruptcy petition to make a determination as to
   whether such contracts or leases should be assumed.
        The courts have determined that a contract for deed in which the debtor is the
   buyer does not constitute an executory contract under the Bankruptcy Code.
   Therefore, the trustee doesn’t need to determine immediately whether to assume
   such contracts or cure all defaults under them.
       New York does not use the term contract for deed. A trustee may assume or
   reject an executed contract for the purchase and sale of real property whether the
   debtor was buyer or seller. In New York, "land contract" refers to an agreement to
   sell land over time where the seller retains title until the price is paid. A trustee may
   assume or reject these contracts.
       The trustee also can avoid or set aside transfers not properly recorded or
   perfected under state law. If, for example, a creditor has failed to perfect a security
   interest under the UCC, the trustee may avoid the lien in its entirety. In addition, a
   trustee may avoid certain statutory liens or liens created by operation of law, such as
   any statutory lien for rent.

Exempt Property
Exempt property includes a debtor’s real and personal property that
cannot be seized or sold to satisfy creditors’ claims. Exemptions, which are not
available to partnerships or corporations, are intended to provide individuals with the
minimum to start anew following bankruptcy.

New York State law determines exemptions, and debtors in the state may not opt for
federal exemptions. (See the list of New York State Exemptions at the end of this

Fair market value is used to determine the value of exemptions. If exempt property is
subject to a lien, the debtor may claim as exempt the value of the property in excess of

the lien amount – or its "equity." If a married couple files a joint petition, both spouses
must claim the same exemptions, but the value limitations may be doubled.

Property claimed by a debtor as exempt generally remains subject to any voluntary
liens that were granted. But the Bankruptcy Code grants a debtor the power to avoid
certain consensual security interests – called lien avoidance power – that would
otherwise attach to certain types of personal property, including implements, tools of
the trade, household goods, furnishings, and personal effects. Lien avoidance power is
subject to the value limitations. In New York, for example, the “tools of the trade”
exemption is $600, so the avoidance rule is not very valuable. In some states, lien
avoidance power can be applied to farm machinery. But it does not apply to “purchase
money liens” where the lender gives money to purchase an item or finances the
purchase and retains a lien until the price is paid.

It may be possible to convert nonexempt assets into exempt property before filing a
bankruptcy petition. But this should be undertaken only after careful consideration of
its ramifications.

Once debtors select their exemptions, the trustee and creditors are given a period of
time to object to them. In New York, it is 30 days from the conclusion of the creditors
meeting. If no one objects, the exemptions stand.

Distribution Priorities
After a trustee has collected all nonexempt assets and liquidated them, the estate is
ready to be closed. Generally, property that is subject to a valid lien, but in which the
debtor has no equity, is used to satisfy the lien. If a creditor ends up with less money
than what is owed, the person can file a claim as an unsecured creditor with the
bankruptcy court.

The Bankruptcy Code establishes the following priorities for payment of claims:
1. Administration expenses, such as the trustee’s commission and professional fees.
2. Certain claims incurred in an involuntary case.
3. Wages, salaries and benefits incurred within 90 days before filing up to $4,650.
4. Claims of persons raising grain against a debtor who operates a grain storage facility
and fishermen up to $4,650.
5. Deposits for rental of certain property up to $2,100.
6. Claims for child and spousal support.
7. Certain taxes.
8. Unsecured claims.
Next in line are creditors whose claims are for fines, penalties, or damages which is not
compensation for direct monetary losses suffered by the claim holder.

If property remains after these claimants, all unsecured creditors receive interest at the
legal rate from the date the bankruptcy petition was filed. The debtor receives any
funds or property remaining after interest is paid. If the debtor's assets are insufficient
to pay in full all of the claims within a particular classification, all creditors share on a
pro-rata basis.

If there are numerous disputes between the debtor and creditors or among creditors,
complete administration of the estate may take several months. If there are no disputes
involving the debtor, the person’s involvement with the administration of the case
usually is complete within 120 days from the date the petition was filed. By that time,
the debtor will have received a discharge from all liabilities listed on the bankruptcy
petition. The discharge does not release any property that the debtor retains from any
lien granted prior to filing bankruptcy. The bankruptcy court extinguishes only those
liens that may be avoided; all others remain intact.

Chapter 7 bankruptcy is designed for farmers who have decided to stop farming. Once
a Chapter 7 bankruptcy petition has been filed, all property passes to a trustee, and a
farmer cannot continue to operate the business. The trustee collects all the debtor's
nonexempt property and uses it to pay unsecured creditors. To the extent that this
property is insufficient, the debtor generally will be discharged from any further

The following exemptions are allowed pursuant to New York State law. Exemptions are
found in various laws, but the bulk of them are governed by §§5205 and 5206 of the
Civil Practice Law and Rules and §§282 and 283 of the Debtor and Creditor Law. The
following items of personal property are exempt up to $5,000.00.

I.      All stoves and necessary fuel for 60 days.
II.     Sewing machine.
III.    Family bible and pictures. School books not exceeding $50 in value.
IV.     Seat or pew occupied in a place of public worship.
V.      Domestic animals with necessary food for 60 days up to $450 in value.
VI.     All wearing apparel, household furniture, refrigerator, radio, television,
        crockery, tableware and cooking utensils.
VII.    Wedding ring, watch not exceeding $35.
VIII.   Necessary working tools including those of a mechanic, farm machinery, team,
        professional instruments, furniture, and library not exceeding $600 in value.

The following are exempt without regard to amount unless otherwise stated:

I.      Annuities (There is a lot of conflicting case law concerning the exemption for
        annuities. Individuals should consult with an attorney regarding the matter.)
II.     All pensions, Kehoe plans, 401(k) plans and IRAs.
III.    90% of all income earned within 60 days prior to the bankruptcy filing.
IV.     90% of any money due or to become due for the sale of milk produced on a farm.
V.      Security deposits for an apartment, utilities, etc.
VI.     Medical and dental accessions.
VII.    Guide dog.
VIII.   Recovery for personal injuries up to $7,500.
IX.     Proceeds and avails of an insurance policy.
X.      $10,000 in equity per debtor in his/her homestead.
XI.     In the event the debtor does not claim a homestead exemption, he/she may claim
        a cash exemption of $2,500. Cash is specifically defined as currency of the United
        States at face value, savings bonds, federal, state and local income tax refund,
        and deposit accounts in any state or federally chartered depository institution.
        (For example, a mutual fund held in a brokerage account is not considered
        exempt cash.)
XII.    $2,400 equity in a motor vehicle for each debtor.
XIII.   All payments for social security, unemployment compensation or local public
        assistance, veterans benefits, disability, illness or unemployment benefits,
        alimony, and support or separate maintenance to the extent reasonably necessary
        for the support of the debtor and dependents.
XIV.    All payments under a stock bonus pension.
XV.     Profit sharing plan.
XVI.    All payments traceable to an award under crime victims reparation, payment on
        account of wrongful death, and compensation of the loss of future earnings to the
        extent reasonably necessary for the support of the debtor and any dependents.


Reference: Kunkel, Phillip L. ,Scott T. Larison and Hall & Byers, P.A., Attorneys
Chapter 11 Reorganizations, The College of Agricultural, Food and Environmental
Sciences, University of Minnesota Extension Service, St. Cloud, MN 1998

Revised by Allan Bentkofsky, Attorney; Bentkofsky & Simmonds, LLP, Auburn, NY
December 2002


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