An Overview of the Bankruptcy Code

An Overview of the Bankruptcy Code Federal Bar Association Bankruptcy Section January 2007 William L. Wallander Courtney S. Lauer Vinson & Elkins L.L.P. Dallas, Texas ____________________________________________________________________ TABLE OF CONTENTS I. AN OVERVIEW OF THE BANKRUPTCY CODE ........................................................1 A. B. C. D. E. INTRODUCTION .............................................................................................................. 1 POWER OF THE BANKRUPTCY COURT ............................................................................. 1 COMMENCEMENT OF THE CASE ...................................................................................... 1 MEETING OF CREDITORS ................................................................................................ 2 AUTOMATIC STAY ......................................................................................................... 3 1. Effect of the Automatic Stay .................................................................................. 3 2. Relief from the Automatic Stay.............................................................................. 5 USE/SALE OF THE PROPERTY OF THE ESTATE .................................................................. 6 OBTAINING CREDIT........................................................................................................ 6 EXECUTORY CONTRACTS AND UNEXPIRED LEASES ......................................................... 7 PROOF OF CLAIM ........................................................................................................... 8 SECURED/UNSECURED STATUS OF CREDITORS................................................................ 8 PROPERTY OF THE ESTATE ............................................................................................. 9 DISCHARGE ................................................................................................................... 9 1. Effect of a Bankruptcy Discharge........................................................................... 9 2. Exceptions to Discharge......................................................................................... 9 3. No More “Super Discharge” in Chapter 13........................................................... 10 TURNOVER OF PROPERTY OF THE ESTATE ..................................................................... 10 DISCRIMINATION ......................................................................................................... 10 “STRONG-ARM” POWERS ............................................................................................. 11 PREFERENCES .............................................................................................................. 11 FRAUDULENT TRANSFERS ............................................................................................ 12 UNAUTHORIZED POST-PETITION TRANSFERS ................................................................ 12 SETOFFS IN BANKRUPTCY ............................................................................................ 12 ABANDONMENT OF PROPERTY OF THE ESTATE .............................................................. 13 CHAPTER 7 – LIQUIDATION .......................................................................................... 13 1. The Trustee.......................................................................................................... 13 2. Liquidation/Distribution of Property of the Estate ................................................ 14 3. “Means Test” – a Major Hurdle to Filing a Chapter 7........................................... 15 CHAPTER 13 – INDIVIDUAL REORGANIZATION .............................................................. 15 1. The Process.......................................................................................................... 15 2. The Trustee.......................................................................................................... 16 3. Qualifications and Reasons to be in Chapter 13.................................................... 16 CHAPTER 11 – REORGANIZATION ................................................................................. 16 1. “Debtor in Possession”......................................................................................... 16 2. Chapter 11 Trustee............................................................................................... 17 3. Conversion or Dismissal ...................................................................................... 17 4. Chapter 11 Plan of Reorganization Process .......................................................... 18 F. G. H. I. J. K. L. M. N. O. P. Q. R. S. T. U. V. W. II. GLOSSARY OF BANKRUPTCY TERMS ....................................................................26 -i- I. AN OVERVIEW OF THE BANKRUPTCY CODE A. Introduction This paper provides an overview of the Bankruptcy Code in general terms and includes discussion of some of the major changes made by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”).1 B. Power of the Bankruptcy Court The bankruptcy court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of the Bankruptcy Code.2 Bankruptcy courts are courts of equity and, accordingly, are empowered with broad remedial powers to fashion relief in furtherance of the provisions, policies and principles of the Bankruptcy Code.3 Although the power of the bankruptcy court is broad, Section 105 does not authorize a bankruptcy court to order relief that is inconsistent with the Bankruptcy Code or is otherwise unavailable under more specific laws.4 C. Commencement of the Case A bankruptcy case may be commenced voluntarily when an eligible debtor files a bankruptcy petition. 5 An individual may file a case under Chapter 7 or, if the individual has regular income and owes less than $307,675 in noncontingent, liquidated, unsecured debt and less than $922,975 in noncontingent, liquidated, secured debt, under Chapter 13.6 An individual may file jointly with his or her spouse.7 As will be discussed below in the Section on Chapter 7, changes to the Bankruptcy Code under BAPCPA have made it far more difficult for an individual to file a Chapter 7.8 One such change that will apply to individual debtors seeking relief under Chapter 7 or under Chapter 13 is the requirement, under new subSection (h) of Section 109, that an individual, to be eligible to be a debtor, must have “during the 180-day period preceding the date of filing of the petition by such individual, received from an approved nonprofit budget and credit counseling agency . . . an individual or group briefing (including a briefing conducted by telephone or on the Internet) that outlined the opportunities 1 The authors acknowledge the contributions of Marc Taubenfeld, who authored Section I(V) “Chapter 13 – Individual Reorganization” of this paper, and the helpful comments of Rob Colwell. 2 3 See 11 U.S.C. § 105(a). In re Mirant Corp., 378 F.3d 511, 523 (5th Cir. 2004); Davis v. Davis (In re Davis), 170 F.3d 475, 492 (5th Cir. 1999). 4 See Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206, 108 S.Ct. 963, 968 (1988); Chiasson v. J. Louis Matherne and Assoc. (In re Oxford Mgt, Inc.), 4 F.3d 1329, 1333-1334 (5th Cir. 1993). 5 6 See 11 U.S.C. § 301. See 11 U.S.C. § 109(e). If the individual’s debt exceeds either of the threshold amounts, he may only file under Chapter 7 or Chapter 11. These figures are adjusted periodically, pursuant to 11 U.S.C. § 104. 7 8 See 11 U.S.C. §§ 301 and 302(a). The general effective date of the Bankruptcy Reform Act is October 17, 2005. The major changes under Chapter 7 will apply to cases filed on or after the effective date. An Overview of the Bankruptcy Code – Page 1 for available credit counseling and assisted such individual in performing a related budget analysis.” Corporations and other business entities may file under Chapter 7 or Chapter 11. A corporation or other business entity that files under Chapter 7, however, is not eligible to receive a discharge.9 An individual, partnership or corporation also may be placed into a bankruptcy involuntarily.10 Involuntary petitions may be filed by three or more holders of noncontingent, undisputed and unsecured claims which aggregate at least $12,300 if a debtor has 12 or more holders of such claims. 11 If a debtor has fewer than 12 holders of noncontingent, undisputed unsecured claims, one or more of such holders that hold an aggregate claim of at least $12,300 may file the involuntary petition. 12 If an involuntary petition is filed, the bankruptcy court will hold a trial to determine whether an order for relief in bankruptcy should be granted.13 D. Meeting of Creditors Within a reasonable time after an order for relief in a bankruptcy case, the United States Trustee will convene and preside at a meeting of the creditors.14 The bankruptcy court is specifically prohibited from presiding at or attending any such meeting of creditors.15 At the meeting of creditors, the bankruptcy debtor will be put under oath, and creditors will be provided with an opportunity to ask the debtor questions regarding indebtedness, collateral, etc.16 9 See 11 U.S.C. § 727(a)(1). 10 Interestingly, Section 303 states that an involuntary case may be commenced “only under Chapter 7 or 11 of this title, and only against a person . . . that may be a debtor under the Chapter under which such case is commenced.” 11 U.S.C. § 303(a). If an individual is not eligible to be a debtor under any Chapter of the Bankruptcy Code unless he or she has first met the new credit counseling requirements of Section 109(h)(1), and, presumably, one cannot force an individual to “receive” credit counseling, it raises the issue of whether an involuntary petition may be commenced against an individual under the new provisions. 11 12 See 11 U.S.C. § 303(b)(1). See 11 U.S.C. § 303(b)(2). This would exclude claims of employees or insiders of the debtor and any transferee of an avoidable transfer, e.g., preferences, fraudulent transfer, unauthorized post-petition transfer, etc. 13 If the court finds that the debtor is generally not paying its debts as they become due, unless they are the subject of a bona fide dispute, or if a custodian was appointed or took possession of substantially all of the property of a debtor, the court will order relief. If a bankruptcy court finds that an involuntary petition is filed in bad faith, the entities filing such a petition may be subject to liability. See 11 U.S.C. § 341(a). In a Chapter 7 case, the appointed Chapter 7 trustee will usually preside over these meetings. 15 16 14 See 11 U.S.C. § 341(c). See 11 U.S.C. § 343. An Overview of the Bankruptcy Code – Page 2 E. Automatic Stay 1. Effect of the Automatic Stay The automatic stay is a broad federal injunction designed to stop most acts or actions against a debtor or property of the estate.17 Section 362 stays commencement or continuation of all judicial, administrative or other actions or proceedings against a debtor, enforcement against a debtor of any judgment, acts to obtain possession of property of the estate or to exercise control over property of the estate, acts to create, perfect or enforce liens against property of the estate, acts to create, perfect or enforce against property of the debtor any lien, any act to collect, assess or recover a claim against the debtor, or any setoff.18 Essentially, the automatic stay operates to prevent all collection efforts against a borrower in bankruptcy. However, Section 362(b) lists certain actions that are excluded from the operation of the automatic stay. The number of actions that are excluded from the operation of the automatic stay increased significantly with the amendments to Section 362 under BAPCPA. Some of the excluded actions are: • • the commencement or continuation of a criminal action or proceeding against the debtor (§ 362(b)(1)); the commencement or continuation of a civil action or proceeding for the establishment of paternity or the establishment or modification of a “domestic support obligation,” concerning child custody or visitation, for the dissolution of marriage (except to the extent that such proceeding seeks to determine the division of property that is property of the estate), or regarding domestic violence (§ 362(b)(2)(A)); the collection of a domestic support obligation from property that is not property of the estate (§ 362(b)(2)(B)); the perfection of a lien within thirty (30) days 19 of the granting of the lien by the debtor (§ 362(b)(3)); the commencement or continuation of an action or proceeding by a governmental unit to enforce such governmental unit’s police and regulatory power (§ 362(b)(4));20 a tax audit, the issuance to the debtor of a notice of tax deficiency, a demand for tax returns, or a tax assessment (§ 362(b)(9)); • • • • 17 18 19 20 See, generally, 11 U.S.C. § 362. See 11 U.S.C. § 362(a). Section 547(e)(2)(A) formerly referenced a ten (10) day time period. Note that a governmental unit cannot collect a money judgment against a debtor. An Overview of the Bankruptcy Code – Page 3 • any act by a lessor to the debtor under a lease of nonresidential real property that has terminated by its terms before the commencement of or during the bankruptcy case to obtain possession of the leased property (§ 362(b)(10)); the presentment of a negotiable instrument and the giving of notice of and protesting dishonor of such an instrument (§ 362(b)(11)); the creation or perfection of a statutory lien for an ad valorem property tax or a special tax or special assessment on real property whether or not ad valorem if such tax or assessment comes due after the date of the filing of the petition (§ 362(b)(18));21 the withholding of income from a debtor’s wages and collection of amounts withheld for the repayment of a loan by the debtor from his 401(k) or other pension, profit-sharing, stock bonus, or other qualified plan (§ 362(b)(19)); any act to enforce any lien against or security interest in real property following entry of the order under (d)(4)22 as to such real property in any prior case under this title for a period of 2 years after the date of the entry of such an order, except that the debtor may move for relief from the order based upon changed circumstances or for other good cause shown (§ 362(b)(20)); any act to enforce any lien against or security interest in real property if the debtor is ineligible under Section 109(g)23 to be a debtor or if the case was filed in violation of a bankruptcy court order in a prior case prohibiting the debtor from being a debtor in another case (§ 362(b)(21)); the continuation of any eviction by a lessor against a debtor involving residential real property where the lessor has obtained a judgment of possession prepetition (§ 362(b)(22)); an eviction action that seeks possession of the residential property in which the debtor is the lessee based on “endangerment of such property or the illegal use of controlled substances on such property, but only if the lessor files with the court, and serves upon the debtor, a certification under penalty of perjury that • • • • • • • 21 22 The italicized language was added by BAPCPA. Section 362(d)(4) provides: (A) (i) if a single or joint case is filed by or against a debtor who is an individual under this title, and if 2 or more single or joint cases of the debtor were pending within the previous year but were dismissed, other than a case refiled under section 707(b), the stay under subsection (a) shall not go into effect upon the filing of the later case; and (ii) on request of a party in interest, the court shall promptly enter an order confirming that no stay is in effect. 23 11 U.S.C. § 109(g) provides that an individual cannot be a debtor who has been a debtor in a case pending at any time in the preceding 180 days if the case was dismissed for willful failure of the debtor to abide by orders or to appear before the court in prosecution of the case or the debtor voluntarily dismissed the case following a request for relief from the stay. An Overview of the Bankruptcy Code – Page 4 such an eviction action has been filed, or that the debtor, during the 30-day period preceding the date of the filing of the certification, has endangered property or illegally used or allowed to be used a controlled substance on the property.” (§ 362(b)(23)); • any transfer that is “not avoidable under Section 544 and that is not avoidable under Section 549”24 (§ 362(b)(24)). The Bankruptcy Code provides that the willful violation of the automatic stay can result in compensatory and punitive damages against a creditor if an individual is injured. 25 Most courts have held that because the word “individual” is used, damages under Section 362(k) may not be awarded to a corporate debtor.26 Some of these courts have held, however, that damages may be awarded for willful violation of the stay pursuant to the court’s general contempt powers or pursuant to its equitable powers under Section 105(a).27 2. Relief from the Automatic Stay A creditor may obtain relief from the automatic stay for cause, including lack of adequate protection.28 Also, a creditor may obtain relief from the automatic stay of an act against property of the debtor if the debtor has no equity in the property and the property is not necessary for an effective reorganization.29 For property to be necessary to an effective reorganization, the debtor must demonstrate that a reasonable possibility of a successful reorganization exists within a reasonable period of time. In Chapter 7 cases, a creditor need only show that a debtor has no equity in property in order to obtain relief from the automatic stay. Other than the examples of “cause” listed above, the Bankruptcy Code does not provide a definition of “cause.” However, many bankruptcy courts have determined whether sufficient “cause” exists for relief from the stay by balancing the hardship to the creditor from a continuation of the automatic stay against the hardship to the debtor from the modification of the stay. 30 For example, if a lender had initiated a lawsuit against the borrower prior to the borrower’s bankruptcy filing, a lender may petition a court for relief from the automatic stay in order to proceed with such litigation. Some courts imply that cause may exist for modifying 24 It appears, at least with respect to the reference to Section 549, that Congress is legislatively overruling the courts, including the Fifth Circuit, that have held that Section 549(c), which provides that a trustee may not avoid a post-petition transfer “of real property to a good faith purchaser without knowledge of the commencement of the case and for present fair equivalent value,” does not constitute an exception to the automatic stay and that an unauthorized post-petition transfer violates the automatic stay and is therefore invalid. See Bustamante v. Cueva (In re Cueva), 371 F.3d 232, 238 (5th Cir. 2004). 25 26 See 11 U.S.C. § 362(k). See, e.g., Smith v. Lounsbury (In re Amberjack Interests, Inc.), 2005 WL 1595293 at *2 n.1 (Bankr. S.D. Tex., July 8, 2005). 27 28 29 30 See, e.g., In re San Angelo Pro Hockey Club, Inc., 292 B.R. 118, 124 (Bankr. N.D. Tex. 2003). See 11 U.S.C. § 362(d)(1). See 11 U.S.C. § 362(d)(2). Matter of Fernstrom Storage & Van Co., 938 F.2d 731 (7th Cir. 1991). An Overview of the Bankruptcy Code – Page 5 the automatic stay if the pending litigation had reached an advanced stage prior to the bankruptcy filing.31 Also, if a creditor asserts a right to setoff, the automatic stay may be modified if such creditor establishes its right to setoff pursuant to Section 553.32 Cause, for purposes of relief from the automatic stay, may also be established if judicial economy would be best served by such relief.33 F. Use/Sale of the Property of the Estate A bankruptcy debtor may use, sell or lease property of the estate in the ordinary course of business without notice or hearing.34 The bankruptcy court will look to numerous issues to determine whether the use, sale or lease of property subject to a lien is in the “ordinary course of the debtor’s business” including industry practice and previous operations of the debtor.35 A trustee may not use, sell or lease cash collateral without court authority unless the creditor consents to such use or the court authorizes such use after notice and a hearing.36 A trustee may not use property of the estate outside of the ordinary course of business without court authorization, after notice and a hearing. 37 Under certain circumstances, a trustee may sell property free and clear of a creditor’s lien in the property. 38 The trustee must, in any event, provide adequate protection of all interests in property of the estate which is used, sold or leased, and any use, sale or lease must be consistent with any relief from the automatic stay granted by the bankruptcy court.39 G. Obtaining Credit The trustee may need to obtain credit to operate the bankruptcy estate. Credit may be obtained in the ordinary course of business as an administrative expense.40 The trustee may seek court authority to obtain credit other than in the ordinary course.41 If a trustee is unable to 31 32 33 34 35 In re Sonnax Indus., 907 F.2d 1280 (2d Cir. 1990). In re Orlinski, 140 B.R. 600 (Bankr. S.D. Ga. 1991). In re Holtkamp, 669 F.2d 505 (7th Cir. 1982). See 11 U.S.C. § 363(c)(1). In re Glosser Bros., Inc., 124 B.R. 664 (Bankr. W.D. Pa. 1991); In re McDonald Bros. Const., Inc., 114 B.R. 989 (Bankr. N.D. Ill. 1990). 36 See 11 U.S.C. § 363(c)(2). Cash collateral means cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents whenever acquired in which the estate and an entity other than the estate have an interest, and includes the proceeds, products, offspring, rents, or profits of property subject to a perfected security interest of a creditor. 11 U.S.C. § 363(a). Typically, creditors and a debtor in possession or trustee can arrive at an agreement for use of cash collateral which will adequately protect the creditor. 37 38 See 11 U.S.C. § 363(b)(1). Section 363(f) permits a sale of estate property free and clear of any interest in the property if applicable nonbankruptcy law permits such a sale free and clear of the interest, if the creditor consents, if the interest is a lien and the price is greater than the aggregate value of all liens on the property, if the interest is in bona fide dispute, or if the creditor could be compelled, in a legal or equitable proceeding, to accept the money satisfaction for such interest. 39 40 41 See 11 U.S.C. §§ 363(e) and 363(b). See 11 U.S.C. § 364(a). See 11 U.S.C. § 364(b). An Overview of the Bankruptcy Code – Page 6 obtain credit, the court may authorize the obtaining of such credit with priority over all administrative expenses, secured by a lien on unencumbered property of the estate, or secured by a junior lien on encumbered property of the estate.42 Also, the court may authorize the obtaining of credit secured by a senior or equal lien on encumbered property of the estate only if the trustee is unable to obtain such credit otherwise and the existing lienholder is adequately protected.43 H. 44 Executory Contracts and Unexpired Leases Executory contracts and unexpired leases are separately addressed in the Bankruptcy Code. Neither term is defined in the Bankruptcy Code.45 Executory contracts are contracts with obligations by both parties to the contract such that the failure to perform would result in a material breach of the contract. Executory contracts and unexpired leases may be assumed or rejected in bankruptcy. If assumed, they will be afforded administrative claim status and performance should be completed as if bankruptcy had not been filed. If rejected, the holder of the claim under an executory contract or unexpired lease will hold an unsecured claim for damages.46 The Bankruptcy Code has limitations on such claims for leases of real property47 and employment contracts.48 Claimants are also subject to damages mitigation requirements. Clauses that purport to terminate an executory contract or unexpired lease on account of a bankruptcy filing are generally not enforceable and are known as “ipso facto” clauses.49 The automatic stay enjoins a creditor from terminating an executory contract or unexpired lease, and, pending the debtor’s decision to assume or reject the executory contract, the counterparty to such contract must continue to perform. 50 A creditor may seek to compel assumption or rejection of an executory contract or unexpired lease by motion with the bankruptcy court.51 The Bankruptcy Code sets time limitations for the assumption or rejection of unexpired non-residential real estate leases. Under Section 365(d)(4) the debtor has 120 days following the filing of the bankruptcy petition to assume or reject an unexpired lease of nonresidential real property or else the lease will be deemed rejected. Absent the prior written consent of the lessor, the bankruptcy court may only extend the period for 90 days. In a Chapter 7 case, the time limit for the assumption or rejection of executory contracts or unexpired leases is sixty 42 43 44 45 See 11 U.S.C. § 364(c). See 11 U.S.C. § 364(d)(1). See 11 U.S.C. § 365. A contract is generally considered executory “if at the time of the bankruptcy filing, the failure of either party to complete performance would constitute a material breach of the contract, thereby excusing the performance of the other party.” In re Murexco Petroleum, Inc., 15 F.3d 60, 62-63 (5th Cir. 1994) (citing as the source for the definition a two-part article by Professor Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn.L.Rev. 439, 458-62 (1973), and Executory Contracts in Bankruptcy: Part II, 57 Minn.L.Rev. 479 (1974)). 46 47 48 49 50 51 See 11 U.S.C. § 365(g)(1); In re Mirant Corp., 378 F.3d 511, 520 (5th Cir. 2004). See 11 U.S.C. § 502(b)(6). See 11 U.S.C. § 502(b)(7). See 11 U.S.C. § 365(e). See In re El Paso Refinery, L.P., 220 B.R. 37 (Bankr. W.D. Tex. 1998). See 11 U.S.C. § 365(d)(2). An Overview of the Bankruptcy Code – Page 7 (60) days following the filing of the bankruptcy petition. The bankruptcy court for cause shown may extend these time limits. Certain contracts (e.g., forward contracts, swap agreement, commodities contracts, securities agreements) are afforded special treatment and remedies under the Bankruptcy Code which are beyond the scope of this paper. I. 52 Proof of Claim Generally, a creditor must file a proof of claim or it will lose its claim against a debtor. The proof of claim should have attached to it all evidence of indebtedness, security interests and liens, and perfection of the security interests and liens. The filing of a proof of claim provides a creditor with prima facie evidence of the amount and validity of its claim. 53 It is a good practice for creditors to file a proof of claim early in any bankruptcy case. The proof of claim process requires a creditor to review its claim and all support for the claim. If a claim is a contingent or unliquidated claim, the bankruptcy court will estimate the amount.54 Also, if it is a case under Chapter 11 and the claim is scheduled but the debtor has not listed the claim as contingent, unliquidated, or disputed, the creditor does not need to file a proof of claim. 55 J. Secured/Unsecured Status of Creditors A creditor will be determined to have a secured claim to the extent of its interests in property of the estate plus the amount of any allowable setoff right of the creditor.56 The valuation of property in determining the secured status of a creditor will be determined in light of the purpose of the valuation and the proposed disposition or use of the property.57 Thus, valuation will differ if the property is to be used in connection with an ongoing concern or a liquidation of the debtor. If a creditor is oversecured, the claim of the creditor may include, in addition to the creditor’s pre-petition claim, post-petition interest, and any reasonable fees, costs or charges provided for in the creditor’s loan documents and collateral documents.58 If the trustee preserves or disposes of property of the estate subject to a lien, the trustee may, under certain circumstances, recover from the property the reasonable and necessary costs of doing so.59 The Supreme Court has held that the Bankruptcy Code does not provide an administrative claimant with an independent right to seek payment of its claim from property encumbered by the secured creditor’s lien. 60 52 53 54 55 56 57 58 59 60 See 11 U.S.C. § 501; Fed R. Bankr. P. 3002(a). See Fed. R. Bankr. P. 3001. See 11 U.S.C. § 502(c). Fed. R. Bankr. P. 3003(b). See 11 U.S.C. § 506(a). Id. See 11 U.S.C. § 506(b). See 11 U.S.C. § 506(c). Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1, 120 S.Ct. 1942, 147 L.Ed.2d 1 (2000). An Overview of the Bankruptcy Code – Page 8 K. Property of the Estate When the bankruptcy petition is filed, an estate of property is created.61 Under Section 541(a) of the Bankruptcy Code, the estate is comprised of all legal or equitable interests of the debtor as of the commencement of the bankruptcy case, except to the extent excluded by Section 541(b).62 The legislative history of Section 541 establishes that Section 541(a) is intended to be very broad and includes every type of property to which the debtor is entitled, including tangible and intangible property, causes of action, contract rights, etc.63 Amended Section 541(b) adds certain types of property to the list of property excluded from the definition of “property of the estate,” mostly relating to certain retirement plans and education or tuition savings plans.64 L. Discharge 1. Effect of a Bankruptcy Discharge A discharge in bankruptcy voids any judgment to the extent that it is a determination of personal liability, operates as an injunction against future actions to recover against the debtor for personal liability and, with certain limitations, operates as an injunction against attempts to collect from community property acquired after the commencement of the case.65 2. Exceptions to Discharge A debtor in bankruptcy does not always obtain a discharge of all debts.66 Debts arising on account of (1) certain taxes, (2) property or loans obtained through fraudulent representations, (3) fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny, (4) child support, (5) willful and malicious injury by the bankruptcy debtor to another entity or property of another entity, (6) certain student loans, and (7) other types of non-dischargeable debts as listed in the Bankruptcy Code may not be discharged.67 A creditor must file a complaint to determine dischargeability of a particular debt.68 There are time deadlines and bar dates for the filing of such actions.69 Recently, the Supreme Court held that 61 62 See 11 U.S.C. § 541. See 11 U.S.C. § 541(a)(1). It will also include community property under the sole, equal or joint management and control of the debtor or community property liable for a claim against the debtor or the debtor’s spouse, to the extent the interest is so liable. The property of the estate also includes property recovered by the trustee for the estate, inheritances, divorce case distributions or death benefits received by debtor within 180 days of the filing of the petition, proceeds of property of the estate, or interest in property that the estate acquires after the commencement of the case. The exceptions to property of the estate are beyond the scope of this paper. 63 64 65 66 H.R. REP. NO. 595, 95th Cong., 1st Sess. 367-68 (1977); S. REP. NO. 989, 95th Cong., 2d Sess. 82-3 (1978). See § 541(b)(5)-(7). See 11 U.S.C. § 524(a). 11 U.S.C. § 523 provides generally for exceptions to discharge. 11 U.S.C. § 727 provides generally for objections to a discharge in a Chapter 7 bankruptcy case. 67 68 69 See 11 U.S.C. § 523(a)(1)-(10). See 11 U.S.C. § 523(c). See FED. R. BANKR. P. 4007. An Overview of the Bankruptcy Code – Page 9 the deadline for filing dischargeability complaints is not jurisdictional and may be waived by the debtor.70 3. No More “Super Discharge” in Chapter 13 Under BAPCPA, Chapter 13 debtors are no longer entitled to what had been known as a “super discharge.” Congress amended Section 1328(a) to provide that certain types of claims that were previously discharged in a Chapter 13 no longer are: claims (i) for trust fund taxes, (ii) for income taxes for which no return was filed or was filed after the date the return was due and after two years before the petition date or with respect to which the debtor made a fraudulent return or willfully attempted to evade or defeat, (iii) for money, property, or services obtained by false pretenses, false representation, or actual fraud, (iv) neither listed nor scheduled in time to permit timely filing of a proof of claim, (v) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny, and (vi) for restitution or damages awarded in a civil action against the debtor as a result of willful or malicious injury that caused personal injury to or death of an individual.71 M. Turnover of Property of the Estate Creditors in possession, custody, or control of property that a trustee may use, sell or lease or which the debtor may exempt, must deliver to the trustee, and account for, the property or the value of such property.72 A creditor that controls property and fails to turn over property to the trustee may be held liable for willful violation of the automatic stay. Entities that owe a debt that is property of the estate must pay the debt to the trustee, unless the debt may be properly offset against a claim of the creditor.73 N. Discrimination The Bankruptcy Code prohibits the discrimination against a debtor who is or has been a debtor in bankruptcy solely based on such debtor’s bankruptcy, insolvency or dischargeability of debts.74 The discrimination provision applies to government agencies and to employers. The threshold question of whether Section 525 of the Bankruptcy Code is applicable is whether the alleged discrimination is based solely upon the fact that the debtor filed for bankruptcy relief, was insolvent, or had debts which were discharged.75 Furthermore, the language of 70 71 72 73 See Kondrick v. Ryan, 540 U.S. 443, 124 S.Ct. 906 (2004). See 11 U.S.C. § 1328(a)(2) and (4), eff. October 17, 2005. See 11 U.S.C. § 542. See 11 U.S.C. § 542(b). The rules for offset are beyond the scope of this article and should be analyzed on a case-by-case basis. 74 75 See 11 U.S.C. § 525. Laracuente v. Chase Manhattan Bank, 891 F.2d 17 (1st Cir. 1989); Comeaux v. Brown & Williamson Tobacco Co., 915 F.2d 1264 (9th Cir. 1990); In re Exquisito Services, Inc., 823 F.2d 151 (5th Cir. 1987). An Overview of the Bankruptcy Code – Page 10 Section 525 implies that a debtor may be protected from discrimination after the debtor’s bankruptcy case is terminated.76 O. “Strong-Arm” Powers The commencement of a bankruptcy case provides the trustee with certain powers that would be held by lien creditors, execution creditors or bona fide purchasers of real property.77 Additionally, a trustee may avoid transfers of an interest of a debtor in property to the extent such a transfer is voidable under applicable law by a creditor holding an allowed claim in the bankruptcy case.78 This would include use of state fraudulent transfer laws to avoid preferences and fraudulent conveyances. P. Preferences Preference litigation is a common risk to unsecured and undersecured creditors. Payments (1) to and for the benefit of a creditor, (2) for or on account of an antecedent debt owed by the debtor before the transfer is made, (3) made while the debtor was insolvent (a) on or within ninety days (non-insiders) or (b) between 90 days and one year (insiders) before the filing of the petition, (4) that enables the creditor to receive more than it would receive in a case under Chapter 7, may be avoided as a preferential transfer.79 The essence of a preferential transfer is that it diminishes the debtor’s bankruptcy estate and prefers a creditor who would not be entitled to such a payment by virtue of an enforceable lien, setoff or other means. Defenses to preferences include contemporaneous exchanges for new value and ordinary course of business payments.80 Prior to the enactment of the Bankruptcy Reform Act, Section 547(c)(2) required a creditor to prove that the payments made by the debtor were in the ordinary course of business of the debtor and made according to ordinary business terms in the debtor’s industry. As of April 20, 2005, however, the creditor must only prove that the payments made by the debtor were in the ordinary course of business of the debtor or were according to ordinary business terms in the debtor’s industry.81 Congress also added Section 547(h), which provides that the trustee may not avoid a transfer “made as a See, e.g., Matter of Bradley, 989 F.2d 802 (5th Cir. 1993) (the Fifth Circuit determined that a bankruptcy court had subject matter jurisdiction over a discrimination claim by a Chapter 7 debtor whose debts had been discharged). 77 76 See 11 U.S.C. § 544(a). These are known as the “strong-arm” powers. The trustee’s ability to bring an action against a state in the bankruptcy court has been hindered by the Supreme Court’s decision in Seminole Tribe of Florida v. Florida, in which the Court held that Article I of the Constitution does not authorize Congress to abrogate the states’ Eleventh Amendment sovereign immunity, which shields the states from most damage actions in federal court. Seminole Tribe of Florida v. Florida, 517 U.S. 44, 116 S.Ct. 1114, 134 L.Ed.2d 252 (1996). 78 79 80 81 See 11 U.S.C. § 544(b). See 11 U.S.C. § 547(b). See 11 U.S.C. § 547(c). See 11 U.S.C. § 547(c)(2). The amendments to Section 547 apply to any case that was pending or commenced on or after the date of enactment of the Bankruptcy Reform Act (which was April 20, 2005). An Overview of the Bankruptcy Code – Page 11 part of an alternative repayment schedule between the debtor and any creditor of the debtor created by an approved nonprofit budgeting and credit counseling agency.”82 Q. Fraudulent Transfers The Bankruptcy Code permits a trustee to recover transfers made by debtor that are actually or constructively fraudulent.83 Transfers made with actual intent to hinder, delay or defraud any entity which the debtor was or became indebted to are avoidable.84 If a debtor transfers property for less than reasonably equivalent value when the debtor is insolvent or is rendered insolvent by the transfer, or the transfer leaves the debtor with unreasonably small capital, or the debtor makes the transfer with the intent to incur or with the belief that the debtor would incur debts beyond the debtor’s ability to pay, then the transfer is voidable as constructively fraudulent.85 R. Unauthorized Post-Petition Transfers A trustee may avoid any transfer of property of the estate that is made after the commencement of the bankruptcy estate and is not authorized by the Bankruptcy Code or the bankruptcy court.86 Occasionally, a debtor in bankruptcy will attempt to prefer a particular creditor by keeping a particular debt current without bankruptcy court authorization. This can become a problem if these payments are being made from property of the estate. A creditor should, therefore, obtain court authority prior to receiving any post-petition payments on its claim. S. Setoffs in Bankruptcy The Bankruptcy Code does not affect any right of a creditor to offset a mutual debt owing by a creditor to the debtor that arose before the commencement of the bankruptcy case against a claim of the creditor against the debtor which also arose before the commencement of the case.87 Exceptions to this general rule include claims that are not allowed, claims acquired by a creditor for the purpose of obtaining an offset right, or preferential offset rights.88 As noted above, a creditor may not pursue its offset rights without obtaining relief from the automatic stay.89 A creditor’s exercise of a right of recoupment, however, is not subject to the automatic stay.90 82 83 84 85 See 11 U.S.C. § 547(h), eff. April 20, 2005, as to cases pending on or commenced after April 20, 2005. See 11 U.S.C. § 548. See 11 U.S.C. § 548(a)(1). See 11 U.S.C. § 548(a)(2). The Bankruptcy Code provides protection for certain bona fide purchasers and subsequent transferees who take in good faith for value. See 11 U.S.C. §§ 548(d)(1) and 550(b). 86 87 88 89 90 See 11 U.S.C. § 549(a). See 11 U.S.C. § 553(a). See id.; 11 U.S.C. § 553(b). See Kosadnar v. Metropolitan Life Ins. Co. (In re Kosadnar), 157 F.3d 1011, 1013-14 (5th Cir. 1998). See id. at 1014. An Overview of the Bankruptcy Code – Page 12 T. Abandonment of Property of the Estate A trustee may abandon property of the bankruptcy estate that is burdensome to the estate or that is of inconsequential value to the estate.91 If the trustee will not abandon property, a creditor may move the bankruptcy court to order the trustee to abandon property that is burdensome to the estate or that is of inconsequential value and benefit to the estate.92 Abandonment of property from the estate has the legal effect of revesting the property in the debtor. It does not provide a creditor with relief from the automatic stay. Scheduled property that is not otherwise administered at a time of the closing of a bankruptcy estate is abandoned by operation of law when the estate is closed.93 If property of the estate is not abandoned and not administered, the property remains property of the estate.94 Occasionally, a debtor will neglect to schedule certain property. The unscheduled property becomes property of the estate and is not abandoned by the estate even after the bankruptcy case is closed. U. Chapter 7 – Liquidation 1. The Trustee The bankruptcy estate in a Chapter 7 bankruptcy case is administered by the Chapter 7 trustee. Initially, an interim trustee is appointed until such time as another trustee is elected.95 If a trustee is not elected at the meeting of creditors, the interim trustee will serve as the trustee in the Chapter 7 bankruptcy case.96 The Chapter 7 trustee must collect and reduce to money the property of the estate “as expeditiously as is compatible with the best interests of parties in interest.”97 When a borrower files for relief under Chapter 7, it is the trustee with whom a creditor must deal in connection with property of the estate. For example, once relief from the automatic stay is obtained against non-exempt property, notices required to be sent to the borrower must be sent to the trustee.98 91 92 93 94 95 96 97 See 11 U.S.C. § 554(a). See 11 U.S.C. § 554(b). See 11 U.S.C. § 554(c). See 11 U.S.C. § 554(d). See 11 U.S.C. § 701. See 11 U.S.C. § 702(d). See 11 U.S.C. § 704(a)(1) (2005). Other duties of the Chapter 7 trustee are that the trustee be accountable for all property received, investigate the financial affairs of the debtor, examine proofs of claim and object to same if a purpose would be served, oppose the discharge of the debtor if advisable, furnish information concerning the estate and its administration as is requested by a party in interest (unless the court orders otherwise) and make a final report and file a final account of the administration of the estate with the bankruptcy court and the United States Trustee. 98 It is good practice to notify the borrower, the trustee and any other entities that need to be notified under applicable law. An Overview of the Bankruptcy Code – Page 13 2. Liquidation/Distribution of Property of the Estate Under a Chapter 7 liquidation, the trustee collects the property and, as applicable, reduces the property of the estate to money for distribution to creditors.99 The distribution of property of the estate is governed by the Bankruptcy Code.100 The statutory distribution scheme may be affected by a bankruptcy court’s power to equitably subordinate claims. 101 The first level of claims to be paid are priority claims. 102 The listing of priority claims is found in Section 507 of the Bankruptcy Code. Priority claims will include, as first priority, allowed unsecured claims for domestic support obligations.103 Priority claims also include the administrative expenses of the estate,104 claims arising in the ordinary course of the debtor’s business or financial affairs during the “gap period” between the filing of an involuntary petition and an order for relief,105 and other priority claims including, certain wage, salary or commissions claims,106 claims for contributions to employee benefit plan, 107 certain claims of grain producers and United States fishermen, claims for security deposits, claims of governmental units for income taxes, property taxes, withholding taxes, employment taxes, excise taxes, etc.108 The second level of distributions goes to allowed unsecured claims, proofs of which are timely filed or tardily filed by a creditor which did not have notice or actual knowledge of the case in time for timely filing of proof of claim and the proof of claim is filed in time to permit payment of the claim.109 The third level of distribution is payment of allowed unsecured claims, proofs of which are tardily filed.110 The fourth level of distribution is payment of allowed claims for any fine, penalty, or forfeiture or for multiple, exemplary or punitive damages arising before the earlier of the order for relief or the appointment of a trustee, to the extent same are not compensation for actual pecuniary loss suffered by the holder of the claim. 111 The fifth level of distribution is interest at the legal rate on any of the claims in the first four levels, i.e., types of unsecured claims.112 The sixth level of distribution, if any, is to the debtor.113 If a case is converted to Chapter 7 from Chapter 11, Chapter 12 or Chapter 13, 99 See 11 U.S.C. § 704(1). See 11 U.S.C. § 726. See 11 U.S.C. § 726(a). Principles of equitable subordination are incorporated in 11 U.S.C. § 510(c). See 11 U.S.C. § 726(a)(1). See 11 U.S.C. § 507(a)(1). See 11 U.S.C. §§ 507(a)(2) and 503(b). See 11 U.S.C. §§ 507(a)(3) and 502(f). See 11 U.S.C. § 507(a)(4). 100 101 102 103 104 105 106 107 See 11 U.S.C. § 507(a)(5). The priority amount for Sections 507(a)(4) and (5) has been increased from $4,925 to $10,000, and the look back period in Section 507(a)(4) (dealing with wages) has been increased from 90 days to 180 days before the petition date. 108 109 110 111 112 113 For a full listing of priority claims see 11 U.S.C. § 507. See 11 U.S.C. § 726(a)(2). See 11 U.S.C. § 726(a)(3). See 11 U.S.C. § 726(a)(4). See 11 U.S.C. § 726(a)(5). See 11 U.S.C. § 726(a)(6). An Overview of the Bankruptcy Code – Page 14 the administrative expenses under the Chapter 7 bankruptcy case will have priority over the administrative expenses of the case from which the bankruptcy case was converted.114 Proceeds from community property are segregated from other property of the estate and are subject to a different distribution scheme than non-community property of the estate.115 3. “Means Test” – a Major Hurdle to Filing a Chapter 7 One of the most significant changes to the Bankruptcy Code made by the Bankruptcy Reform Act is the creation by Congress of the so-called “means test” as a hurdle for individuals seeking to file a Chapter 7 case. The “means test” is found in new Section 707(b)(2) and essentially provides that if a debtor’s income does not exceed the state’s median income, he is entitled to file a Chapter 7, provided he did not file the petition in bad faith or the totality of his financial circumstances does not indicate abuse. If, on the other hand, the debtor’s income exceeds the state’s median income, then a complicated “means test” must be applied to determine whether the Chapter 7 should be dismissed or converted (with consent of the debtor) to a case under Chapter 13 because of abuse. The “means test” involves a calculation of the debtor’s income, less certain expenses, over a five-year period. Essentially, if the debtor, after application of the “means test,” is found to have the “means” to pay back a certain percentage of his debt, the filing of the Chapter 7 petition will be presumed to have been an abuse of the provisions of Chapter 7 under Section 707(b)(1), and he will then have the option of converting the Chapter 7 case to one under Chapter 13 or having the Chapter 7 case dismissed. V. Chapter 13 – Individual Reorganization 1. The Process In a case under Chapter 13, a debtor with a regular income, who may be an individual or a couple, and who may include a sole proprietorship or unincorporated business operated by the debtor, reorganizes by way of paying amounts into a Chapter 13 plan for a period of anywhere from three (3) to five (5) years.116 Payments under the plan are determined by looking at Schedules I and J, with the debtor proposing to pay the difference between those two schedules, or the debtor’s “disposable income,” to creditors through the trustee over a term of years.117 If the debtor completes all payments under a confirmed Plan, the debtor then obtains his or her discharge.118 114 See 11 U.S.C. § 726(b). The Chapter 7 “burial expenses” are given priority to ensure final administration of the bankruptcy estate. 115 See 11 U.S.C. § 726(c). For example, administrative expenses are paid either from community property or from other property of the estate “as the interest of justice requires.” 11 U.S.C. § 726(c)(1). The legislative history of 11 U.S.C. § 726 indicates that community claims are paid (i) first from community property, except to the extent that such property is solely liable for the debts of the debtor; (ii) second from community property that is solely liable for the debts of the debtor; (iii) third from non-community property; and (iv) fourth from whatever property remains in the estate. 116 117 118 See 11 U.S.C. §§ 109(e) and 1322(d). See 11 U.S.C. §§ 1322(a) and 1325(b). See 11 U.S.C. § 1328. An Overview of the Bankruptcy Code – Page 15 2. The Trustee The Chapter 13 trustee’s primary functions, in addition to reviewing the schedules and Statements of Financial Affairs filed, are to review claims filed, to supervise the confirmation process, and to collect and disburse funds received from the debtor both pre-confirmation and post-confirmation until the term of the Plan is complete or the case is dismissed. 119 The Chapter 13 trustee’s compensation for such work is based on a set percentage of the amount collected and disbursed.120 3. Qualifications and Reasons to be in Chapter 13 There are specific debt limits for both secured and unsecured debt which are also qualifiers as to whether a debtor can be in a Chapter 13 case.121 The major reasons that debtors opt to proceed in a Chapter 13 case, versus a Chapter 7 case, currently include the ability to: (a) bring mortgage arrearages current;122 (b) stop penalties and interest accruing on taxes; (c) keep excess property over the relevant exemption limits;123 and (d) effect a cram-down on secured personal property.124 Under BAPCPA, more Chapter 13 cases are anticipated because of the significant hurdles to filing Chapter 7 cases created by the Bankruptcy Reform Act.125 W. Chapter 11 – Reorganization 1. “Debtor in Possession” In a case under Chapter 11, the debtor becomes a “debtor in possession.”126 The debtor in possession has all the rights of a trustee (other than to compensation) and must perform all the duties of a trustee.127 For example, under Chapter 11 the trustee may operate the debtor’s business.128 Thus, the debtor in possession may operate the debtor’s business in a Chapter 11 case. The debtor in possession may also be subject to certain limitations applicable to a trustee. The Ninth Circuit has held that the two-year limitations period governing the commencement of avoidance actions limits debtors in possession, as well as trustees.129 119 120 121 See 11 U.S.C. § 1302(b). See 11 U.S.C. §§ 326(b) and 330(a) and (c). See 11 U.S.C. §§ 109(e). The debt limits are periodically adjusted pursuant to 11 U.S.C. § 104, with such adjusted amounts set forth in the footnotes to that section. 122 123 124 125 126 127 128 129 See 11 U.S.C. § 1322(b)(3). See 11 U.S.C. § 1325(a)(4). See 11 U.S.C. §§ 1322(b)(2) and 1324(a)(5). See Section I(T)(3), supra, and the footnotes and attachments relating to same. See 11 U.S.C. § 1101(1). See 11 U.S.C. § 1107(a). See 11 U.S.C. § 1108. In re Softwaire Centre Int’l Inc., 944 F.2d 682 (9th Cir. 1993). An Overview of the Bankruptcy Code – Page 16 2. Chapter 11 Trustee A trustee may be appointed in a Chapter 11 bankruptcy case for cause including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, if the appointment of a trustee is in the interest of creditors, any equity security holders and other interests of the estate, or if grounds exist to convert or dismiss the case under Section 1112, but the court determines that the appointment of a trustee is in the best interests of creditors and the estate.130 Courts generally agree, however, that the appointment of a Chapter 11 trustee is an extraordinary remedy. 131 Under new Section 1104(e), the United States Trustee “shall move for the appointment of a trustee . . . if there are reasonable grounds to suspect that current members of the governing body of the debtor, the debtor’s chief executive or chief financial officer, or members of the governing body who selected the debtor’s chief executive or chief financial officer, participated in actual fraud, dishonesty, or criminal conduct in the management of the debtor or the debtor’s public financial reporting.”132 A Chapter 11 trustee has duties similar to the Chapter 7 trustee.133 If the debtor has not done so, the Chapter 11 trustee must file schedules of assets and liabilities of the debtor.134 A Chapter 11 trustee must investigate the business and financial condition of the debtor and determine whether it is desirable to continue the business or to attempt a formulation of a plan.135 As soon as practicable, the Chapter 11 trustee must file a plan or report why the trustee will not file a plan, recommend conversion of the case to a case under another Chapter of the Bankruptcy Code or recommend dismissal of the case.136 If a plan is confirmed, the Chapter 11 trustee must file such reports as are necessary or that the court requires. 137 In sum, the Chapter 11 trustee has the bulk of the same duties as the Chapter 7 trustee, although the focus of the Chapter 11 trustee will be on the ongoing operation of the business and a determination whether it makes sense to formulate a plan of reorganization. 3. Conversion or Dismissal The debtor may convert a case from Chapter 11 to Chapter 7 of the Bankruptcy Code unless the debtor is not a debtor in possession, the bankruptcy case is an involuntary bankruptcy case, or the bankruptcy case was converted to a Chapter 11 other than at the debtor’s request.138 Under new Section 1112(b)(1), except as provided in 1112(b)(2), or if the court determines that the appointment of a trustee would be in the best interests of creditors, on request of a party in interest and after notice and a hearing, the court shall convert the case to 130 131 132 133 See 11 U.S.C. § 1104(a)(1)-(3). In re North Star Contracting Corp., 128 B.R. 66 (Bankr. S.D.N.Y. 1991). See new Section 1104(e) (emphasis added). See 11 U.S.C. § 1106(a)(1). One difference is that the Chapter 11 trustee does not have a duty to collect and reduce to money the property of the estate. 134 135 136 137 138 See 11 U.S.C. § 1106(a)(2). See 11 U.S.C. § 1106(a)(3). See 11 U.S.C. § 1106(a)(5). See 11 U.S.C. § 1106(a)(7). See 11 U.S.C. § 1112(a). An Overview of the Bankruptcy Code – Page 17 Chapter 7 or dismiss the case if the movant establishes cause.139 “Cause” now includes substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation, gross mismanagement of the estate, failure to maintain appropriate insurance that poses a risk to the estate or to the public, unauthorized use of cash collateral substantially harmful to one or more creditors, failure to comply with an order of the court, unexcused failure to satisfy timely any filing or reporting requirement established by the Bankruptcy Code or by the Bankruptcy or Local Rules, failure to attend the meeting of creditors or a Rule 2004 examination without cause shown by the debtor, failure to timely provide information or attend meetings reasonably requested by the United States Trustee, failure to timely pay post-petition taxes or to file tax returns postpetition, failure to file a disclosure statement or to file or confirm a plan within the time fixed by the Bankruptcy Code or by the bankruptcy court, revocation of an order of confirmation under Section 1114, inability to effectuate substantial consummation of a confirmed plan, material default by the debtor with respect to a confirmed plan, termination of a confirmed plan by reason of the occurrence of a condition specified in the plan, and failure of the debtor to pay any domestic support obligation that first becomes payable after the date of the filing of the petition.140 If the debtor fails to file its schedules and list of 20 largest unsecured claim holders, the bankruptcy court may convert a case to Chapter 7 or dismiss the case, whichever is in the best interests of creditors, upon request by the United States Trustee.141 4. Chapter 11 Plan of Reorganization Process a. Filing the Plan of Reorganization The debtor in possession is required to file a plan as soon as practicable. 142 The plan will set forth the details of how the debtor intends to reorganize and treat its creditors. Although the debtor may file a plan at any time in a Chapter 11 case, the debtor has the exclusive right to file a plan only during the first 120 days after the petition date.143 The debtor may choose to file a plan with the voluntary petition initiating the case. If the debtor does not file its plan within the 120-day exclusivity period, or does not file a plan that is accepted before 180 days after the petition date, any party in interest may file a plan.144 The 120-day exclusivity period may be reduced or extended, for cause, after notice and a hearing, by the court upon request by a party in interest before the expiration of the period,145 but, under new Section 1121(d)(2), the 120-day period may not be extended beyond 18 months 139 140 141 142 143 144 145 See 11 U.S.C. § 1112(b)(1). See 11 U.S.C. § 1112(b)(4). See 11 U.S.C. § 1112(e). See 11 U.S.C. § 1106(a)(5). See 11 U.S.C. § 1121. See 11 U.S.C. § 1121(c). See 11 U.S.C. § 1121(d)(1). An Overview of the Bankruptcy Code – Page 18 from the petition date, and the 180-day period may not be extended beyond 20 months after the petition date.146 b. Classification of Claims or Interests For the purpose of determining the treatment of the creditors, each claim or interest is placed into a class.147 The plan may place more than one claim or interest into a class only if such claims or interests are substantially similar.148 In practice, each secured claim is placed into its own class due to its unique interest in certain property of the estate and all unsecured claims are placed into one class due to their common treatment. Certain unsecured creditors may be placed in a separate class for the purpose of administrative convenience when each unsecured claim is less than or reduced to a certain amount.149 The plan may provide for these small claims to be paid in full. The court on motion after hearing on notice may determine the classes of creditors and equity security holders for the purpose of the plan and its acceptance.150 c. Contents of the Plan of Reorganization The Bankruptcy Code sets forth those plan provisions which are mandatory. 151 The plan must designate classes of claims and interests.152 Classification is not required for priority claims since their treatment is statutorily provided for.153 The plan must specify any class of claims or interests that is not impaired under the plan. 154 The plan must specify the treatment of any class or claims impaired under the plan. 155 It should provide for the same treatment to 146 147 148 149 150 151 152 153 154 155 See 11 U.S.C. § 1121(d)(2). See 11 U.S.C. § 1122(a). Id. See 11 U.S.C. § 1122(b). See FED. R. BANKR. P. 3013. See 11 U.S.C. § 1123(a). See 11 U.S.C. § 1123(a)(1). See 11 U.S.C. § 1129(a)(9). See 11 U.S.C. § 1123(a)(2). See 11 U.S.C. § 1123(a)(3) An Overview of the Bankruptcy Code – Page 19 each claim or interest in a particular class unless the claim or interest consents to less favorable treatment. The plan must provide adequate means for the plan’s implementation.156 d. Impairment of Claims or Interests Every class of claims or interests is considered impaired under a plan unless the plan (a) leaves the legal, equitable and contractual rights of each claim or interest unaltered; (b)(i) cures any default that occurred before or after the commencement of the case other than a default that occurred under the terms of the agreement due to the insolvency of the debtor or of a kind that Section 365(b)(2) expressly does not require to be cured, (ii) reinstates the maturity of the claim as such maturity existed before the default, (iii) compensates the holder of the claim for any damages that the holder incurred due to reliance on the contractual agreement, (iv) compensates the holder of a claim or interest arising from failure to perform a nonmonetary obligation for any actual pecuniary loss incurred by such holder arising from such failure, and (v) does not alter the legal, equitable or contractual rights to which the holder of the claim is entitled.157 e. Solicitation and the Disclosure Statement Before acceptance of a plan may be solicited by the plan proponent, the plan must be transmitted to each holder of a claim entitled to vote along with a written disclosure statement approved by the court as containing adequate information. 158 Adequate information means information of a kind and in sufficient detail to allow a reasonable investor the opportunity to make an informed judgment about the plan.159 Under BAPCPA, the disclosure statement must contain a discussion of potential “material Federal tax consequences of the plan to the debtor, any successor to the debtor, and a hypothetical investor typical of the holders of claims or interests in the case.”160 The disclosure statement need not contain a valuation of the debtor or 156 See 11 U.S.C. § 1123(a)(5). This includes: (1) retention by the debtor of all or part of the property of the estate; (2) transfer of all or part of the property of the estate to one or more entities, whether organized before or after the confirmation of such plan; (3) merger or consolidation of the debtor with one or more persons; (4) sale of all or any part of the property of the estate, either subject to a fee or any lien, or the distribution of all or any part of the property of the estate among those having an interest in such property of the estate; (5) satisfaction or modification of any lien; (6) cancellation or modification of any indenture or similar instrument; (7) curing or waiving of any default; (8) extension of a maturity date or a change in an interest rate or other term of outstanding securities; (9) amendment of the debtor’s charter; or (10) issuance of securities of the debtor, or of any related entity for cash, for property, for existing securities, or in exchange for claims or interests, or for any other appropriate purpose. Id. The plan may: (1) impair or leave unimpaired any class of claims or interests; (2) provide for the assumption, rejection or assignment of any executed contract or unexpired lease not previously rejected; (3) provide for the settlement or adjustment of any claim or interest belonging to the debtor or to the estate; (4) provide for the retention and enforcement of any claim or interest by the debtor; (5) provide for the sale of all, or substantially all of the assets of the estate and for the distribution of the proceeds to the holders of claims and interests; (6) any other provisions not prohibited by the Bankruptcy Code. See 11 U.S.C. § 1123(b). 157 158 159 160 See 11 U.S.C. § 1124. See 11 U.S.C. § 1125. See 11 U.S.C. § 1125(a)(1). See 11 U.S.C. § 1125(a)(1) (emphasis added). An Overview of the Bankruptcy Code – Page 20 an appraisal of the debtor’s assets.161 A different disclosure statement for each class is permitted, but each member of a class must receive an identical disclosure statement.162 The court must hold a hearing to consider the disclosure statement filed by the debtor with no less than 25 days notice to the creditors, equity security holders and other parties in interest. Notice must be sent by the proponent of the plan. 163 The court may also set a date for the confirmation hearing.164 Once the disclosure statement is approved by the court, the debtor in possession must mail the following to all creditors and equity security holders: • • • • • the plan or a court approved summary of the plan; the disclosure statement; notice of time within which acceptances or rejections must be received; the date fixed for confirmation hearing, if any; and any other information required by the court; and in addition, all creditors and equity security holders must receive a ballot.165 f. Acceptance and Voting on the Plan of Reorganization A class of claims will have voted to accept a plan if the plan is accepted by its members that hold at least two-thirds in amount and more than one-half in number of the allowed claims of that class.166 A class of interests must vote in favor of the plan by at least two-thirds in amount of the allowed interests for that class to accept the plan.167 A class that is not impaired under the plan is presumed to have accepted the plan. Solicitation of acceptances to an unimpaired class is not required because they are “conclusively presumed” to have accepted the plan.168 The following entities are allowed to vote on a plan: • • any creditor with an allowable claim; a security holder with an allowable claim as of the date the order approving the disclosure statement is entered; and 161 162 163 164 165 166 167 168 See 11 U.S.C. § 1125(a)(1). See 11 U.S.C. § 1125(c). See FED. R. BANKR. P. 3017(a). See FED. R. BANKR. P. 3017(a). See id. See 11 U.S.C. § 1126(c). See 11 U.S.C. § 1126(d). See 11 U.S.C. § 1126. An Overview of the Bankruptcy Code – Page 21 • an equity security holder with an allowable claim on the date the order approving the disclosure statement is entered.169 However, where a creditor is found to be an “insider” due to its “control” of a debtor, such creditor’s acceptance of a plan will not be counted in “cram-down” circumstances.170 g. Modification of Plan of Reorganization A plan may be modified at any time before the plan’s confirmation so long as the plan complies with the required form and contents of the Bankruptcy Code.171 The proponent of the plan may modify the plan after the confirmation of the plan but before substantial consummation of the plan so long as the court, after notice and a hearing, confirms the modified plan. Once the plan is modified, a holder of a claim or interest that has accepted or rejected the plan will still be deemed to have accepted or rejected the modified plan unless the holder changes its previous vote.172 Any accepted plan that is modified before its confirmation will be deemed accepted by these holders of claims and interest that previously accepted the plan, provided that the court finds the modification does not adversely affect the treatment of these claims or interest.173 h. The Confirmation Hearing After notice and a hearing, the court will hold a hearing on confirmation of the plan. Any party in interest may object to the confirmation of the plan.174 The proponent of the plan must give the debtor, all creditors and all indenture trustees not less than 25 days notice of the time fixed for filing objections to the plan and the date of the hearing to consider confirmation of a plan.175 i. Confirmation of the Plan of Reorganization and “Cram Down” As to consensual plans, the bankruptcy court will confirm the proposed plan only if all of the requirements of Section 1129 are met. These requirements include: • the plan and the plan proponent must comply in all respects with the provisions of the Bankruptcy Code and the plan has been proposed in good faith;176 169 170 171 172 173 174 175 176 See FED. R. BANKR. P. 3018(a). See 11 U.S.C. § 1129(a)(1); In re Heights BanCorp., 89 B.R. 795 (Bankr. S.D. Iowa 1988). See 11 U.S.C. §§ 1122 and 1123. See 11 U.S.C. § 1127(d). See FED. R. BANKR. P. 3019. See 11 U.S.C. § 1128. See FED. R. BANKR. P. 2002(b). See 11 U.S.C. § 1129(a)(1)-(3). An Overview of the Bankruptcy Code – Page 22 • • the plan must disclose the identity and affiliations of the future management provided in the plan as well as compensation for services paid to insiders;177 the plan must disclose that all payments made by the proponent of the plan, the debtor or person acquiring property under the plan is subject to approval of the bankruptcy court;178 any rate change provided in the plan has obtained the approval of the appropriate regulatory commission;179 treatment of a holder of a claim in an impaired class: • unless holder has accepted the plan, the holder must receive value at least as great as the holder would have received in a Chapter 7 liquidation of the debtor;180 or if the class has made an election under Bankruptcy Code Section 1111(b)(2), then each holder must receive value equivalent to the estate’s interest in the property that secures the holder’s claim;181 • • • • • all classes have accepted the plan. If any class has rejected the plan, that class must not be impaired under the plan;182 unless the holder of a particular claim has agreed to different treatment, the plan must provide payment of: • • administrative expenses in cash on the effective date of the plan; employee related claims, employee benefit claims, claims of grain producers and fisherman, unearned deposits in cash on the effective date of the plan if such class has rejected the plan, otherwise, the claims may be paid in deferred cash payments equal to the value of the claim; claims of certain governmental units in regular installments in cash equal to the value of the claim over a period ending not later than 5 years after the date of the order for relief and in a manner not less favorable than the most favored nonpriority unsecured claim provided for by the plan; and • 177 178 179 180 181 182 See 11 U.S.C. § 1129(a)(5). See 11 U.S.C. § 1129(a)(4). See 11 U.S.C. § 1129(a)(6). See 11 U.S.C. § 1129(a)(7)(A). See 11 U.S.C. § 1129(a)(7)(B). See 11 U.S.C. § 1129(a)(8). An Overview of the Bankruptcy Code – Page 23 • secured claim which would otherwise meet the description of an unsecured claim of a governmental unit under Section 507(a)(8), but for the secured status of that claim, in the same manner as above.183 • • • if any class of claims is impaired under the plan, then at least one impaired class must accept the plan notwithstanding acceptance by insiders;184 the confirmation of the plan is not likely to be followed by the liquidation of the debtor or further need for reorganization;185 and the plan must provide for appropriate treatment of all retiree benefits as required.186 If all of the confirmation requirements are met with the exception of the requirement in Section 1129(a)(8) that all impaired classes accept the plan, the court may still confirm the plan via “cramdown” if the plan does not discriminate unfairly and is fair and equitable with respect to each class of claims or interests that is impaired but has not accepted the plan. For a plan to be fair and equitable, the following requirements must be met: • the plan must provide that secured creditors retain their liens in the collateral and will receive deferred cash payments totaling at least the allowed amount of the claim or the indubitable equivalent of their claim;187 the plan must provide that each unsecured claimant receive the allowed amount of its claim or that no holders of a junior interest to the unsecured claimants will receive a distribution of property;188 and the plan must provide that each such class receive or retain property equal to the value of any fixed liquidation preference, any fixed redemption price or the value of the interest, whichever is greatest or no junior class will receive or retain property under the plan. 189 • • In In re Bonner Mall Partnership, the Ninth Circuit determined that the new value exception to the absolute priority rule survived the enactment of the Bankruptcy Code.190 The court-developed new value exception permits shareholders of the debtor to maintain an interest in the reorganized corporation in exchange for new capital account contributions even where impaired creditors do not receive full payment on their claims and object to the confirmation of 183 184 185 186 187 188 189 190 See 11 U.S.C. § 1129(a)(9). See 11 U.S.C. § 1129(a)(8). See 11 U.S.C. § 1129(a)(11). See 11 U.S.C. § 1129(a)(13). See 11 U.S.C. § 1129(b)(2)(A). See 11 U.S.C. § 1129(b)(2)(B)(ii). See 11 U.S.C. § 1129(b)(2)(C). In re Bonner Mall Partnership, 2 F.3d 899 (9th Cir. 1993). An Overview of the Bankruptcy Code – Page 24 a proposed plan of reorganization. In a recent decision, the Supreme Court refused to address whether or not the new value exception remains viable, but found that even if it is viable, a Chapter 11 plan could not be confirmed where the plan provided for old equity holders to contribute new capital and receive ownership interests in the reorganized company without allowing others to compete for the equity or propose a competing plan of reorganization.191 j. Effect of Confirmation The confirmation of the plan operates to vest all of the property of the estate in the debtor and to discharge the debtor from all pre-confirmation debt, except as may be provided in the plan.192 k. Plan Implementation and Distribution Once the plan is confirmed and implemented, the bankruptcy court retains jurisdiction to direct the debtor to perform any act necessary for the consummation of the plan.193 If a plan provides for the presentment or surrender of a security or any other act as a condition to participating in the distribution under the plan, then the act must occur no later than five years after the date of confirmation.194 After confirmation of a plan, distribution must be made to creditors with allowed claims, holders of stock, bonds, debentures, notes and other securities that have not been disallowed and to any indentured trustees with allowed claims. l. Final Decree The final decree may be entered by the court after the estate is fully administered. The final decree will act to discharge any trustee, cancel the trustee’s bond and close the case.195 Injunctive relief may be included in the final decree.196 Bank of America, N.A. v. 203 North LaSalle Street Partnership, 526 U.S. 434, 119 S.Ct. 1411, 143 L.Ed.2d 607 (1999). 192 193 194 195 196 191 See 11 U.S.C. § 1141. See 11 U.S.C. § 1142. See 11 U.S.C. § 1143. See 11 U.S.C. § 350. See FED. R. BANKR. P. 3022. An Overview of the Bankruptcy Code – Page 25 II. GLOSSARY OF BANKRUPTCY TERMS Note: The following definitions are provided to assist the reader in understanding some of the terms used in Chapter 11 proceedings generally. For more detailed and exact definitions, please consult the Bankruptcy Code and legal counsel. Administrative Claims. Fees of court-authorized professionals, trustee’s commissions and claims of trade creditors and others for credit extended after the entry of the order for relief. Administrative claims generally are entitled to and must be paid before any prepetition unsecured creditors. Automatic Stay. When a Chapter 11 petition is filed, creditors are automatically prohibited from attempting to collect their prepetition claims from the Debtor or proceeding against property of the Debtor without first obtaining permission from the court to do so. Cash Collateral. Cash and cash equivalents which serve as collateral for a secured creditor’s claim. Included in this category are cash, bank deposits, proceeds from the sale of assets, accounts receivable collections and rents. Class of Creditors. Creditors are normally divided into classes in a Plan of Reorganization. The claims of general unsecured creditors are usually grouped together as one class, although there are on occasion sufficient distinctions among the general unsecured creditors so as to justify dividing them into two or more classes. Confirmation. The approval by the court of a Plan of Reorganization. Consensual Plan. A Plan of Reorganization accepted by every class of creditors and equity holders. It is rare that a consensual Plan is not approved by the court. Conversion. The Bankruptcy Code, in general, allows a Debtor to reorganize under Chapter 11 or to be liquidated under Chapter 7. A case may be changed, or converted from administration under one Chapter to another by order of the court or upon request of the Debtor, any creditor, the U.S. Trustee or any other party in interest. Creditors will often move to convert a Chapter 11 case to Chapter 7 if it does not appear that the Debtor will reorganize or if they feel that they would recover more in liquidation than under a reorganization. Cramdown. Confirmation of a Plan of Reorganization over the objection of a class of creditors or equity holders. A cramdown can occur only if at least one class of creditors whose claims are adversely affected by the Plan vote to accept it. The court will cram down a Plan on a dissenting class only if it finds that the Plan does not discriminate unfairly against that class and it is fair and equitable as to that class. Debtor. The entity undergoing reorganization. Debtor in Possession. Unless and until a trustee is appointed, a Debtor remains in possession of its assets and will manage its own affairs. The Debtor in Possession has a fiduciary obligation to the creditors, much the same as a court-appointed trustee. Discharge. The release of claims against the Debtor. An Overview of the Bankruptcy Code – Page 26 Disclosure Statement. When creditors vote on a Plan, they will receive the Plan, a ballot and a disclosure statement. The disclosure statement is intended to give creditors sufficient information about the Debtor and the Plan to permit them to make an informed judgment as to whether to vote for or against the Plan. The Debtor cannot send the disclosure statement to creditors until it has been approved by the court, after notice and a hearing. Examiner. A person appointed by the court upon motion of creditors or the U.S. Trustee to look into the Debtor’s books and records and dealings with third parties. The scope of the examiner’s duties is established by the court. The report prepared by the examiner is usually filed with the court and maintained as a public record. Fraudulent Conveyance. Transfers that are deemed to be in fraud of creditors can be avoided by the debtor in possession or trustee, either under state law or under the Bankruptcy Code. General Unsecured Claims. Those unsecured claims that are not administrative claims or priority claims. Involuntary Petition. Three or more creditors with undisputed, liquidated claims can put a Debtor into bankruptcy by filing an involuntary petition if the Debtor is not paying its debts generally as they become due. One creditor may do this if the Debtor has fewer than 12 creditors. The court will give the Debtor a chance to respond to the involuntary petition. It will then hold a hearing on the involuntary petition. If the petitioning creditors prove their case, the court will enter an order for relief against the Debtor. Order for Relief. The declaration that the Debtor’s business is subject to the court’s jurisdiction. In a voluntary case, an order for relief is automatically entered when the petition is filed. In an involuntary case, an order for relief can only be entered after giving the Debtor the opportunity to defend the allegations in the petition. Petition. The documents filed with the court that initiate a bankruptcy case. Plan of Reorganization. Sometimes referred to by the shortened term Plan, the document which, when approved by the court, specifies the treatment of the claims of the debtor’s creditors. A confirmed Plan is binding on all creditors, even those who did not vote in favor of the Plan. Where the Debtor’s assets are liquidated in a Chapter 11 case, this document may be called a Plan of Liquidation. Preference. Payments made to creditors within 90 days prior to the filing of a petition on account of pre-existing debts may, under some circumstances, be avoided by the debtor in possession or trustee. The 90-day period is extended to one year if the creditor is an insider of the Debtor. Prepackaged Plan. A Plan for which the solicitation of votes has occurred prior to the filing of the bankruptcy case. Pre-negotiated Plan. A Plan for which agreements have been reached as to creditor treatment prior to the filing of the bankruptcy case. An Overview of the Bankruptcy Code – Page 27 Priority Claims. Prepetition unsecured claims that are entitled to be paid before the claims of the general unsecured creditors. The most common priority claims are for wages, employee benefits, customer deposits and taxes. Proof of Claim. The document filed with the court by a creditor which establishes the amount and basis of its claim. Rule 2004 Examination. A procedure (similar to a deposition) for obtaining information from the Debtor and third parties about the assets and liabilities of the Debtor and other matters relevant to the case. The party being examined is asked questions under oath before a stenographer, who prepares a written transcript of the examination. The party may also be required to produce documents relevant to the case. Schedules. A document filed with the court by the Debtor setting forth in detail its assets and liabilities. Section 341 Hearing. Commonly referred to as the first meeting of creditors, the Debtor appears at an informal hearing, which in a Chapter 11 case is conducted by the U.S. Trustee. All creditors are entitled to ask the Debtor questions about its business, its assets and liabilities, and other matters relevant to the reorganization. Secured Creditor. A creditor whose claim is backed by collateral. Statement of Affairs. A document filed with the court by the Debtor that sets forth certain information about the Debtor’s business, management and finances. The statement of affairs is normally filed with the schedules. Super-Priority Administrative Claim. A type of administrative claim that has priority over other administrative claims. Super-priority administrative claim status is often granted to a secured lender in connection with a cash collateral or borrowing stipulation. Trustee. A person appointed by the U.S. Trustee who is entrusted with the responsibility of managing the Debtor’s business, pursuing claims against third parties and maximizing the payment to creditors through a reorganization or, if appropriate, a liquidation of the business. In a Chapter 11 case, a trustee is appointed only upon court order after motion by a creditor, the U.S. Trustee or another party in interest. Grounds for appointment of a trustee include fraud, dishonesty and gross mismanagement by the Debtor. U.S. Trustee. An officer of the U.S. Department of Justice responsible for monitoring Chapter 11 cases. The U.S. Trustee is responsible for appointing trustees and presiding at the Section 341 hearing. The U.S. Trustee has the right to be heard on any matter coming before the court and to file motions with the court in furtherance of his duties. Voluntary Petition. A petition filed by the Debtor. Most Chapter 11 cases are commenced by the filing of a voluntary petition. 1161721_1.DOC An Overview of the Bankruptcy Code – Page 28