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Suggested Additional Assignments
Research: Exempt Property
Under the Code, individual debtors are permitted to keep certain exempt property. However, the Code
allows state law to establish the amount and type of this exempt property. Ask students to determine your
state’s law on exempt property. A list of state exemptions is available at
http://www.bcsalliance.com/bankruptcy_stateexemptions.html.
Chapter Overview
Chapter Theme
As in many areas of law, bankruptcy law must balance competing interests – in this case, the interests of
the creditor and debtor. When an individual or business files for bankruptcy protection, generally neither
debtor nor creditor comes out whole. Traditionally, American law was viewed as favoring debtors over
creditors. Does the law favor one side over the other, or does it have the balance about right?
Overview of the Bankruptcy Code
The federal Bankruptcy Code (Code) is divided into eight chapters. All chapters except one have odd
numbers. Chapters 1, 3, and five are administrative rules that generally apply to all types of bankruptcy
proceedings. These chapters, for example, define terms and establish the rules of the bankruptcy court.
Chapters 7, 9, 11, 12, and 13 are substantive rules for different types of bankruptcies. All of these
substantive chapters have one of two objectives—rehabilitation or liquidation.
Chapter 7 Liquidation
When debtors are unable to develop a feasible plan for rehabilitation under Chapter 11 or 13, Chapter 7
provides for liquidation.
Filing a Petition
A case begins with the filing of a bankruptcy petition in federal district court. Any individual, partnership,
corporation, or other business organization that lives, conducts business, or owns property in the United
States can file under the Code. May be voluntary or involuntary.
Trustee
The trustee is responsible for gathering the bankrupt’s assets and dividing them among creditors.
Creditors
After the court issues an order for relief, the U.S. Trustee calls a meeting of all of the creditors.
Automatic Stay
An automatic stay prohibits creditors from independently collecting debts that the debtor incurred before
the petition was filed. Once the petition is filed, the debtor's assets must be distributed according to the
priorities set by law, not according to who can strong-arm the debtor most forcibly. The ability to stay
creditors’ claims and obtain breathing room can be a powerful incentive for a struggling business to file
for bankruptcy.
Case: Jackson v. Holiday Furniture1
Facts: Cora and Frank Jackson purchased a recliner chair on credit from Dan Holiday Furniture. They
made payments for seven months until November, when they filed for bankruptcy protection.
Although the store knew about the bankruptcy filing, a collector called the Jacksons’ house ten times
between November 15 and December 1 and left a card in their door threatening repossession of the chair.
On Dec 1, Frank went to Dan Holiday to pay the $230.00 owed for November and December. He told the
store about the bankruptcy filing, but allegedly added that he and his wife wanted to continue making
payments directly to Dan Holiday.
In early January, Dan Holiday employees learned that Frank had died the month before. Nonetheless,
collectors telephoned Cora Jackson 26 times between January 14 and February 19. The storeowner’s
sister left the following message on Cora’s answering machine:
Hello. This is Judy over at Dan Holiday Furniture. And this is the last time I am going to call you. If
you do not call me I will be at your house. And I expect you to call me today. If there is a problem I
need to speak to you about it. You need to call me. We need to get this thing going. You are a January
and February payment behind. And if you think you are going to get away with it, you’ve got another
thing coming.
When Cora returned home on February 18, she found seven bright yellow slips of paper in her door jamb
stating that a Dan Holiday truck had stopped by to repossess her furniture. The threat to send a truck was
merely a ruse designed to frighten Cora into paying. In fact, the store did not want the furniture back.
What they wanted was to talk directly to her about making payments. The store also sent Cora a letter
threatening repossession and legal action. Cora’s bankruptcy attorney then contacted the store and all
collection activity ceased.
Issues: Did Dan Holiday violate the automatic stay provisions of the Bankruptcy Code? What is the
penalty for a violation?
Excerpts from Judge Venters’s Decision: The automatic stay prohibits the commencement or
continuation of any action against the debtor that arose before the commencement of the bankruptcy case
and forbids any act by a pre-petition creditor to obtain possession of property of the bankruptcy estate. An
individual injured by a creditor’s violation of the automatic stay shall recover actual damages, including
costs and attorneys’ fees, and in appropriate circumstances, may recover punitive damages.
In this case, there is no question that Dan Holiday repeatedly violated the automatic stay. [T]he Court
finds that the Jacksons suffered financial damages in the amount of $230.00, which represents the coerced
payments that Dan Holiday received from Frank Jackson on December 1.
The Court finds that punitive damages are warranted in this case based on Dan Holiday’s egregious,
intentional violations of the automatic stay. Dan Holiday’s conduct was remarkably bad in that, after it
had actual knowledge of the Jacksons’ bankruptcy, and after coercing payments from the Jacksons
covering the months of November and December, it made no less than 26 telephone calls to the Jacksons’
household in January and February. Dan Holiday’s continued collection efforts were in flagrant violation
of the protections Congress afforded to debtors under the automatic stay.
In this matter the Court is somewhat hampered in assessing punitive damages by the lack of evidence
concerning the ability of Dan Holiday to pay. [An owner] testified that Dan Holiday was a family-owned
business that has been in existence for 52 years, and the Court assumes that it is a relatively small
business. Under the circumstances of this case, the Court believes that an appropriate penalty would be
$100.00 for each illegal contact with the Jacksons after December 1, when it is crystal clear that Dan
Holiday had actual knowledge of the Jacksons’ bankruptcy filing, for a total of $2,800.00. The Court
believes that this penalty will be sufficient to sting the pocketbook of Dan Holiday and impress upon Dan
1 309 B.R. 33; 2004 Bankr. LEXIS 548 United States Bankruptcy Court for the Western District of
Missouri, 2004.
Holiday and its owners and employees the importance of debtor protections under the Bankruptcy Code,
as well as to deter further transgressions.
The Court also will award the Jacksons their attorneys’ fees and costs in the amount of $1,142.42, an
amount the Court considers eminently fair and reasonable under the circumstances of this case.
Question: What is the goal of the automatic stay?
Question: How did Dan Holiday Furniture violate the automatic stay provisions?
Question: But didn’t Frank Jackson say he wanted to continue paying the store?
Answer: That doesn’t matter. The Bankruptcy Code does not permit the debtor to cut special deals
Question: The court awarded punitive damages to Jackson—would a court do that anytime a creditor
violates the automatic stay?
General Question: Even if the store’s behavior had been legal, was it ethical? Would the store’s
owners have wanted to receive threatening phone calls and letters while they were grieving for the
loss of a loved one?
Bankruptcy Estate
The filing of the bankruptcy petition creates a new legal entity separate from the debtor—the bankruptcy
estate. All of the bankrupt’s assets pass to the estate except exempt property and new property that the
debtor acquires after the petition is filed.
Exempt Property
In order to save individual (not business) debtors from destitution, the Code permits them to keep some
property. The amount of property is determined by state law and varies dramatically from state to state.
However, under the BAPCPA, debtors can take advantage of state exemptions only if they have lived in
their state for two years. Debtors can exempt only $146,450 of any house acquired within 40 months of
the bankruptcy.
Students who completed the Exempt Property assignment could present their findings at this time.
General Questions:
What is the law on exempt property in your state?
General Question: After falling into debt, former baseball commissioner, Bowie Kuhn, traded in his
New Jersey home for a million dollar mansion in Florida. His goal was to take advantage of Florida's
generous laws. Was this an ethical decision?
Question: Kuhn got into financial trouble when his law partnership filed for bankruptcy. One of his
partners was convicted of defrauding clients and was sentenced to 70 months in prison. How do you
think Kuhn rationalized his decision to buy a house in Florida?
Answer: Undoubtedly, he thought that, since the debts had belonged to the partnership and had been
caused in particular by the dishonest acts of one of his partners, he should not be penalized. In
General Questions: Is the BAPCPA fair? Does it strike the proper balance between the rights of
creditors and debtors? Should a debtor be allowed to exempt a mansion as long as he has lived in
it for 40 months before filing? Alternatively, would it be fair to allow all debtors to hang on to a
home, no matter how valuable? Debtors do have to live someplace.
Voidable Preferences
A preference is when a debtor unfairly pays creditors immediately before filing a bankruptcy petition.
Preferences take two forms: payments and liens. The trustee can void any transfer (whether payment or
lien) that meets all of the following requirements:
The transfer was to a creditor of the bankrupt.
It was to pay an existing debt.
The creditor received more from the transfer than she would have received during the
bankruptcy process.
The debtor’s liabilities exceeded assets at the time of the transfer.
The transfer took place in the 90-day period before the filing of the petition.
Payment of Claims
Claims are paid in the following order:
Secured Claims. Creditors whose loans are secured by specific collateral are paid first.
Priority Claims. There are seven subcategories of priority claims. Each subcategory is paid in
order, with the first group receiving full payment before the next group receives anything:
Administrative expenses
Gap expenses
Payments to employees
Employee benefit plans, consumer deposits, alimony and child support, drunken injuries
and taxes
Unsecured Claims. All three of these unsecured subcategories have an equal claim and must be
paid together:
Secured claims that exceed the value of the available collateral
Priority claims that exceed the priority limits
All other unsecured claims
Question: Why are claims paid in this order?
Answer: Congress felt that this was a fair allocation of a debtor's assets. Secured claims are paid first,
Question: Do students agree with these priorities?
Answer: Students sometimes comment on the fact that fees of lawyers and accountants are at the top
of the list under priority claims. No one would expect a creditor to lend additional unsecured money
Discharge
Once a bankruptcy estate has been distributed to creditors, they cannot make a claim against the debtor
for money owed before the filing, whether or not they actually received any payment. These pre-petition
debts are discharged.
Debts That Cannot Be Discharged
These debts are not discharged by bankruptcy:
Income taxes for the three years prior to filing and property taxes for the prior year
Money obtained fraudulently
Any loan of more than $600 that a consumer uses to purchase luxury goods within 90
days before the order for relief is granted
Cash advances on a credit card totaling more than $875 that an individual debtor takes
out within 70 days before the order of relief
Debts omitted from the Schedule of Assets and Liabilities that was filed with the petition,
if the creditor did not know about the bankruptcy and therefore did not file a proof of claim
Money that the debtor stole or obtained through a violation of fiduciary duty
Money owed for alimony, maintenance, or child support
Debts stemming from intentional and malicious injury
Fines and penalties owed to the government
Liability for injuries caused by the debtor while operating an automobile under the
influence of drugs or alcohol
Liability for breach of duty to a bank
Student loans guaranteed by the government. These loans cannot be discharged until
seven years after the due date. Even then, the court can discharge these loans only if the student
has acted in good faith and payment would cause undue hardship.
Debts stemming from a violation of securities laws
Question: What is the logic behind making these debts non-dischargeable?
Answer:
Congress drafted the Code, and it wants to ensure that its taxes, fines, and penalties are
paid.
Congress wanted to discourage consumers from purchasing luxury goods and then
Case: In re Stern2
Facts: James Stern took out student loans to attend college and law school. Afterwards, he had difficulty
finding a job as a lawyer, so he opened his own practice. Both he and his wife earned less than $20,000 a
year.
A client sued Stern for malpractice. Although Stern won, his malpractice premiums increased so
much that he could no longer afford the insurance. Believing that his debt and default on his student loans
2 288 B.R. 36; 2002 Bankr. LEXIS 1609 United States Bankruptcy Court for the Northern District of
New York, 2002.
made him unemployable as a lawyer, he moved with his wife to her native country, France. Unfortunately,
he did not speak French and, therefore, could not obtain a job, even as a street sweeper. His wife’s total
income over six months in France was $2,200. Even more unfortunately, their expenses in France were
higher than in the United States.
Stern owed $147,000 in student loans: $56,000 in principal and $91,000 in interest. He calculated that
paying this debt would cost $1,167 per month over 30 years. He asked the court to discharge these student
loans on grounds of undue hardship. As he put it, “I’m never going to be able to get a house, I’m never
going to be able to have a car, and I won’t—you know, I want to have kids. I want to be responsible, and I
can’t—I can’t possibly pay this amount and have a life, not with what I expect I’ll be able to earn.”
Issue: Is Stern entitled to a discharge of his student loans on grounds of undue hardship?
Excerpts from Judge Gerling’s Decision:3[E]ducational loans are different from most loans. They are
made without business considerations, without security, without cosigners, and rely for repayment solely
on the debtor’s future increased income resulting from the education. In this sense, the loan is viewed as a
mortgage on the debtor’s future.
[To obtain a discharge] Stern must prove more than his present inability to pay his student loan
obligations. He must also establish that his current financial hardship is likely to be long-term. In this
case, Stern possesses both a bachelor’s degree and a Juris Doctorate. Stern apparently has decided that he
no longer wishes to pursue a legal career. He is certainly well within his rights to make such a choice.
Nevertheless, [b]orrowers under the various guaranteed student loan programs are obligated to repay their
loans even if they are unable to obtain employment in their chosen field of study.
The Court finds disturbing Stern’s failure to maximize his income and minimize his expenses. He and
his wife have elected to relocate to France where Stern admitted that the cost of living is higher. Nor is
there any evidence that he ever made any effort to obtain employment in the United States in order to
enhance his earnings, whether it be in business, government, or in a private law firm in Syracuse or
elsewhere. Instead, he opted to move to a country where he acknowledges he cannot even get a job as a
street sweeper because of his inability to speak the language.
Obviously, Stern would prefer to be in a position that would allow him to allocate those monies [he
owes] to a mortgage on a home or to the raising of children. Those are certainly commendable goals; but
the fact that they may not be attainable at this time because of the student loans and Stern’s, as well as his
wife’s, current employment situation, does not meet the fundamental standard from which “undue
hardship” is measured and does not provide a basis for granting Stern [even] a partial discharge at this
time.
While Stern and his wife have experienced some “bumps in the road,” the direction they take in the
future appears very much in their control based on their age, health, and education. Indeed, it is the very
education that he obtained as a result of the student loans at both the undergraduate and graduate levels,
which, arguably, should ultimately allow him to pursue employment opportunities not available to others
who were unable to pursue higher education for whatever reason. While Stern testified that he no longer
wishes to continue in the legal profession, certainly, there are other career opportunities available to him
by virtue of his education, training, and experience.
Question: What is the moral of this case?
Answer: Student loans are a serious obligation. If borrowers don’t repay their loans, then lenders
will not have funds available to loan to other worthy students. Therefore, if students are going to
3 Although the court refers to Stern as “Debtor,” we use his surname.
Circumstances That Prevent Debts Be Discharged
The Code also prohibits the discharge of debts under the following circumstances:
Business organizations. Under Chapter 7 (but not the other Chapters), only the debts of
individuals can be discharged, not those of business organizations. Once its assets have been
distributed, the organization must cease operation. If it continues in business, it is responsible for
all pre-petition debts.
Revocation. A court can revoke a discharge within one year if it discovers the debtor
engaged in fraud or concealment.
Dishonesty or bad faith behavior.
Repeated filings for bankruptcy.
Rea+rmation
Sometimes debtors are willing to reaffirm a debt, meaning they promise to pay even after discharge.
Case: In re Grisham4
Facts: Two months before filing for bankruptcy, William Grisham bought a Dodge Truck (Nitro-V6
Utility 4D SLT 2WD). At the time of his bankruptcy filing, the vehicle was worth $16,000, but he owed
$17,500 on it. The annual interest rate was 17.5%, the monthly payments were $400, and the payment
schedule was almost 6 years. In addition, Grisham owed:
$29,000 to the IRS
$75,000 in alimony
$100,000 in student loans
$70,000 in unsecured debt
$274,000 total in addition to the truck
Grisham sought to reaffirm the truck loan. Should the court allow him to do so?
Issue: Would reaffirmation of this debt create an undue hardship for the debtor?
Excerpts from Judge Jernigan’s Decision: [F]rom the outset, this court was concerned that the Debtor
wished to reaffirm debt on personal property in which there is no equity. [T]he Debtor describes himself
as "retired/unemployed." The Debtor's only source of income is $1,928 per month of social security
income and $1,698 per month of unemployment benefits—the latter of which will soon expire. The
Debtor owns no real property and testified that he currently resides rent-free at a relative's home. The
Debtor's monthly net income, after deducting his living expenses, is a negative $1,091.
While the monthly payments on the vehicle are not eye-popping, for this Debtor, in his current situation,
it is unduly burdensome. In particular, this Debtor is burdened with several obligations that will likely
survive his discharge in bankruptcy (large IRS debt; large alimony; and large student loan debt). Finally,
the court heard no compelling testimony to justify why the Debtor purchased his vehicle right before
filing bankruptcy (sometimes this may be defensible and sometimes not). In summary, the court will not
stamp its seal of approval on the Debtor's reaffirmation of the debt. To do so would create a hardship on
this Debtor and does not otherwise seem justified.
Bankruptcy is about "fresh starts" and new beginnings. It is about belt-tightening and shedding past bad
habits. Too often, a reaffirmation agreement will reveal that someone just does not comprehend this, and
wants to go forward in a manner that will impair his fresh start and perpetuate bad habits from the past.
The court realizes that this is sometimes complicated. [T]here are probably situations in which a
vehicle-lender will repossess the debtor's vehicle post-discharge, even when the debtor is making regular
and timely contractual payments for the car post-discharge—for the simple reason that the debtor did not
"reaffirm." Thus, the court can understand why a debtor and his counsel might see the wisdom
of entering into a reaffirmation agreement, even if they can envision the court may never approve it
4 436 B.R. 896; 2010 Bankr. LEXIS 2907 US BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF TEXAS, 2010.
because of the negative math. Perhaps they imagine that this will help the debtor with the car lender
post-discharge, if they at least tried to get the reaffirmation agreement approved with the court. Moreover,
perhaps the debtor genuinely needs a car and worries that, absent an attempt at a reaffirmation agreement,
he will surely lose the car post-discharge and may not be able to purchase (i.e., obtain financing) for
another vehicle in the near future.
The court realizes that we are in a world where car lenders may not always act like economically
rational animals. And, the court appreciates that car lenders may sometimes have their own economic
pressures with which to contend. But, again, the fresh start is the overriding purpose of a Chapter 7
bankruptcy case. Many reaffirmation agreements presented to the court are the farthest thing from a "fresh
start" that one could ever imagine. Many times it is time to say "good riddance" to the car. And many
times—maybe, just maybe—a car lender will see the wisdom of renegotiating a car loan if reaffirmation
is denied.
Accordingly, IT IS ORDERED that the Reaffirmation Agreement is disapproved.
Question: Did the court agree to the reaffirmation?
Question: Is the debtor’s truck going to be repossessed?
Question: What might be the debtor’s reason for the reaffirmation?
Additional Case: In re: John & Julie Homan5
Facts: The Hoffmans filed Chapter 7 bankruptcy. Among their debts was a loan for $11,500 secured by
their 1999 Dodge Caravan. The car was worth less than half the amount of the loan, thus, there was no
economic sense to pay back twice the value of their car. However, Mrs. Hoffman’s mother was a
co-signer on the car. If they defaulted, she would have to pay. To protect her, the Hoffmans signed a
reaffirmation agreement promising to repay the car loan at the rate of $96 per week. The Hoffman’s
monthly income of $4,799.12 was $35.87 less than their expenses. Because they had lost their house, they
were living with his parents and paying $600 a month in rent.
The Hoffman’s lawyer refused to approve the reaffirmation agreement because it had a negative
monthly budget. The Hoffmans asked the Court to approve the agreement.
Issue: Will the court approve a reaffirmation agreement that shows a negative monthly balance?
Holding: No, according to the court the reaffirmation agreement would impose an undue hardship on the
Hoffmans and thus would not be in their best interest. According to the court, there was no evidence
supporting the conclusion that the Hoffmans could afford to make the payments required under the
reaffirmation agreement. Their monthly deficit of $35.87 is possibly larger now than at the time of filing
because “Mrs. Hoffman’s income will be reduced by $2,000 per month due to a change in employers.”
According to the court, the Hoffman’s desire to protect Mrs. Hoffman’s mother is not enough to make
their willingness to reaffirm their legal liability for their discharged debt to be in their best interest. Not
approving the reaffirmation agreement does not necessarily mean that they will lose their car or that Mrs.
Hoffman’s mother will be faced with a demand for payment. The Bankruptcy Code allows debtors to
continue to make voluntary payments.
Question: What is a co-signer?
5 358 B.R. 839; 2006 Bankr. LEXIS 3841, United States Bankruptcy Court for the Western District of
Virginia, 2006.
Question: How did the status of Mrs. Hoffman’s mother as a co-signer discourage the Hoffmans
from defaulting on the loan?
Answer: Because Mrs. Hoffman’s mother was a co-signer, if the Hoffmans defaulted on the loan
Question: What does reaffirmation mean?
Question: Why wouldn’t a court allow a debtor to pay back a debt voluntarily, it seems counter
to the goals of bankruptcy?
Answer: The goals of bankruptcy are to preserve as much of the debtor’s property as possible, to
divide the debtor’s assets fairly between the creditors and the debtor, and to divide the debtor’s
