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Chapter 38
BANKRUPTCY
I. Federal Bankruptcy Law
A. Case Administration-Chapter 3
1. Commencement of the Case
a. Voluntary Petitions
b. Involuntary Petitions
2. Dismissal
3. Automatic Stays
4. Trustees
5. Meetings of Creditors
B. Creditors, the Debtor, and the
Estate-Chapter 5
1. Creditors
a. Proof of Claims
b. Secured and Unsecured
Claims
c. Priority of Claims
d. Subordination of Claims
2. Debtors
a. Debtor's Duties
b. Debtor's Exemptions
c. Discharge
3. The Estate
a. Trustee as Lien Creditor
b. Voidable Preferences
c. Fraudulent Transfers
d. Statutory Liens
C. Liquidation–Chapter 7
1. Proceedings
2. Conversion
3. Dismissal
4. Distribution of the Estate
5. Discharge
D. Reorganization–Chapter 11
1. Proceedings
2. Plan of Reorganization
3. Acceptance of Plan
4. Confirmation of Plan
a. Good Faith
b. Feasibility
c. Cash Payments
d. Acceptance by Creditors
5. Effect of Confirmation
E. Adjustment of Debts of Individuals-Chapter 13
1. Proceedings
2. Conversion or Dismissal
3. The Plan
4. Confirmation
5. Effect of Confirmation
6. Discharge
II. Creditors' Rights & Debtor Relief Outside Bankruptcy
A. Creditors' Rights
1. Prejudgment Remedies
2. Postjudgment Remedies
B. Debtor's Relief
1. Compositions
2. Assignments for Benefit of Creditors
3. Equity Receiverships
Cases in This Chapter
Marrama v. Citizens Bank
Radlax Gateway Hotel, LLC v. Amalgamated Bank
Hamilton v. Lanning
Chapter Outcomes
After reading and studying this chapter, the student should be able to:
Explain (a) the requirements for voluntary and involuntary bankruptcy
cases, (b) the priorities of creditors’ claims, (c) the debtor’s
exemptions, and (d) the debts that are not dischargeable in
bankruptcy.
Explain the duties of a trustee and his rights (a) as a lien creditor, (b)
to avoid preferential transfers, (c) to avoid fraudulent transfers, and
(d) to avoid statutory liens.
Explain the procedure followed in distributing the debtor’s estate
under Chapter 7.
Compare the adjustment of debt proceedings under Chapters 11 and
13.
Identify and de&ne the nonbankruptcy compromises between debtors
and creditors.
TEACHING NOTES
Both individuals and corporations sometimes encounter &nancial crises and
business misfortune that may lead to an accumulation of debts that exceeds
total assets, or they may for some other reason be unable to pay their debts
when due. In this chapter, we will outline one method of debtor relief — a
proceeding in a federal court under federal bankruptcy law.
I. FEDERAL BANKRUPTCY LAW
Bankruptcy legislation serves a dual purpose: (1) to bring about a quick,
equitable distribution of the debtor’s property among her creditors and (2) to
discharge the debtor from her debts, enabling her to rehabilitate herself and
to start afresh.
The US Bankruptcy Code consists of eight odd-numbered chapters and one
even-numbered chapter. Chapters 7, 9, 11, 12, and 13 provide &ve different
types of proceedings; Chapters 1, 3, and 5 apply to those &ve proceedings.
Straight, or ordinary, bankruptcy (Chapter 7) provides for the liquidation and
termination of the debtor’s business, whereas the other proceedings provide
for the reorganization and adjustment of the debtor’s debts and the
continuance of the debtor’s business.
Chapter 7 applies to all debtors, with the exception of railroads,
insurance companies, banks, savings and loan associations,
homestead associations, licensed small business investment
companies, and credit unions. In the past several years, 60 to 75
percent of bankruptcies have been &led under Chapter 7. Moreover,
Chapter 7 has special provisions for liquidating the estates of
stockbrokers and commodity brokers.
Chapter 11 applies to railroads and any person who may be a debtor
under Chapter 7 (except a stockbroker or a commodity broker). Less
than 1 percent of bankruptcies are &led under Chapter 11.
Chapter 9 applies only to municipalities that are generally authorized
to be debtors under that chapter, that are insolvent, and that desire to
effect plans to adjust their debts.
Chapter 12 applies to individuals, or individuals and their spouses,
who are engaged in farming if 50 percent of their gross income is from
farming, their aggregate debts do not exceed $$4,031,575 and at
least 50 percent of their debts arise out of farming operations. Less
than one-tenth of 1 percent of bankruptcies are &led under Chapter
12. Corporations or partnerships also may qualify for Chapter 12. The
2005 Act made Chapter 12 permanent and extended its coverage to
certain family &shermen if 50 percent of their gross income is from
commercial &shing, their aggregate debts do not exceed $1,868,200,
and at least 80 percent of their debts arise out of commercial &shing
operations.
A. CHAPTER 3 — CASE ADMINISTRATION
Chapter 3 of the Bankruptcy Code contains provisions dealing with the
commencement of the case, the meetings of creditors, the o?cers who
administer the case, and the o?cers’ administrative powers.
Commencement of the Case
Voluntary Petitions — More than 99 percent of all bankruptcy petitions are
&led voluntarily. Any eligible person may &le a voluntary petition for
bankruptcy which must list all creditors, property owned, list of exempt
property, and a statement of the debtor’s a0airs; &ling constitutes an
automatic order for relief. Insolvency is not required in order to &le a
voluntary petition.
The 2005 Act added a requirement that all individual debtors (with a few
exceptions) receive credit counseling from an approved nonpro&t budget and
credit counseling agency within the 180-day period before &ling the petition.
Involuntary Petitions — A debtor may be forced into involuntary
bankruptcy (Chapter 7 or 11) (1) by three or more creditors who have
unsecured claims which total $15,325 or more, or (2) if the debtor has fewer
Dismissal
The court is empowered to dismiss a Chapter 7case &led by an individual
debtor whose debts are mostly consumer debts if granting that relief would
substantially abuse the provisions of Chapter 7. Under Chapter 11, the court
may dismiss a case for cause after notice and a hearing. Section 1112(b).
Automatic Stays
Following the &ling of a voluntary or involuntary petition an order of relief is
issued: All creditors are precluded from taking legal action against the
debtor.
*** Chapter Outcome***
Explain the duties of a trustee and his rights (a) as a lien creditor, (b) to avoid
preferential
transfers, (c) to avoid fraudulent transfers, and (d) to avoid statutory liens.
Trustees
The trustee of an estate may be selected by the creditors (Chapter 7 or, if
the court orders a trustee, in Chapter 11) or appointed, (Chapters 12 and
13). Under Chapter 7, the trustee is responsible for collecting, liquidating,
and distributing the debtor’s estate.
Meetings of Creditors
*** Chapter Outcome***
Explain (a) the requirements for voluntary and involuntary cases, (b) the priorities of
creditors’ claims, (c) the debtor’s exemptions, and (d) the debts that are not
dischargeable in bankruptcy.
B. CREDITORS, THE DEBTOR, & THE ESTATE—CHAPTER 5
Creditors
The Bankruptcy Code de&nes a creditor as any entity having a claim (right to
payment) against the debtor that arose at the time of or before the order for
relief.
Proof of Claims — Must be &led in a timely manner. The Court may not
allow a claim if: it is unenforceable against the debtor or his property, it is
for unmatured interest, it may be o0set against a debt owed the debtor, or it
is for insider/attorney services that are overvalued.
Priority of Claims — All secured claims are paid &rst, with the remaining
assets distributed among creditors with unsecured claims according to their
priority. The order of priority is:
1. Domestic support obligations (Alimony and support of spouse or child)
Subject to the expenses of a trustee in administering assets that can
be used to pay these obligations.
2. “ Expense of administration of the debtor’s estate
3. Gap” creditors (arising in the ordinary course of business after
commencement of the case but before either the appointment of the
trustee or the order for relief)
4. Wages, salaries, or commissions earned within 180 days of &ling or
date of cessation of business, whichever comes &rst, up to $12,475
5. Contributions to employee bene&t plan up to $12,475 multiplied by
Subordination of Claims — When two claims have equal priority, the court
may, on equitable grounds, decide which shall be paid &rst. Claims by a
parent corporation against subsidiary may be subordinated where it is
demonstrated that the parent was guilty of unconscionable mismanagement
to the detriment of other creditors.
Debtors
Debtor’s Duties — Under the Bankruptcy Code, the debtor must &le a list
of creditors, a schedule of assets and liabilities, and a statement of &nancial
a0airs. In any case in which a trustee is serving, the debtor must cooperate
with the trustee and surrender to the trustee all property of the estate and
all records relating to property of the estate.
Debtor’s Exemptions — Certain property is exempt from bankruptcy
proceedings including,
3. up to $575 for any particular item, and not to exceed $12,250 in
aggregate value, of household furnishings, household goods, wearing
apparel, appliances, books, animals, crops, or musical instruments
that are primarily for personal, family, or household use;
4. up to $1,550 in jewelry;
5. any property up to $1,225 plus up to $11,500 of any unused amount
of the &rst exemption;
6. up to $2,300 in implements, professional books, or tools of the
debtor’s trade;
7. unmatured life insurance contracts owned by the debtor, other than a
credit life insurance contract;
8. professionally prescribed health aids;
9. social security, veteran’s, and disability bene&ts;
In addition, the debtor may avoid judicial liens on any exempt property and
nonpossessory, nonpurchase money security interests on certain household
goods, tools of the trade, and professionally prescribed health aids.
State law can, by speci&c legislation, limit exemptions. (More than
three-quarters of the states have done so.)
The 2005 Act speci&es that a debtor’s exemption is governed by the law of
the State where the debtor was domiciled for 730 days immediately before
&ling. If the debtor did not maintain a domicile in a single State for the
730-day period, then the governing law is of the State where the debtor was
domiciled for 180 days immediately preceding the 730-day period (or for a
longer portion of such 180-day period than in any other State).
Whether or not Federal or State exemptions apply, the 2005 Act provides
that tax-exempt retirement accounts are exempt. IRAs are subject to a
$1,245,475 cap periodically adjusted for inflation. Nevertheless, the 2005 Act
makes exempt property liable for nondischargeable domestic support
obligations.
The 2005 Act also imposes limits on the use of State homestead exemptions.
First, to the extent that the homestead was obtained through fraudulent
conversion of nonexempt assets during the ten-year period before &ling the
days before &ling to the debtor’s current principal residence if both
residences are located in the same State. Third, a debtor may not exempt
more than $155,675 if (1) the debtor has been convicted of a felony, which
under the circumstances demonstrates that the &ling of the case was an
abuse of the Bankruptcy Cod; or (2) the debtor owes a debt arising from (a)
any violation of State or Federal securities laws; (b) fraud, deceit, or
manipulation in a &duciary capacity or in connection with the purchase or
1. certain taxes and customs duties and debt incurred to pay such taxes or
custom duties;
2. legal liabilities for obtaining money, property, or services by false
pretenses, false representations, or actual fraud;
3. legal liability for willful and malicious injuries to the person or property of
another;
4. domestic support obligations and property settlements arising from
divorce or separation proceedings;
5. debts not scheduled, unless the creditor knew of the bankruptcy;
6. debts the debtor created by fraud or defalcation while acting in a
&duciary capacity, embezzlement, or larceny;
7. student loans unless excluding the debt from discharge would impose
undue hardship;
The Estate
Includes all legal and equitable interests of the debtor in nonexempt property
at the time bankruptcy proceedings are &led, and also covers property
acquired by the debtor within 180 days after commencement of the case
through inheritance, property settlement, divorce decree, or life insurance
proceeds.
Trustee as Lien Creditor — The trustee acquires the rights and powers of
a hypothetical judicial lien creditor — has priority over a creditor with an
unperfected security interest.
Voidable Preferences — Allows the trustee to invalidate pre-bankruptcy
transfers:
1) made to or for the creditor’s bene&t;
2) made for or on account of an antecedent debt;
3) made while the debtor was insolvent;
4) made within 90 days of the &ling; and
5) if the creditor receives more than he would under Chapter 7.
The 90 day rule does not apply to an exchange for new value (such as a
purchase of an automobile), enabling security interests, and payment of a
debt in the ordinary course of business.
The trustee may not void transfers of property of less than $650 for debtors
whose debts are primarily consumer debts. In a case &led by a debtor
*** Chapter Outcome***
Explain the procedure followed in distributing the debtor’s estate under Chapter 7.
C. CHAPTER 7 — LIQUIDATION
Liquidation involves terminating the business of the debtor, distributing his
nonexempt assets, and, usually, discharging all his dischargeable debts.
Proceedings
Proceedings under Chapter 7 apply to all debtors except railroads, insurance
companies, banks, savings and loan associations, homestead associations,
and credit unions. Begins with an interim trustee, who can become
permanent trustee if the creditors do not select someone else. Trustee
collects and sells property, investigates the debtor’s &nancial a0airs,
examines claims, decides whether to oppose a discharge of debts and makes
reports. A committee of 3-11 unsecured creditors makes recommendations
to the trustee.
Conversion
The debtor may convert a case under Chapter 7 to Chapter 11 or 13;
however any waiver of this right is unenforceable. Moreover, on request of a
CASE 38-1
MARRAMA v. CITIZENS BANK
Supreme Court of the United States, 2007
549 U.S. 365, 127 S.Ct. 1105,166 L.Ed.2d 956
http://scholar.google.com/scholar_case?q=549+U.S.+365&hl=en&as_sdt=2,34&case=1525401286002576802&scilh=0
Stevens, J.
The principal purpose of the Bankruptcy Code is to grant a “‘fresh start’” to the “‘honest but
unfortunate debtor.’” [Citation.] Both Chapter 7 and Chapter 13 of the Code permit an
insolvent individual to discharge certain unpaid debts toward that end. Chapter 7 authorizes
a discharge of prepetition debts following the liquidation of the debtor’s assets by a
bankruptcy trustee, who then distributes the proceeds to creditors. Chapter 13 authorizes an
individual with regular income to obtain a discharge after the successful completion of a
payment plan approved by the bankruptcy court. Under Chapter 7 the debtor’s non-exempt
Chapter 13. In the former context, despite the absence of any statutory provision specifically
addressing the issue, the federal courts are virtually unanimous that prepetition bad-faith
conduct may cause a forfeiture of any right to proceed with a Chapter 13 case. In the latter
context, however, some courts have suggested that even a bad-faith debtor has an absolute
right to convert at least one Chapter 7 proceeding into a Chapter 13 case even though the
case will thereafter be dismissed or immediately returned to Chapter 7. We granted certiorari
to decide whether the Code mandates that procedural anomaly. [Citation.]
On March 11, 2003, petitioner, Robert Marrama, filed a voluntary petition under Chapter
7, thereby creating an estate consisting of all his property “wherever located and by
whomever held.” §541(a). Respondent Mark DeGiacomo is the trustee of that estate.
Respondent Citizens Bank of Massachusetts (hereinafter Bank) is the principal creditor.
In verified schedules attached to his petition, Marrama made a number of statements
about his principal asset, a house in Maine, that were misleading or inaccurate. For instance,
while he disclosed that he was the sole beneficiary of the trust that owned the property, he
After Marrama’s examination at the meeting of creditors, see §341, the trustee advised
Marrama’s counsel that he intended to recover the Maine property as an asset of the estate.
Thereafter, Marrama filed * * * a motion to convert [to Chapter 13], to which both the
trustee and the Bank filed objections. Relying primarily on Marrama’s attempt to conceal the
Maine property from his creditors, the trustee contended that the request to convert was
made in bad faith and would constitute an abuse of the bankruptcy process. The Bank
opposed the conversion on similar grounds.
that the courts in this case correctly held that Marrama forfeited his right to proceed under
Chapter 13.
* * *
The class of honest but unfortunate debtors who do possess an absolute right to convert
their cases from Chapter 7 to Chapter 13 includes the vast majority of the hundreds of
thousands of individuals who file Chapter 7 petitions each year. Congress sought to give
these individuals the chance to repay their debts should they acquire the means to do so.
Moreover, as the Court of Appeals observed, the reference in §706(a) to the unenforceability
A statutory provision protecting a borrower from waiver is not a shield against forfeiture.
Nothing in the text of either §706 or §1307(c) (or the legislative history of either provision)
limits the authority of the court to take appropriate action in response to fraudulent conduct
by the atypical litigant who has demonstrated that he is not entitled to the relief available to
the typical debtor. On the contrary, the broad authority granted to bankruptcy judges to take
any action that is necessary or appropriate “to prevent an abuse of process” described in
Dismissal
The court may dismiss a Chapter 7 case for cause after notice and a hearing.
In a case &led by an individual debtor whose debts are primarily consumer
debts, the court may dismiss a case or, with the debtor’s consent, convert
the case to one under Chapter 11 or 13, if the court &nds that granting relief
would be an abuse of the provisions of Chapter 7.
Under the means test abuse is presumed (i.e., the debtor is not eligible for
Chapter 7 unless the debtor can prove special circumstances) for an
individual debtor whose net current monthly income is greater than the State
707.
Distribution of the Estate
Assets of the estate are distributed in the following order:
1. Secured creditors, on their security interests.
2. Creditors entitled to a priority, in the order provided.
3. Unsecured creditors who &led their claims on time (or tardily, if they
did not have notice or actual knowledge of the bankruptcy.)
4. Unsecured creditors who &led their claims late.
5. Claims for &nes and multiple, exemplary, or punitive damages.
6. Interest at the legal rate from the date of the &ling of the petition, to
all of the above claimants.
7. Whatever property remains, to the debtor.
NOTE: See Figure 38-1: Collection and Distribution of the Debtor’s Estate.
Discharge
Following distribution of the estate a debtor may receive a discharge except
where the debtor: (1) is not an individual; (2) has destroyed, falsi&ed,
concealed, or failed to keep records; (3) has knowingly and fraudulently
made a false oath or used a false claim; (4) has transferred, removed,
destroyed, or concealed any of his property with intent to hinder, delay, or
defraud his creditors; (5) has been granted a discharge within the previous
*** Chapter Outcome***
Compare the adjustment of debt proceedings under Chapters 11 and 13.
D. REORGANIZATION — CHAPTER 11
As an alternative to liquidation, Chapter 11 allows the development of an
equitable and feasible plan of reorganization to allow a business to continue
operation and to keep possession of its business assets. Reorganization is
the process of correcting or eliminating the factors that caused the distress
of a business enterprise and thereby preserving its value.
Chapter 11 permits but does not require a sale of assets. Rather, it
contemplates that the debtor will keep its assets and use them to generate
&led by a small business. The amendments de&ne small business to include
(1) persons engaged in commercial or business activities whose aggregate,
noncontingent, liquidated debts do not exceed $2,490,925 (subject to
periodic adjustments for inflation); and (2) for a case in which the United
States trustee has not appointed a committee of unsecured creditors, or
where the court has determined that the committee of unsecured creditors is
not su?ciently active and representative to provide effective oversight of the
debtor. Under a small business case the U.S. trustee has additional oversight
duties, the debtor has additional reporting requirements, while the plan
process can be simpler and the time periods and deadlines are di0erent.
Proceedings
Any debtor eligible for Chapter 7 (excluding stockbrokers, commodity
brokers), PLUS railroads are eligible for an involuntary or voluntary Chapter
11 petition. Although the debtor will remain in possession of the property
and continue to manage the business, a committee of unsecured creditors
will be appointed to assist during the reorganization process.
The court may order for cause the appointment of a trustee who is elected
Plan of Reorganization
For 120 days after the order for relief, the debtor has the exclusive right to
&le a plan unless a trustee has been appointed. The plan must divide all
creditor claims into classes, explain how each will be handled, and be
approved by the court.
Acceptance of Plan
To be accepted, each class of claims must approve the plan by creditors that
hold at least two-thirds in amount and more than one-half of the allowed
claims of such class that actually voted on the plan. A class of interests
must be approved by holders of at least two-thirds in amount of the allowed
interests of such class that actually voted on the plan.
Effect of Confirmation
The con&rmed plan binds the debtor and any creditor, equity security holder,
or general partner of the debtor and discharges the debtor from all prior
debts and liabilities, except as otherwise provided. It does not discharge an
individual debtor from debts that are not dischargeable.
