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Chapter 31
Bankruptcy Law
INTRODUCTION
Bankruptcy law is designed to accomplish two main goals: to provide relief and protection to debtors who have
“gotten in over their heads” and to provide a fair means of distributing a debtor’s assets among creditors. Thus, the
law attempts to protect the rights of debtor and creditor, with an emphasis on requiring debtors to pay as many of their
debts as they can.
ADDITIONAL BACKGROUND—
Bankruptcy—A Creditor’s Remedy?
Originally, bankruptcy represented a creditor’s remedy, not debtor’s relief. In Great Britain, in the
sixteenth century, creditors used the bankruptcy laws to obtain all of the property of a merchant behind in the
payment of debts. At the time, only merchants were subject to the bankruptcy laws. Creditors could seize a
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CHAPTER OUTLINE
I. The Bankruptcy Code
The U.S. Constitution gave Congress the power to establish “uniform laws on the subject of bankruptcies
throughout the United States.” Federal bankruptcy laws (as amended most recently in the 2005 Bankruptcy
Reform Act) are called the Bankruptcy Code or the Code.
ADDITIONAL BACKGROUND—
Bankruptcy Abuse and Consumer Protection Act (BACPA) of 2005
The most significant changes to bankruptcy law in nearly thirty years occurred in 2005, with the
enactment of the Bankruptcy Abuse and Consumer Protection Act (BACPA) of 2005.
For individual debtors, key changes from previous law included—
• Debtors’ attorneys may be liable for inaccurate, incomplete, or other erroneous information in
documents filed with the court.
• Creditors can review a debtor’s federal tax filings, to compare them against court-filed documents and
to challenge discrepancies.
• Creditors who have not been properly notified of a bankruptcy filing may be able to foreclose on a
fines and victim restitution, and civil liability for willful and malicious injury or death.
• Under Chapter 13, the entire amount of a secured claim, such as a car loan, must be repaid (instead
of, for example, reducing the amount to o current value).
• Spousal and child support debts have top priority (except for a trustee’s expenses). The automatic
stay can be lifted to collect child support debts.
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on attempts to defraud creditors or avoid crime-related or tort-based liability.
• Protection was extended on retirement and college-savings plans (see an ADDITIONAL BACKGROUND
elsewhere in this chapter).
For small-business debtors, key changes from previous law included—
• Small-business debtors are those with $2 million or less in debt on the date they file for bankruptcy.
• A U.S. Trustee can inspect the premises and the books of a small-business debtor.
• Small-business debtors must include copies of balance sheets, income statements, cash-flow
statements, federal tax returns, and other documents with their bankruptcy petitions. Such debtors must
also file periodic financial reports with information on profitability and cash receipts. Forms that debtors
must submit to creditors before their approval of a Chapter 11 plan or reorganization were simplified.
A. GOALS OF BANKRUPTCY LAW
Bankruptcy law has two main goals—
• To protect a debtor by giving him or her a fresh start without creditors’ claims.
• To ensure equitable treatment of creditors competing for a debtor’s assets.
B. BANKRUPTCY COURTS
ENHANCING YOUR LECTURE—
LIVE CHATTING WITH
YOUR STATE’S BANKRUPTCY COURT
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Chatting on social media has become a way of life for most younger people in this country and
elsewhere. Online chats preceded social media and are still used at retail Web sites. Today, some tech-savvy
employees at bankruptcy courts are using the retail online chat model to answer questions about bankruptcy.
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ARIZONA WAS FIRST TO USE LIVE CHATS
The U.S. Bankruptcy Court for the District of Arizona started live chatting several years ago. It added live
chat to its Web site as part of a strategic initiative to educate the public about bankruptcy. Rather than leaving
WHO USES BANKRUPTCY COURT CHAT ROOMS?
At first, only individuals interested in filing for bankruptcy without an attorney used the live chat services.
When paralegals learned that they could get quick answers to their questions online, they also began to use
the services.
Then, during the real estate meltdown, many real estate lawyers expanded into the area of bankruptcy
also have used live chat to expand their knowledge of bankruptcy law.
THE COURTS AND FACEBOOK
In this age of expanding social media, many courts have created their own Facebook pages.
For example, the Supreme Court, Superior Court, and Tax Court have a Facebook page that covers
all three courts.
Increasingly bankruptcy courts are posting announcements on their Facebook pages. Anyone who has
CRITICAL THINKING
Are there any downsides to live chats with bankruptcy courts? If so, what are they? Inexperienced
C. TYPES OF BANKRUPTCY RELIEF
The Bankruptcy Code is in Title 11 of the U.S.C. and has eight chapters. Chapters 1, 3, and 5 include
definitions and provisions governing case administration, creditors, debtors, and estates.
• Chapter 7 provides for liquidation.
• Chapter 9 governs the adjustment of municipal debts.
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D. SPECIAL REQUIREMENTS OF CONSUMER DEBTORS
II. Liquidation Proceedings
In a Chapter 7 liquidation (an ordinary or “straight” bankruptcy), a debtor states his or her debts and turns his
or her assets over to a trustee, who sells nonexempt assets and distributes the proceeds to creditors. With
exceptions, the rest of the debts are discharged.
A. VOLUNTARY BANKRUPTCY
Within 180 days of receiving credit counseling from an approved nonprofit agency, a debtor can file a
ADDITIONAL BACKGROUND—
Voluntary Bankruptcy Information
In the case from which the following is excerpted, In re Riddle, 344 Bankr.702 (S.D. Fla. 2006), the court
held that the information provided by the debtors was complete and, thus their case was not subject to
automatic dismissal under the BAPCPA.
SUA SPONTE ORDER DETERMINING DEBTORS’ COMPLIANCE WITH FILING REQUIREMENTS OF
SECTION 521(a)(1)
A. JAY CRISTOL, Chief Judge.
Pursuant to 11 U.S.C. § 521(i), if an individual debtor in a voluntary case under Chapter 7 or 13 fails to
file all of the information required under 11 U.S.C. § 521(a)(1) within 45 days after the date of the filing of the
petition, the case shall be “automatically dismissed” effective on the 46th day after the date of the filing of the
petition.
The Court has reviewed the docket and the papers filed by debtors in this case and believes the
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what the docket does not show?
What is the clue on the 46th day?
Is the case still here, or gone away?
And if a debtor did not do
what the Code had told him to
and no concerned party knew it,
Still the Code says the debtor blew it.
Well that is what it seems to say:
the debtor’s case is then “ Oy vay! ”
This kind of law is symptomatic
of something very problematic.
For if the Trustee does not know
then which way should the trustee go?
Should the trustee’s view prismatic
continue to search the debtor’s attic
and collect debtors’ assets in his fist
for distribution in a case that stands
After a dismissal automatic
would this not be a bit erratic?
The poor trustee cannot know
the docket does not dismissal show.
What’s a poor trustee to do—
except perhaps to say, “Boo hoo!”
And if the case goes on as normal
and debtor gets a discharge formal,
what if a year later some fanatic
claims the case was dismissed automatic?
Was there a case, or wasn’t there one?
How do you undo what’s been done?
Debtor’s property is gone as if by a thief,
and Debtor is stripped but gets no relief.
I do not like dismissal automatic.
On this point I am emphatic!
I do not wish to be dramatic,
but I can not endure this static.
Dismissal automatic is not understood.
Something more in 521 is needed
for dismissal automatic to be heeded.
For all concerned this is not good.
Before this problem gets too old
it would be good if we were told:
What does automatic dismissal mean?
And by what means can it been seen?
Are we only left to guess?
Oh please Congress, fix this mess!
Until it’s fixed what should I do?
How can I explain this mess to you?
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If the Code required an old fashioned order,
that would create a legal border,
with complying debtors’ cases defended
and 521 violators’ cases ended,
from the unknown status of dismissal automatic,
The dismissal automatic problem would be gone,
and debtors, trustees and courts could move on.
As to this case, how should I proceed?
Review of the record is warranted, indeed.
A very careful record review,
tells this Court what it should do.
Was this case dismissed automatic?
It definitely was NOT and that’s emphatic.
Based upon the Court’s review, the Court has determined that the debtors have complied with the
information requirements of 11 U.S.C. § 521(a)(1).
Accordingly, it is ORDERED:
1. This case is not subject to automatic dismissal under 11 U.S.C. § 521(i)(1) or (2).
Trustee, debtors and debtors’ counsel, if any. The motion should specifically identify the information and
document(s) required by 11 U.S.C. § 521(a)(1) that the debtors have failed to file.
2. If any party in interest has any reason to contest the Court’s finding that the debtors have filed all
information required by 11 U.S.C. § 521(a)(1), that party shall file a motion for reconsideration not later than
1. Chapter 7 Schedules
A voluntary petition must contain—
• A schedule of secured and unsecured creditors and what is owed to each.
• A statement of the debtor’s financial affairs.
• A list of the debtor’s property.
• A statement of the debtor’s current income and expenses.
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2. Tax Returns during Bankruptcy
A tax return must be filed each year while a case is pending, with a copy provided to the court.
3. Substantial Abuse—Means Test
A grant of relief cannot be “substantial abuse” of Chapter 7.
a. The Basic Formula
If a debtor’s family income is more than the median family income in the state in which the
petition is filed, the petition may be dismissed on a presumption of abuse.
b. Applying the Means Test to Future Disposable Income
c. Can the Debtor Afford to Pay Unsecured Debts?
4. Additional Grounds for Dismissal
5. Order for Relief
The filling of the petition constitutes an order for relief (a discharge of debts). Creditors must be
notified within twenty days.
B. INVOLUNTARY BANKRUPTCY
Creditors can force debtors (not farmers or charitable institutions) into involuntary bankruptcy.
1. Requirements
For an involuntary action to be filed—
2. Order for Relief
If the debtor challenges the petition, the court will enter an order for relief if it finds—
• The debtor is not paying debts as they become due.
C. AUTOMATIC STAY
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The automatic stay protects a debtor’s property from creditors’ actions. A creditor’s willful violation of the
stay may entitle a party to recover compensatory and punitive damages, costs, and attorneys’ fees.
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1. The Adequate Protection Doctrine
Secured creditors can ask the court to protect them from losing the value of their security as a
result of the stay. Debtors can be required to make cash [payments or provide additional collateral
to offset any loss in value.
ADDITIONAL BACKGROUND—
Adequate Protection under Chapters 7, 11, and 13
A secured creditor is protected from losing his or her security as a result of the automatic stay by a
concept known as adequate protection. The following is the text of 11 U.S.C. Section 361, a section of the
Bankruptcy Code providing for adequate protection under Chapters 7, 11, and 13 (for adequate protection
rules that apply in Chapter 12 cases, see the ADDITIONAL BACKGROUND accompanying the section on Chapter
12 below).
TITLE 11. BANKRUPTCY
CHAPTER 3—CASE ADMINISTRATION
SUBCHAPTER IV—ADMINISTRATIVE POWERS
§ 361. Adequate protection
When adequate protection is required under section 362, 363, or 364 of this title of an interest of an entity in
property, such adequate protection may be provided by—
(3) granting such other relief, other than entitling such entity to compensation allowable under section
503(b)(1) of this title as an administrative expense, as will result in the realization by such entity of the
indubitable equivalent of such entity’s interest in such property.
2. Exceptions to the Automatic Stay
3. Requests for Relief from the Automatic Stay
A creditor may be granted relief from the stay sixty days after requesting it.
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a. Secured Property
A stay on a secured debt may be lifted forty–five days after the first creditors’ meeting unless
the debtor reaffirms the debt.
b. Bad Faith
D. ESTATE IN BANKRUPTCY
Commencement of a Chapter 7 proceeding creates an estate in property, which consists of all the
debtor’s legal and equitable interests in property before the filing of the petition.
E. THE BANKRUPTCY TRUSTEE
A trustee’s principal duty is to collect and reduce to money the property of the debtor’s estate and to
close up the estate as fast as is compatible with the parties’ best interests.
1. Duties for Means Testing
Within ten days of the first creditors’ meeting, the trustee must review the debtor’s filing and
2. The Trustee’s Powers
• Right to possession—The trustee has a right to possession of the debtor’s property and can
require persons holding a debtor’s property when a petition is filed to give the property to the
trustee.
3. Voidable Rights
A trustee can use any ground—including fraud, duress, incapacity, and mutual mistake—that a
debtor can use to obtain return of the debtor’s property.
4. Preferences
A trustee can recover a debtor’s payment or transfer of property made to a creditor within ninety
days before the petition in preference to others.
a. Preferences to Insiders
b. Transfers That Do Not Constitute a Preferences
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certain amount without it constituting a preference. Domestic-support debts and transfers
under a credit-counseling service’s negotiated schedule are excepted.
5. Fraudulent Transfers
A trustee may avoid fraudulent transfers made within two years of the filing of the petition or made
F. EXEMPTIONS
A debtor can exempt certain property from bankruptcy, choosing between exemptions provided under
state law and federal law. (States may bar the use of federal exemptions.) The Bankruptcy Code’s
exemptions include-
1. Federal Exemptions
• Up to a certain amount (specific amounts are stated in the text) in equity in the debtor’s
residence and burial plot.
• Interest in a motor vehicle up to a certain amount.
ADDITIONAL BACKGROUND—
Exemption for Retirement and College Savings
According to a decision of the United States Supreme Court, individual retirement accounts (IRAs) could
not be seized during bankruptcy.a The Court explained that the IRAs were protected under 11 U.S.C. Section
522(d)(10)(E), which exempted “payment under a stock plan, pension, profit sharing, annuity, or similar plan
or contract on account of . . . age.” The Court reasoned that a right to payment from an IRA “is casually
connected to . . . age” and IRAs “provide income that substitutes for wages earned as salary or hourly
compensation.” Left open were questions concerning the amount of the assets that were exempt and whether
Roth IRAs—a specific type of IRA—were also covered.
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college at current prices. A certain amount can be deposited in a Coverdell account each year, with
withdrawals tax-free to pay for education. Not exempt under BACPA, however, are contributions to college-
2. State Exemptions
To claim a state’s homestead exemption, the debtor must have lived in the state for two years be-
fore filing the petition.
3. Limitations on th4 Homestead Exemption
Certain other residency and dollar limits may apply. Home equity may not be protected if a debt
arose from a crime or tort indicating substantial abuse.
G. CREDITORS’ MEETING
The U.S. trustee calls the creditors’ meeting within twenty and forty days of the petition. The debtor must
attend (unless excused by the court) and submit to examination under oath. At the meeting, the trustee
H. CREDITORS’ CLAIMS
Normally, creditors must file proof of their claims within ninety days of the meeting. In a disputed or
unliquidated claim, the court sets the value. Any creditor’s claim is allowed automatically unless
I. DISTRIBUTION OF PROPERTY
1. Distribution to Secured Creditors
If collateral is surrendered, a secured party can accept it in full satisfaction of the debt or sell it,
apply the proceeds to the debt, and become an unsecured creditor for the difference.
CASE SYNOPSIS—
Case 31.1: In re Anderson
Henry Anderson filed a voluntary petition in a federal bankruptcy court for relief under Chapter 11 of the
Bankruptcy Code. The U.S. Department of the Treasury, through the Internal Revenue Service (IRS), filed a
proof of claim against the bankruptcy estate for $997,551.80, of which $987,082.88 was secured by
Anderson’s property. Stubbs & Perdue, P.A., served as his counsel. During the proceedings, the court
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Notes and Questions
Should federal and state statutes list in detail which debts take priority for discharge, payment,
and exemption under the Bankruptcy Code? Or should debtors, creditors, trustees, and judges be
given more discretion to debate and determine the priority in individual cases? Why?
2. Distribution to Unsecured Creditors
There is an order in which unsecured debts are paid. Each class must be paid before the next
class. If proceeds are insufficient to pay all creditors in a class, payment is proportional, and
classes lower in priority receive nothing. Any amount remaining goes to the debtor. The order of
priority is—
• Claims for domestic-support obligations.
• Administrative expenses.
• In an involuntary bankruptcy, expenses incurred in the ordinary course of business.
J. DISCHARGE
1. Exceptions to Discharge
The most important claims not dischargeable under Chapter 7 include the following—
• Claims for back taxes accruing within two years prior to bankruptcy.
• Claims for amounts borrowed r to pay federal, or any non-dischargeable, taxes.
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2. Objections to Discharge
The following circumstances (relating to the debtor’s conduct and not to the debt) will cause a
discharge to be denied—
• The debtor’s concealment or destruction of property with the intent to hinder, delay, or defraud
a creditor.
• The debtor’s fraudulent concealment or destruction of records, or failure to keep adequate
records, of his or her financial condition.
CASE SYNOPSIS—
Case 31.2: In re Cummings
Clarence and Pamela Cummings filed a petition for a Chapter 7 bankruptcy in a federal bankruptcy court.
After the Cummings filed two amended versions of the required schedules, the trustee asked for additional
time to investigate. The court granted the request. The Cummings then filed a third amended schedule in
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Notes and Questions
What might the debtors have done to avoid an unfavorable result in this case? The debtors should