18 UNIT SIX: CREDITORS’ RIGHTS AND BANKRUPTCY
In any event, it is not likely that the debtors could have successfully avoided disclosing the existence of
A discharged debt is not treated as taxable income. If it were, how would a debtor’s situation be
different? If a discharged debt were treated as taxable income, a debtor would be required to pay income tax
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Exceptions to Discharge
Cases focusing on exceptions to discharge in bankruptcy proceedings include the following.
• In re Roach, __ Bankr. __, 2003 WL 115191 (E.D.La. 2003) (a debtor, a recovering alcoholic whose
earning potential as a nurse was somewhat limited by restrictions placed on her employment as result of her
history of alcoholism, did not show that her present inability, without undue hardship, to repay her student
loan was likely to persist for a significant portion of loan repayment period, and was not be relieved of the
debt).
• In re Murphy, 282 F.3d 868 (5th Cir. 2002) (in holding that all of a debtor’s federally guaranteed student–
K. REAFFIRMATION OF DEBT
1. Procedures
A reaffirmation agreement must be filed with the court before a discharge is granted. Court approval
2. Required Disclosures
CHAPTER 31: BANKRUPTCY LAW 19
Creditors must disclose to the debtor certain information (examples are in the text) to “[b]e sure you
can afford the payments.” A debtor can rescind the agreement any time before discharge or within
sixty days of filing the agreement, whichever is later.
III. Reorganizations
• Corporations commonly use Chapter 11, but any debtor (except a stockbroker or a commodities broker)
eligible for Chapter 7 is eligible for Chapter 11.
A. WORKOUTS
Workouts are sometimes used in place of bankruptcies.
B. BEST INTERESTS OF THE CREDITOR
After notice and a hearing, a court may dismiss a case “for cause.”
C. DEBTOR IN POSSESSION
A debtor generally continues in business as a debtor in possession. The court may appoint a trustee to
operate the business if gross mismanagement is shown or if appointing a trustee is otherwise in the
estate’s best interest.
D. CREDITORS’ COMMITTEES
A committee of unsecured creditors is appointed to consult with the debtor (or the trustee) about
E. THE REORGANIZATION PLAN
1. Filing the Plan
The text sets out the deadlines, purposes, and details of a Chapter 11 plan.
2. Acceptance of the Plan
3. Confirmation of the Plan
For an individual, confirmation requires payment of domestic-support obligations. For a small
4. Discharge
20 UNIT SIX: CREDITORS’ RIGHTS AND BANKRUPTCY
A plan is binding on confirmation. Claims are not discharged if they would be denied in a liquidation
proceeding. An individual debtor is not discharged until a plan’s completion.
ENHANCING YOUR LECTURE—
WHAT CAN YOU DO TO PREPARE
FOR A CHAPTER 11 REORGANIZATION?
Chapter 11 of the Bankruptcy Code expresses the broad public policy of encouraging commerce. To this
end, Chapter 11 allows a financially troubled business firm to petition for reorganization in bankruptcy while it
is still solvent so that the firm’s business can continue. Small businesses, however, do not fare very well
PLAN AHEAD
If you ever are a small-business owner contemplating Chapter 11 reorganization, you can improve your
chances of being among the survivors by planning ahead. To ensure the greatest possibility of success, you
should take action before, not after, entering bankruptcy proceedings. Your first step, of course, should be to
do everything possible to avoid having to resort to Chapter 11. Discuss your financial troubles openly and
cooperatively with creditors to see if you can agree on a workout or some other arrangement.
CONSULT WITH CREDITORS
Most important, you should form a Chapter 11 plan prior to entering bankruptcy proceedings. Consult
with creditors in advance to see what kind of a plan would be acceptable to them, and prepare your plan
accordingly. Having an acceptable plan prepared before you file will expedite the proceedings and thus save
substantially on costs.
CHECKLIST FOR THE SMALL-BUSINESS OWNER
1. Try to negotiate workouts with creditors to avoid costly Chapter 11 proceedings.
3. Consult with creditors in advance, and have an acceptable Chapter 11 plan prepared before filing to
CHAPTER 31: BANKRUPTCY LAW 21
expedite bankruptcy proceedings and save on costs.
IV. Bankruptcy Relief under Chapter 12 and Chapter 13
A. INDIVIDUALS’ REPAYMENT PLANS—CHAPTER 13
Individuals (not partnerships or corporations) with regular income who owe fixed unsecured debts or
fixed secured debts of less than certain statutorily specified amounts may use Chapter 13.
1. Filing the Petition
2. Good Faith Requirement
A debtor must act in good faith at the time of the filing of the plan and the filing of the petition.
CASE SYNOPSIS—
Case 31.3: In re Welsh
David and Sharon Welsh filed a Chapter 13 petition. The bankruptcy trustee objected to the Welshes’
proposed plan on the ground that it was not proposed in good faith because of the “minuscule” payments to
unsecured claims while they were living in a $400,000 home, making payments on various luxury and
……………………….…………………………..………………………………..…………………………………………
Notes and Questions
What Bankruptcy Code requirements were at the center of this case? There were two Bankruptcy
22 UNIT SIX: CREDITORS’ RIGHTS AND BANKRUPTCY
Should a debtor be required to attempt to negotiate a repayment plan with a creditor to show good
3. The Repayment Plan
Only a debtor may file a plan. This plan may provide for the payment of all obligations in full or for
payment of an amount less than 100 percent. The plan must provide for—
• Turnover of the debtor’s future earnings or income to the trustee to execute the plan.
a. Length of the Plan
Subject to the means test for family median income, the time for payment may not exceed
three years unless the court extends it to five years.
b. Confirmation of the Plan
This will occur in a hearing within twenty to forty-five days after the creditors’ meeting if—
• Secured creditors accept it.
• It provides that creditors retain their liens.
• The debtor surrenders property securing the claims to the creditors.
• Creditors with purchase-money security interests in (a) motor vehicles bought within 910
days of a petition retain their liens until they are paid in full and (b) other personal
property bought within one year are covered by the plan.
c. Discharge
Most debts are dischargeable, except—
• Allowed claims not provided for by the plan.
• Certain long-term debts.
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B. FAMILY FARMERS AND FISHERMEN—CHAPTER 12
Chapter 12 is for a family farmer or fisherman, as defined in the Code.
SPECIAL EXHIBIT—
The Bankruptcy Process
The following illustration outlines the basic steps in the bankruptcy process for a non-business debtor.
BANKRUPTCY PETITION—MEANS TEST
• Certain expenses are exempted to determine whether a debtor
can pay 25 percent of unsecured debt.
• Income is compared to debtor’s state’s median to determine
whether a Chapter 7 filing is permissible.
OR
OR
OR
CREDIT-COUNSELING
Debtor must meet with a counselor within six months
before filing for bankruptcy.
CREDITOR-APPROVED
DEBT-MANAGEMENT
PLAN
OR
CHAPTER 31: BANKRUPTCY LAW 25
1. Definitions
• Family farmer—one whose gross income is at least 50 percent farm dependent and whose
debts—which cannot exceed $4,031,575—are at least 50 percent farm-related. This includes
partnerships and close corporations that are at least 50 percent owned by a farm family.
• Family fisherman—one whose gross income is at least 50 percent dependent on commercial
2. Filing the Petition
A Chapter 12 filing is similar to a Chapter 13 filing. The debtor must file a plan not later than ninety
3. Content and Confirmation of the Plan
The content of a plan under Chapter 12 is basically the same as that of a Chapter 13 repayment
ADDITIONAL BACKGROUND—
Adequate Protection under Chapter 12
A secured creditor can petition to lift the automatic stay for adequate protection of his or her interest if
the value of the collateral is less than the amount of the secured debt. The rules pertaining to adequate
protection under Chapter 12 differ from those that apply to proceedings under other chapters. The following
is the text of 11 U.S.C. Section 1205, a section of the Code providing for adequate protection under Chapter
12.
TITLE 11. BANKRUPTCY
CHAPTER 12—ADJUSTMENT OF DEBTS OF A FAMILY FARMER WITH REGULAR ANNUAL INCOME
SUBCHAPTER I—OFFICERS, ADMINISTRATION, AND THE ESTATE
§ 1205. Adequate protection
(a) Section 361 does not apply in a case under this chapter.
(b) In a case under this chapter, when adequate protection is required under section 362, 363, or 364 of this
ownership interest in property;
26 UNIT SIX: CREDITORS’ RIGHTS AND BANKRUPTCY
CHAPTER 31: BANKRUPTCY LAW 27
(2) providing to such entity an additional or replacement lien to the extent that such stay, use, sale, lease, or
grant results in a decrease in the value of property securing a claim or of an entity’s ownership interest in
property;
(Added Pub.L. 99-554, Title II, § 255, Oct. 27, 1986, 100 Stat. 3107.)
REPEAL OF SECTION AND SAVINGS PROVISIONS
< Pub.L. 99-554, Title III, § 302(f), Oct. 27, 1986, 100 Stat. 3124, repealed this section on Oct. 1, 1993, and
all cases commenced or pending under chapter 12 of title 11, United States Code, and all matters and
TEACHING SUGGESTIONS
1. Students might be reminded that the bankruptcy laws offer relief not only to the debtor who has expended
too much credit, but also to the creditor who has extended too much credit.
2. When discussing the differences and similarities among the Code’s chapters, ask students which chapter
3. Students could research their state’s exemptions and compare them to the federal exemptions.
4. One way to outline the trustee’s powers for students is to note that a trustee has general and specific
powers. The general powers inhere in the trustee’s position, which is equivalent in rights to that of certain
5. One detail of the Code that often interests students is the status of student loans. Student loans that are
not dischargeable under Chapter 7 include certain loans due less than five years after the first installment
28 UNIT SIX: CREDITORS’ RIGHTS AND BANKRUPTCY
payment. The five-year period does not include temporary suspensions of payments. Ask students to
imagine that Art borrows $5,000 in September 2006 to finish graduate school. Art graduates in June 2007.
The first installment payment comes due in December, but Art has not found a job and obtains a one-time six-
month suspension of payments. In June 2014, Art files a petition to declare bankruptcy under Chapter 7. If
repaying the loan would constitute undue hardship, is Art’s loan dischargeable? The limitation on
6. From a creditor’s point of view, there are several steps to take to assure the payment of a debt before a
petition in bankruptcy is filed. These include the following.
• Obtain personal and corporate guaranties in credit agreements.
• Obtain collateral for credit.
• Perfect a security interest according to UCC Article 9.
Once a petition has been filed, to try to recoup payment, a creditor might do the following.
• Stop the delivery of goods in transit (see UCC Article 2).
• File a proof of claim.
• Ask the court to lift the automatic stay.
• Object to plans and statements that are not proposed in good faith.
Cyberlaw Link
What role might the Internet play in the context of bankruptcy filings and proceedings?
DISCUSSION QUESTIONS
1. Who can use Chapter 7? Any debtor, which is defined as any “person,” including individuals, partnerships,
2. What powers does a trustee have? A trustee has general and specific powers. The general powers inhere
in the trustee’s position, which is equivalent in rights to that of certain other parties (for example, a lien creditor who
could have levied execution on the debtor’s property—that is, a trustee generally has priority over an unperfected
CHAPTER 31: BANKRUPTCY LAW 29
3. How are secured debts handled in a bankruptcy proceeding? Within thirty days of filing a petition or
before the first creditors’ meeting, whichever is first, a consumer-debtor must file with the clerk of court a statement of
4. What is the essential difference between bankruptcy under Chapter 7 and bankruptcy under Chapter
11? Under Chapter 7, a debtor’s assets are liquidated; under Chapter 11, a debtor’s assets are administered in the
5. What consideration must a debtor give to a collective bargaining agreement in a Chapter 11 filing? A
debtor may reject a collective bargaining agreement, if that would successfully rehabilitate the debtor. Generally, a
6. Who is eligible for relief under Chapter 13? Individuals (not partnerships or corporations) with regular
7. Can a Chapter 13 proceeding be initiated by involuntary petition? No. Only a debtor can initiate a
8. Do the automatic stay rules apply in Chapter 13 cases? The automatic stay rules apply in Chapter 13
9. Who is eligible for relief under Chapter 12? Any family farmer, with gross income at least 50 percent farm
dependent and debts at least 50 percent farm related, or family fisherman, with gross income at least 50 percent
10. Does the 2005 act adequately balances the interests of creditors and debtors? Why or why not?
Possible responses are stated in the lead-in to the questions. The 2005 act may subject many individuals “to
additional financial risk. Supporters of the new law contend that it will curb abuse by deterring financially troubled
30 UNIT SIX: CREDITORS’ RIGHTS AND BANKRUPTCY
ACTIVITY AND RESEARCH ASSIGNMENTS
1. Ask students to imagine that they are filing for bankruptcy. Have them make a list of their assets and a list of
their debts, and determine which assets they could choose to exempt. From a financial point of view, does
declaring bankruptcy appear to be a favorable alternative for them at this time? (The bankruptcy court in your
2. If the bankruptcy court in your district is nearby, tell students to visit the court to see for themselves persons
EXPLANATIONS OF SELECTED FOOTNOTES IN THE TEXT
Footnote 18: Under 11 U.S.C. Section 1112(b), a court may, after notice and a hearing, dismiss a case
under Chapter 11 “for cause.” The statute lists various circumstances that may constitute “cause,” although the “list is
TITLE 11. BANKRUPTCY
CHAPTER 11—REORGANIZATION
SUBCHAPTER I—OFFICERS AND ADMINISTRATION
§ 1112. Conversion or dismissal
* * * *
(b) Except as provided in subsection (c) of this section, on request of a party in interest or the United States
trustee, and after notice and a hearing, the court may convert a case under this chapter to a case under
chapter 7 of this title or may dismiss a case under this chapter, whichever is in the best interest of creditors
and the estate, for cause, including—
(4) failure to propose a plan under section 1121 of this title within any time fixed by the court;
32 UNIT SIX: CREDITORS’ RIGHTS AND BANKRUPTCY
(5) denial of confirmation of every proposed plan and denial of a request made for additional time for filing
another plan or a modification of a plan;
(7) inability to effectuate substantial consummation of a confirmed plan;
(8) material default by the debtor with respect to a confirmed plan;
(9) termination of a plan by reason of the occurrence of a condition specified in the plan; or
(10) nonpayment of any fees or charges required under chapter 123 of title 28.
(c) The court may not convert a case under this chapter to a case under chapter 7 of this title if the debtor is a
farmer or a corporation that is not a moneyed, business, or commercial corporation, unless the debtor
requests such conversion.
Footnote 24: Jason Ransom filed a Chapter 13 petition. Among his assets, he listed a Toyota Camry that
he owned free of any debt. In his monthly expenses for the means test, he claimed a car-ownership deduction of $471
and a separate $388 deduction for car-operating costs. He proposed a five-year plan that would repay about 25
percent of his unsecured debt. FIA Card Services, N.A., an unsecured creditor, objected to the plan, arguing that he
should not have claimed the car-ownership allowance because he did not make payments on his car. The court
issued a decision in FIA’s favor. A Bankruptcy Appellate Panel and the U.S. Court of Appeals for the Ninth Circuit
affirmed. Ransom appealed.
In Ransom v. FIA Card Services, N.A., the United States Supreme Court affirmed. The Bankruptcy Code
limits a debtor’s expense amounts to those that are “applicable,” or appropriate. A deduction is appropriate only if the
Under the decision in this case, how much more was available over the five years of Ransom’s plan to
pay his creditors? The difference over the five years of a repayment plan, under the decision of the Court in the
Should debtors with older vehicles be allowed to take an additional deduction for operating
What argument might be made in favor of allowing a debtor who lives outside an area with mass
transit to claim a deduction in the “Ownership Costs” category for a car that he or she owns free and clear?
In most of the United States, a car is nearly a necessity. An individual who lives outside a large, urban area with mass
CHAPTER 31: BANKRUPTCY LAW 33
Footnote 26: Francisco filed for bankruptcy under Chapter 13. His plan proposed to pay only the principal
on his student loan and to discharge the interest. No party requested an undue hardship hearing. United Student Aid
Funds, Inc. (the creditor), had notice of the plan and did not object. The plan was confirmed. The creditor did not
appeal. Later, United asked the court to order that the confirmation was void. The court refused. On United’s appeal, a
federal district court reversed this ruling. On further appeal, the U.S. Court of Appeals for the Ninth Circuit reversed
the district court’s judgment. United appealed.
In United Student Aid Funds, Inc. v. Espinosa, the United States Supreme Court affirmed. The bankruptcy
court’s confirmation of Espinosa’s plan was valid. “The Bankruptcy Court’s failure to find undue hardship before
confirming Espinosa’s plan was a legal error. But the order remains enforceable and binding on United because
United had notice of the error and failed to object or timely appeal.”
Is a debtor’s failure to make a payment on a student loan or present inability to make payments
A discharged debt is not treated as taxable income. If it were, how would a debtor’s situation be
different? If a discharged debt were treated as taxable income, a debtor would be required to pay income tax on the
At one point, United argued that if the Court failed to declare the bankruptcy court’s order void, it
would encourage dishonest debtors to abuse the Chapter 13 process. How might such abuse occur? Did the
possibility of such abuse affect the Court’s decision? According to United, debtors could file plans proposing to
dispense with the undue hardship requirement in the hope that the bankruptcy court would overlook the proposal and