Chapter 15
BANKRUPTCY
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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
Chapter Overview
Chapter Theme
As in many areas of law, bankruptcy law must balance competing interests – in this case, the interests of
Quote of the Day
“One could always begin again in America, even again and again. Bankruptcy, which in the fixed society
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 5 are administrative rules that generally apply to all types of bankruptcy
Chapter 7 Liquidation
Filing a Petition
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
Automatic Stay
An automatic stay prohibits creditors from independently collecting debts that the debtor incurred before
2 Unit 2 Contracts and the UCC
creditors’ claims and obtain breathing room can be a powerful incentive for a struggling business to file
for bankruptcy.
Case: Jackson v. Holiday Furniture
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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
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
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
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309 B.R. 33; 2004 Bankr. LEXIS 548 United States Bankruptcy Court for the Western District of Missouri, 2004
Chapter 15 Bankruptcy 3
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?
Question: The court awarded punitive damages to Jackson—would a court do that anytime a creditor
violates the automatic stay?
Dan Holiday a lesson.
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?
Exempt Property
To save individual (not business) debtors from destitution, the Code permits them to keep some property.
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
4 Unit 2 Contracts and the UCC
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.
Payment of Claims
Claims are paid in the following order:
• Secured Claims
• 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:
• 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
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
Question: Do students agree with these priorities?
Answer: Students sometimes comment on the fact that fees of lawyers and accountants are at the top
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
Chapter 15 Bankruptcy 5
• 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 declaring
Case: In re Stern
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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
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
[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.
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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
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: Do you feel sorry for Stern?
Question: How long would it take him to repay his loans?
afford that. His income is only $2,000 a month and his expenses are $2,100.
Question: Are these troubles all his fault?
Answer: Not really. He couldn’t find a job when he graduated from law school. His practice
Question: Then why won’t the court permit him to discharge his student loans?
Answer: Although Stern could not find a job as a lawyer, he should have found employment
Question: What is the moral of this case?
Answer: Student loans are a serious obligation. If borrowers don’t repay their loans, then lenders
Reaffirmation
Sometimes debtors are willing to reaffirm a debt, meaning they promise to pay even after discharge.
Case: In re Grisham
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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
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436 B.R. 896; 2010 Bankr. LEXIS 2907 US BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF TEXAS, 2010
Chapter 15 Bankruptcy 7
$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
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
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
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
Question: Did the court agree to the reaffirmation?
Answer: No; the court said this would hinder the debtor’s “fresh start.”
Question: Is the debtor’s truck going to be reposed?
Question: What might be the debtor’s reason for the reaffirmation?
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Additional Case: In re: John & Julie Hoffman
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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–
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
continue to make voluntary payments.
Question: What is a co-signer?
Answer: A co-signer is a person who signs a loan with another, often assuming obligations and
Question: What debt did the Hoffmans want to reaffirm?
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?
Answer: Reaffirmation means that a debtor, here the Hoffmans, is willing to promise to pay back
a debt, even after discharge.
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
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358 B.R. 839; 2006 Bankr. LEXIS 3841, United States Bankruptcy Court for the Western District of Virginia,
2006.
Chapter 15 Bankruptcy 9
Chapter 11 Reorganization
For a business, the goal of a Chapter 7 bankruptcy is euthanasia—putting it out of its misery by shutting it
down and distributing its assets to creditors. Chapter 11 has a much more complicated and ambitious
customers, creditors, shareholders, and the community.
Case: In re Fox
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Facts: Unable to pay a $2 million fraud judgment owed to United Phosphorus, Ltd., Donald Fox filed a
voluntary petition under Chapter 11 of the Bankruptcy Code. His plan of reorganization envisioned that
he would use revenues from his company, Midland Fumigant, Inc., to pay off his creditors in full over
five years, with interest. CPA Kirk W. Wiesner testified that the plan’s projections were conservative and
could easily be met.
Midland had six classes of creditors. All of the classes accepted the plan, except the two classes in
which United was a member. The bankruptcy judge noted that United had an incentive to oppose
operations, United would be able to raise its prices substantially.
Issues: Was Fox’s plan of reorganization feasible and fair? Should the court impose a cramdown?
Excerpts from Judge Robinson’s Decision: Debtor has proposed a plan which pays all creditors in full,
with interest. United, the only objecting creditor, will be paid in full [within 16 months]. Debtor has
provided a reasonable and orderly repayment of his debts. Debtor’s desire and intent to provide a
mechanism for him to retain his business interests and assets is consistent with the purposes of the
Bankruptcy Code. The plan may satisfy [the Code] even though the plan may not be one which the
creditors would themselves design.
Will the reorganized debtor emerge from bankruptcy solvent and with a reasonable prospect of
success? Debtor’s expert, Kirk Wiesner, analyzed Midland’s financial statements, and determined that
contemplated.
The Plan has a reasonable assurance of success and is not likely to be followed by liquidation, or the
need for further financial reorganization. As such, the Debtor’s Plan meets the feasibility requirement.
The Court further notes that the United States Trustee has filed a statement in support of confirmation of
the Plan.
[T]he Court finds that the Debtor’s Plan is fair and equitable and, as a result, the fact that [two]
Question: Two out of six classes of creditors opposed Midland’s plan yet the court imposed a
cramdown. Is this fair?
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2000 Bankr. LEXIS 1713 United States Bankruptcy Court, District of Kansas, 2000
10 Unit 2 Contracts and the UCC
Answer: Bankruptcy courts certainly listen to any objections that creditors offer to a plan. However,
Question: What was United’s conflict of interest?
prices.
Question: Under what circumstances will a court accept a creditor’s objections and refuse to impose
a cramdown?
Answer: If the plan seems to be promising creditors and shareholders more than the debtor can
Chapter 13 Consumer Reorganizations
The purpose of Chapter 13 is to rehabilitate an individual debtor. It is not available at all to
Requirement of Good Faith
Under Chapter 13, the consumer files a plan of reorganization that must be approved by the court. The
court cannot confirm a plan unless the debtor is acting in good faith and making a reasonable effort to pay
obligations.
You Be the Judge: Marrama v. Citizens Bank of Massachusetts
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Facts: Robert Marrama lied on his Chapter 7 bankruptcy petition. Although he disclosed that he was the
sole beneficiary of a trust that owned a house in Maine, he listed its value as zero. Marrama also denied
that he had transferred any property during the prior year. In fact, the Maine property was valuable, and
Once Marrama found out that the bankruptcy trustees were going after the Maine property, he filed a
notice to convert his Chapter 7 bankruptcy to Chapter 13. The trustees and creditors objected. They
contended that because Marrama had acted in bad faith when he tried to conceal the Maine property, he
should not be permitted to convert. The bankruptcy court agreed. The Supreme Court grated certiorari.
You Be The Judge: Can a bankruptcy court refuse to allow a debtor to convert from Chapter 7 to Chapter
13?
Argument for Marrama: Under the Bankruptcy Code, a Chapter 7 debtor may convert a case, with
only two restrictions. First, the bankrupt can convert only once. Second, the debtor must meet the
the law, whether the Court likes it or not.
Argument for the Bankruptcy Trustee: A bankruptcy court has the unquestioned right to dismiss a
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127 S.Ct. 1105, 2007 LEXIS U.S. 2651, Supreme Court of the United States, 2007.
Chapter 15 Bankruptcy 11
Chapter 13. That individual is not a member of the class of honest but unfortunate debtors whom the
bankruptcy laws were enacted to protect.
Holding: The Supreme Court held 5-4 that the bankruptcy court had the right to prohibit the conversion.
The arguments laid out in the book reflect the opinions of Justice Stevens for the majority and Justice
Alito for the dissent (Scalia, Roberts, Thomas).
Question: Why would a debtor be allowed to discharge debts under Chapter 13 that he is not able to
discharge under Chapter 7?
Multiple Choice Questions
1. CPA QUESTION A voluntary petition filed under the liquidation provisions of Chapter 7 of the
federal Bankruptcy Code:
(a) is not available to a corporation unless it has previously filed a petition under the reorganization
provisions of Chapter 11 of the Code
(b) automatically stays collection actions against the debtor except by secured creditors
(c) will be dismissed unless the debtor has 12 or more unsecured creditors whose claims total at least
$5,000
(d) does not require the debtor to show that the debtor’s liabilities exceed the fair market value of
assets
2. CPA QUESTION Decal Corp. incurred substantial operating losses for the past three years. Unable
to meet its current obligations, Decal filed a petition of reorganization under Chapter 11 of the federal
Bankruptcy Code. Which of the following statements is correct?
(a) A creditors’ committee, if appointed, will consist of unsecured creditors.
(b) The court must appoint a trustee to manage Decal’s affairs.
(c) Decal may continue in business only with the approval of a trustee.
(d) The creditors’ committee must select a trustee to manage Decal’s affairs.
3. CPA QUESTION Unger owes a total of $150,000 to eight unsecured creditors and one fully secured
creditor. Quincy is one of the unsecured creditors and is owed $32,000. Quincy has filed a petition
against Unger under the liquidation provisions of Chapter 7 of the federal Bankruptcy Code. Unger
has been unable to pay debts as they become due. Unger’s liabilities exceed Unger’s assets. Unger
has filed papers opposing the bankruptcy petition. Which of the following statements regarding
Quincy’s petition is correct?
(a) It will be dismissed because the secured creditor failed to join in the filing of the petition.
(b) It will be dismissed because three unsecured creditors must join in the filing of the petition.
(c) It will be granted because Unger’s liabilities exceed Unger’s assets.
(d) It will be granted because Unger is unable to pay Unger’s debts as they become due.
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4. Dale is in bankruptcy proceedings under Chapter 13. Which of the following statements is true?
(a) His debtors must have filed an involuntary petition.
(b) His unsecured creditors will be worse off than if he had filed under Chapter 7.
(c) All of his debts are discharged as soon as the court approves his plan.
(d) His creditors have an opportunity to voice objections to his plan.
5. Grass Co. is in bankruptcy proceedings under Chapter 11, _____________ serves as trustee. In the case
of _____________ the court can approve a plan of reorganization over the objections of the creditors.
(a) the debtor in possession; a cramdown
(b) a person appointed by the U.S. Trustee; fraud
(c) the head of the creditors’ committee; reaffirmation
(d) the U.S. Trustee; voidable preference
Essay Questions
1. James, the owner of an auto parts store, told his employee, Rickey, to clean and paint some tires in the
basement. Highly flammable gasoline fumes accumulated in the poorly ventilated space. James threw
a firecracker into the basement, as a joke, intending only to startle Rickey. Sparks from the firecracker
caused an explosion and fire that severely burned him. He filed a personal injury suit against James
for $1 million. Is this debt dischargeable under Chapter 7?
Answer: Injuries caused by a stupid accident are dischargeable, not those caused intentionally or
2. Mary Price went for a consultation about a surgical procedure to remove abdominal fat. When Robert
Britton met with her, he wore a nametag that identified him as a doctor, and was addressed as
“doctor” by the nurse. Britton then examined Price, touching her stomach and showing her where the
incision would be made. It turned out that Britton was the office manager, not a doctor. Although a
doctor actually performed the surgery on Price, Britton was present. It turned out that the doctor left a
tube in Price’s body at the site of the incision. The area became infected, requiring corrective surgery.
A jury awarded Price $275,000 in damages in a suit against Britton. He subsequently filed a Chapter
7 bankruptcy petition. Is this judgment dischargeable in bankruptcy court?
Chapter 15 Bankruptcy 13
3. You Be the Judge: WRITING PROBLEM Lydia D’Ettore received a degree in computer
programming at the DeVry Institute of Technology, with a grade-point average of 2.51. To finance
her education, she borrowed $20,516.52 from a federal student loan program. After graduation, she
could not find a job in her field, so she went to work as a clerk at an annual salary of $12,500.
D’Ettore and her daughter lived with her parents free of charge. After setting aside $50 a month in
savings and paying bills that included $233 for a new car (a Suzuki Samurai) and $50 for jewelry
from Zales, her disposable income was $125 per month. D’Ettore asked the bankruptcy court to
discharge the debts she owed DeVry for her education. Did the debts to the DeVry Institute impose an
undue hardship on D’Ettore? Argument for D’Ettore: Lydia D’Ettore lives at home with her
parents. Even so, her disposable income is a meager $125 a month. She would have to spend every
single penny of her disposable income for nearly 15 years to pay back her $20,500 debt to DeVry.
That would be an undue hardship. Argument for the Creditors: The U.S. government guaranteed
D’Ettore’s loan. Therefore, if the court discharges it, the American taxpayer will have to pay the bill.
Why should taxpayers subsidize an irresponsible student? D’Ettore must also stop buying new cars
and jewelry. And why should the government pay her debts while she saves money every month?
4. Dr. Ibrahim Khan caused an automobile accident in which a fellow physician, Dolly Yusufji, became
a quadriplegic. Khan signed a contract for the lifetime support of Yusufji. When he refused to make
payments under the contract, she sued him and obtained a judgment for $1,205,400. Khan filed a
Chapter 11 petition. At the time of the bankruptcy hearing, five years after the accident, Khan had not
paid Yusufji anything. She was dependent on a motorized wheelchair; he drove a Rolls-Royce. Is
Khan’s debt dischargeable under Chapter 11?
Answer: The court would not permit this debt to be discharged because Dr. Khan was not acting in
5. After filing for bankruptcy, Yvonne Brown sought permission of the court to reaffirm a $6,000 debt
to her credit union. The debt was unsecured and she was under no obligation to pay it. The credit
union had published the following notice in its newsletter:
If you are thinking about filing bankruptcy, THINK about the long-term implications. This action,
filing bankruptcy, closes the door on TOMORROW. Having no credit means no ability to purchase
cars, houses, credit cards. Look into the future—no loans for the education of your children.
Should the court approve Brown’s reaffirmation?
Answer: The court refused to approve the reaffirmation because the credit union’s threats constituted
Discussion Questions
1. ETHICS On November 5, Hawes, Inc., a small subcontractor, opened an account with Basic Corp., a
supplier of construction materials. Hawes promised to pay its bills within 30 days of purchase.
Although Hawes purchased a substantial quantity of goods on credit from Basic, it made few
payments on the accounts until the following March when it paid Basic over $21,000. On May 14,
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Hawes filed a voluntary petition under Chapter 7. Does the bankruptcy trustee have a right to recover
this payment? Is it fair to Hawes’s other creditors if Basic is allowed to keep the $21,000 payment?
Answer: The bankruptcy court ruled that this payment was a voidable preference. It was not made in
2. Look on the web for your state’s rules on exempt property. Compared with other states and the
federal government, is your state generous or stingy with exemptions? In considering a new
bankruptcy statute, Congress struggled mightily over whether or not to permit state exemptions at all.
Is it fair for exemptions to vary by state? Why should someone in one state fare better than his her
neighbor across the state line?
3. Some states permit debtors an unlimited exemption on their homes. Is it fair for bankrupts to be
allowed to keep multimillion dollar homes, while their creditors remain unpaid? But other states
allow as little as $5,000. Should bankrupts be thrown out on the street? What amount is fair?
4. What about the rules regarding repeated bankruptcy filings? Debtors cannot obtain a discharge under
Chapter 7 within eight years of a prior filing. Under Chapter 13, no discharge is available within four
years of a prior chapter 7 or 11 filing and within two years of a prior Chapter 13 filing. Are these
rules too onerous, too lenient or just right?
5. A bankrupt who owns a house has the option of either paying the mortgage or losing his home. The
only advantage of bankruptcy is that his debt to the bank is discharged. The U.S. House of
Representatives passed a bill permitting a bankruptcy judge to adjust the terms of mortgages to aid
debtors in holding on to their houses. Proponents argued that this change in the law would reduce
foreclosures and stabilize the national housing market. Opponents said that it was not fair to reward
homeowners for being irresponsible. How would you vote if you were in the Senate?
6. In the Grisham case, the debtor had virtually no income but owed about $200,000 in debts that could
not be discharged. What kind of fresh start is that? Should limits be placed on the total debt that
cannot be discharged? Is the list of non-dischargeable debts appropriate?