30-1 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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6• Introduction to Credit and

Secured Transactions• Security Interests in Personal Property

• Bankruptcy

Credit

PART

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Bankruptcy

PA ET RHC 30Success is not built on success. It's built on failure. It's built on frustration. Sometimes its built on catastrophe.

Sumner RedstoneExecutive Chairman

andFounder of Viacom

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Learning Objectives

• Explain purpose of bankruptcy code and types of bankruptcy proceedings (Chapters 7, 11, 12, 13)

• Describe process by which property in a debtor’s estate is distributed to creditors and the debtor is granted discharge in bankruptcy

• Identify dischargeable debts

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• The federal Bankruptcy Code provides an organized procedure for insolvent debtors and is supervised by a federal court

• Primary proceedings include: 1. Straight bankruptcy (liquidations)2. Reorganizations3. Family farms and commercial fishing

operations4. Consumer debt adjustments

The Bankruptcy Code

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• All bankruptcy proceedings begin by filing a petition, either voluntary or involuntary

– A voluntary petition may be filed by an individual, partnership, or corporate debtor

– An involuntary petition may be filed by creditors of a debtor in an attempt to reach debtor’s assets in lieu of payment on debts

The Bankruptcy Code

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• Filing a bankruptcy petition operates as an automatic stay, halting creditor action against a debtor or property, including:– Beginning or continuing judicial proceedings

against the debtor– Actions to repossess the debtor’s property;– Actions to create, perfect, or enforce a lien

against the debtor’s property; and – Setoff of indebtedness owed to debtor before

commencement of the bankruptcy proceeding

The Automatic Stay

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• Once a bankruptcy petition has been filed, the court must first determine whether relief should be ordered– This step automatic for a voluntary

petition or no-contest of involuntary petition

– If debtor contests involuntary petition, then a trial is held on question of whether court should grant relief.

Order of Relief

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• To participate in the estate of a bankrupt debtor, unsecured creditors must file a proof of claim within a certain time, usually six months after the first meeting of creditors

• Bankruptcy Code declares ten types of claims to have priority over other claims– Priority claims are paid after secured

creditors but before other unsecured creditors are paid

Creditor Claims

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• In a liquidation proceeding (straight bankruptcy), the debtor must disclose all property s/he owns and surrender this bankruptcy estate to a bankruptcy trustee– Trustee segregates property that debtor

may keep and then administers, liquidates, and distributes the remainder of the estate

• Relative rights of creditors established by law

Liquidation (Chapter 7)

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• If debtor transfers property or incurs an obligation with intent to hinder, delay, or defraud creditors, transfer voidable by trustee

• Bankruptcy Code permits court to dismiss cases for abuse of process if debtor acted in bad faith or had present or future means to pay a significant portion of their current debts

Fraud and Abuse

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• A bankrupt person not guilty of dishonest acts and who fulfilled duties as a bankrupt is entitled to a discharge in bankruptcy

• A discharge relieves the bankrupt person of further responsibility for dischargeable debts and gives him a fresh start.

• A corporation or partnership is not eligible for a discharge in bankruptcy

Discharge

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• Chapter 11 offers a procedure in which the debtor’s financial affairs can be reorganized rather than liquidated because creditors would benefit more from the continuation of a bankrupt debtor’s business than from the liquidation of debtor’s property

• Chapter 11 is available to individuals and business enterprises

Chapter 11 Reorganization

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• Rather than liquidating the debtor’s estate, a trustee for a Chapter 11 proceeding develops a plan for handling creditor claims and the various interests of persons such as shareholders

• Reorganization plan is essentially a contract between a debtor and its creditors and may involve recapitalization or giving creditors some equity

Trustee Duties Under Chapter 11

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• Plan must: (1) divide creditors into classes; (2) set forth how each creditor will be satisfied; (3) state which claims, or classes of claims, are impaired or adversely affected by the plan; & (4) provide equal treatment to each creditor in a particular class, unless creditors in the class consent to other treatment

• In re Made In Detroit, Inc. : plan not feasible, therefore court unable to confirm plan

The Bankruptcy Plan

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• A reorganization plan must be confirmed by the court before it becomes effective

• Plans may be confirmed by voluntary agreement of creditors or a cram down: – Court forces dissenting creditors whose

claims would be impaired to accept the plan if the court finds it is fair and equitable to the creditors

• If confirmed, debtor must implement plan

The Bankruptcy Plan

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• Chapter 12 is modeled after Chapter 13 and is available only for family farmers and fishermen with regular income

Chapter 12 Bankruptcy

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• Chapter 13 gives individuals who do not want to be declared bankrupt the right to file a voluntary petition for bankruptcy protection, obtaining the opportunity to pay debts in installments and free of such problems as garnishments and attachments of property by creditors

– Must be an individual with regular incomes owing less than a specific amount of debt

Chapter 13 – Consumer Debt

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• After filing, the debtor submits a plan of payment to secured creditors for acceptance– 3-5 year payment plan

• If acceptable to creditors and the court, the court will approve the plan and appoint a trustee to carry out the plan– In re Burt: unacceptable plan because it

was a “cram-down” of creditor’s secured interest

Chapter 13 – Consumer Debt

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Thought Questions

• Why was the right to file for banruptcy protection incorporated into the U.S. Constitution? What is your opinion of the bankruptcy process?